Transcript Document

NOT AN OFFICIAL UNCTAD RECORD
Using Kyoto
mechanisms for
funding oil and gas
sector projects
Lamon Rutten, Chief,
Finance and Energy
United Nations
Conference on Trade and
Development (UNCTAD)
Overview
The Kyoto Protocols’ Clean Development Mechanism (CDM)
How to generate Certified Emission Reductions (CERs)
What are CERs worth?
Using CERs to leverage access to finance
Concluding remarks
The Kyoto Protocol, once ratified, commits developed country
signatories to reduce greenhouse gas emissions by 5.2%
(compared to their 1990 levels) by 2008-2012.
Article 12 of the Protocol allows developed countries and
countries with economies in transition, so-called Annex I
countries, to meet their greenhouse gas reduction commitments by
engaging in what is called “Clean Development Mechanism
(CDM) projects”.
Annex I countries receive certified emission reduction (CERs)
credits for investing in projects that result in additional reductions
in the emission of greenhouse gases in developing countries.
For this, the reductions must be approved and certified.
Russian ratification has brought the Kyoto Protocol into
force.
Furthermore, a 2004 EU Directive on Greenhouse Gases
Emission Trading will also provide for international trading
in CERs.
Moreover, a number of NGOs and corporates are buying CERs
on a voluntary basis, and there are also a number of
government and investors’ programmes in place (including in
the USA).
So the market is there, and will grow more active.
The greenhouse gases
covered by the Kyoto
Protocol:
CO2: carbon dioxide
CH4: methane
N2O: nitrous oxide
HFCs: hydrofluorocarbons
PFCs: perfluorocarbons
SF6: sulphur hexafluoride
Emission measures are
commonly expressed as « CO2
equivalent ».
The market is largest for
CO2. But there are also
markets for the other
greenhouse gases.
Payments are a function of
the contribution of the gas to
the greenhouse effect. E.g.,
for each ton of methane
emissions reduction, the
price would be 21 times as
high as that for the reduction
of CO2 emissions.
Energy
E.g., reducing gas flaring; making energy generation
more efficient; reducing emissions in energy generation;
improving transport.
Industrial processes Improving efficiency of energy use; reduce
emissions from industrial production.
Solvent use
Waste
Improving agricultural techniques (e.g., less
fertilizer), reducing emissions (e.g., different
irrigation techniques for rice production).
Better handling of waste water; improve efficiency of
waste incarneration.
Land-use change, Afforestation and reforestation (e.g., new
timber plantations); selective harvesting
and forestry
In practice, many of these possibilities have not yet been tested.
For a further discussion
on the Clean Development
Mechanism, see
UNCTAD, 2000.
http://r0.unctad.org/ghg/publications
/cdm-report.pdf
And on the implementation
mechanisms, UNCTAD,
2003
http://r0.unctad.org/ghg/
sitecurrent/download_c/
publications.html
How to generate Certified Emission Reductions (CERs)
The obligations under the Kyoto Protocol are obligations of countries.
Governments « repackage » these obligations, e.g. in developed countries by
forcing specific emission limits onto individual companies.
If these companies produce less emissions than they are allowed to, they can
sell the difference (if they produce more, they pay fines). Also, companies in
both developed and developing countries can develop « autonomous » projects
that reduce emissions, or that sequestrate greenhouse gases; if they meet the
requirements of a specific procedure, they then get CERs.
CERs resulting from CDM investment become assets that can be traded in
emerging carbon markets. But whether CERs (or unused emission permits) can
be sold outside of the country is a sovereign decision – states retain the rights
for international trade.
In principle, there are good possibilities in the oil and gas
sector. E.g.,
- reduce gas flaring (in different ways – re-injection, more
efficient flaring, using the gas for local or international
markets)
- replace a fuel by a cleaner one
- improve energy efficiency in the oil and gas sector
(including in transport)
- reduce emissions (e.g., of sulphur in refineries)
Both direct contributions (e.g., using gas instead of coal) and
indirect ones (bringing the gas to a place where it will be
used to replace a “dirtier” fuel) could generate CERs.
An African gas project that generated carbon credits
CMS
Noble
50%
50%
AMCCO
Government
of Equatorial
Guinea
90% of equity
(US$ 244.4
million)
Guarantee of payment of
interest on the notes
Private placements in two
US$ 125 million issues
US$ 200 million political
risk insurance
Institutional
investors
OPIC
US$ 173 million loan
10% of equity (valued
at US$ 27 million)
AMPCO
20-year
contract for
supply of gas
Alba field
operators
US$ 322.5 million
turnkey contract
Raytheon
The AMPCO
methanol project,
Equatorial Guinea
The US Initiative on Joint
Implementation (USIJI), which
administers the U.S. Government's
process for reviewing and accepting
carbon dioxide emissions
reductions, has determined that the
AMPCO project will lead to a
reduction of a total of 71.27 million
metric tons of carbon dioxide
equivalent during the project's 25year life span
In its projects, the World Bank has found significant
improvements in internal rate of return when including
CER sales:
Procedure to get CERs
The project design originates from the host country, and could be in
1 cooperation with some other entity. Feasibility studies based on the project's
potential and local conditions should be assessed as well as receiving
approval from the host government.
2 Validation by the operational entity can take place where the operational
entity resides. Operational entities can be located anywhere as long as they
qualify. The operational entity passes the validation report on to the
3 Executive Board of the CDM for registration.
The project participants monitor the project according to the approved
4 monitoring plan, which is approved in the validation and registration stages.
The operational entity reviews and audits, including on-site visits, to verify
the GHG reductions. The operational entity then delivers a report to the
5 Executive Board of the CDM certifying the reduction.
6 Based on the certification report, the Executive Board will issue the CERs.
Some operational bottlenecks:
Determining the size of the emission reductions.
Reductions are measured as the difference between emissions
with the project, and a “baseline” of emissions. The baseline
can be difficult to establish. This quantification must be clear,
conservative, and based on “sound science”. Then, this number
is reduced by a certain percentage to account for uncertainties.
CERs are given for a reduction of
emissions compared to a baseline,
not compared to the status quo.
.
Proving “additionality”.
Article 12 of the Kyoto Protocol provides that, in order to be
creditable, emissions reductions must be “additional to any that
would occur in the absence of the certified project activity.” It
was agreed that the CDM authorities implementing this
provision should not adopt any rigid test of additionality, and
thus, additionality should not mean that the project would not be
undertaken without the CER payments. However, additionality
criteria have become more stringent, and this part of the
process is in flux.
Implementation can be difficult, time-consuming
and costly
A major problem: the high costs of the procedures. For large
energy projects, these can approach a million $. For smaller
projects, there are simpler rules; but even then, the average
cost that the World Bank has had were, as of mid-2003, US$
250,000 per project (a transaction cost of some 7%). Part of
the reason for the high costs: limited capacity in developing
countries, and ill-prepared governments.
But: certain investors (e.g., the World Bank) are willing to
cover these costs, to be reimbursed only if the project is
successful, through part of the CERs generated in the project.
Transaction Cost Estimates (source: EcoSecurities), (US $)
A) Up-front (pre-operational) Costs:
ER Feasibility Assessment
Monitoring & Verification Plan
Registration
Validation
Legal Work
Total Up-front Costs:
12,000 - 20,000
5,000 - 20,000
10,000
10,000 -15,000
20,000 – 25,000
57,000 – 90,000
B) Operational Phase Costs:
• Sale of CERs Success fee in region of 5 -10% of CER value.
Higher for a small project than a large project.
• Risk Mitigation 1-3% of CER value yearly. Mitigation against
loss of incremental ER value as a consequence of project risk.
• Monitoring and Verification $3,000 – 15,000 per year
See UNCTAD 2003 (rubber)
How much are CERs worth?
Current market prices are volatile and depend to a considerable extent
on the “quality” of the certificates. Markets are segmented.
2002 prices per ton of CO2:
- Dutch tenders (to buy from developing countries): 4.5-4.6 $ per ton
- UK spot trading: 7-9 $ per ton
- Prototype Carbon Fund buys at 3-4 $ per ton, sells to investors for
5.5 $ per ton.
US$ per
ton of
CO2
Why aren’t CERs worth more?
In the EU, an internal price of US$ 15 per ton of CO2 is
expected. Companies have to pay 40 $ per ton in fines if they
exceed their quota (and after 2007, this will be US$ 100 per ton).
In Japan, the costs of reducing emissions can be as much as 100
US$ a ton.
So, you’d expect firms to scramble to buy CERs, driving up
prices to worldwide equilibrium levels. But this is not
happening, nor will it happen soon.
The reason: market distortions. Markets will remain segmented:
Western governments allow only limited purchases of CERs
outside of the country.
How are prices for CERs determined?
The market is still very segmented, and fungibility of CERs is
limited. Efforts are underway to create trading platforms – e.g.,
the Chicago Climate Exchange starting to trade (auction) CERs in
May 2004, mostly targeting voluntary purchases by US
companies, municipalities etc.
But most of the trade is bilateral; with only a limited part passing
through brokers.
It’s Governments that determine where CERs can come from –
and decisions can be politically-driven. Thus, there are many
segmented markets.
Moreover, NGOs and corporates are often willing to pay more for
CERs that come from attractive projects.
Major buyers of CERs:
• international public/private funds (World Bank’s
Prototype Carbon Fund, Community Development Carbon
Fund, BioCarbon Fund, Netherlands’ Clean Development
Facility)
• Private investment funds )- e.g., a 200 mln $ fund
managed by Natsource.
• NGOs (to take them off the market)
• Corporates who want to « warehouse » CERs for future
use. (« banking »)
Using CERs to leverage access to finance
When CERs are sold to an investor, this is generally under a 7- or
10-year contract. This contract sets out the price to be paid, and
the quantity to be bought. Normally, payment is only on delivery.
However, such contracts are a good underlying for financings
backed by the 7- or 10-year receivables. This can take the form
of prepayments (the financier prepays the CERs to be delivered,
and sells them on to the investor); or pre-finance (the contract is
assigned, and payments are made through an escrow account).
Standard mechanism
Investor
Agreement with
host government
Sales contract for
CERs: sponsor has
to deliver certified
CERs
Fînanciers
Financing
agreement
Host
government
Under Kyoto Protocol,
contracts are for 7 (with
2 possible renewals) or
10 years (no renewal).
Project
sponsor
In principle, the investor could make a prepayment for the
CERs to be produced over the time of the contract.
However, major investors such as the World Bank
currently don’t like these risks, and do not pay CERs
before actual delivery (they already take the risk that
CERs are not accepted by the Executive Board of the CDM
and feel this is enough).
Structured finance banks should feel more comfortable
with a prepayment arrangement - or a secured prefinance…and it can represent 5-15% of the total investment
in a project.
One structured finance mechanism
Agreement with
host government
Investor
Host
government
Payment
Escrow
account
Sales contract
for CERs
Assignment
Financiers
Reimbursement
Financing
agreement
Assignment of titles,
rights etc.
Project
sponsor
Project
Note that CERs are paid in hard currency, which could
allow an investor hard currency revenue for a project
that otherwise would generate only local currency.
CERs could also be used to pay suppliers - e.g., an
equipment supplier, who would use the CERs to meet his
own CO2 reduction obligations. Again, this could be a
way to overcome hard currency problems.
Mitigating the risks in the structured finance mechanism
Agreement with
host government
Host
Investor
government
Political risk
insurance
Assignment
(step-in rights)
Agreement with
national government
Insurance
company
Insurance
company
Due diligence;
insistence on
consultation
procedures; legal
opinions
Political risk
insurance (nonratification Kyoto
Protocol)
Project
sponsor
Project
Mitigating the risks in the structured finance mechanism
This agreement will set out the commitments of the
host governments towards the project sponsor. This
is similar to the undertakings governments give for,
say, a power project. It will:
- specify when the project sponsor is entitled to
receive the CERs
Host
government
Agreement with
national government
- allocate some of the risks – e.g., what if because
of government intervention, the project does not
meet its emission reduction targets?
- when will measurement start?
- what if there is a technical problem in the
measurement process?
Project
sponsor
- how is force majeure defined?
Project
Sale of
notes
Buyers of
notes
Possibility of
risk tranches
This type of
aggregation
may be crucial
for some
countries
Special
Purpose
Vehicle
Futures, options,
swaps
Sale of CERs on
market
Sales contracts
for CERs
The securitization
mechanism
Hedge
counterparty
Buyers
Financing
agreements
Project
sponsors
Assignment of titles,
rights etc.
Projects
See for a discussion on how CERs can help project finance, and the
risks involved, UNCTAD 2003
http://r0.unctad.org/ghg/sitecurrent/download_c/publications.html
Structuring and Contracting CDM Transactions
Structuring Transactions
1. Upfront Payment for Future Stream of CERs
2. Forward Contract for Delivery of CERs at Fixed
Prices
3. Forward Contract for Delivery of CERs at
Floating Prices
4. Option Payment for Future Delivery of CERs
5. Spot Market
Issues around Contracting Transactions
Delivery Risk
Timing Risk
Counter-Party Credit Risk
Country Risk & Currency Risk
One risk: “future” CERs do not have the same legal status
as “current” ones.
Once the CERs have been actually generated and
certified, they are irrevocably valid, protecting the buyer
and freeing the seller from any liabilityr.
The stream of possible future CERs would be noncertified. But after the project has been registered with
the CDM authority, the future CERs would be sellable as
“promissory notes” in the forward/futures/options market,
with a market discount based on the risks that anticipated
future credits would not be earned and certified. These
promissory notes will only become CERs if the emission
reduction is indeed delivered.
Concluding remarks
•
The possibility of getting CERs may well influence the choice
of optimal technology (e.g., for energy generation)
•
CERs can have a considerable positive impact on project
economics
•
There are many (possible) projects in the African energy sector
which lead to reduced greenhouse gas emissions
•
But to “translate” this into CERs which can generate finance is
difficult
•
Once a project has started, it’s too late to try to be paid for any
resulting CO2 reduction (there is no “additionality”). So, the
earlier one starts looking at CER possibilities, the better.
For more information:
http://www.unctad.org/ghg