CDM Projects: Risks and Contracts charlotte streck pcf Sao Paulo, Brazil, November 22, 02

Purpose of our ERPA Record agreement Identify responsibilities Establish rights Manage Risk

How does PCF identify and assess risks? –PIN: Risk screen –PCN: Risk matrix –Preparation: Baseline study, Validation, ESR –Appraisal: Assess full range of risks –Structuring: Mitigate risks Assessing Risk

Defining, Assessing, and Reporting Risk PCF establishes a risk profile for the project as soon as it signs an Letter of Intent Project Concept Note –Profiles risk by class, defines specific risk and proposed mitigants –Contains results of “upstream” risk assessment (environment and social or “safeguards” policy risks, sponsor and financing risk, unique carbon asset risk)

Project Risks – – Construction risk (built/operated on schedule?) – – Performance risk (e.g. resource risk) – – Counterparty risk (will offtakers pay on time?) – – Financial and business risk (is capital structure viable, debt serviceable? Is parent company sound? Will product sell?) Sources of Risk I

Sources of Risk II Baseline Risk –Eligibility--will ERs be Kyoto-compliant? –Baseline design--is the baseline robust? Will its assumptions remain valid over time? –Performance--actual performance will determine level of ERs generated

Market/Price Risk –Will there be a market for project-based ERs? –Will contract price meet market price? Policy/Compliance Risk –What if the Kyoto Protocol doesn’t enter into force? –What if host country does not ratify or comply?  Market and Policy Risk are closely linked Sources of Risk III

Risk Allocation Principle: Assign risk to the party best able to bear it PCF primarily assumes: –Kyoto –Baseline –Market Investors/creditors assume most project risks PCF mitigates against project risk Country risk is shared

Assessing Risk Risk Matrix PROJECT RISKS: Technology Resource Completion Env/Social Transmission Delay in plant commissioning, delivery of ERs =>Evaluate technology and Sponsor experience =>Evaluate resource risk (Baseline study) =>Conduct Env. & Social Review =>Evaluate grid reliability, transco contract =>Limit upfront pmt =>Require EIA Risks/ Factors Potential Impact Risk AssessmentPCF Mitigation COUNTRY RISK Macro stability Kyoto Protocol Risk =>Stable investment climate; “A” rating =>WB evaluates country risk =>WB evaluated KP risk Baseline Risk =>Evaluate financial projections/assumptions; =>Sensitivity analysis on key parameters Project generates fewer ERs than expected Financial sustainability =>Baseline study to evaluate. =>conservative ER projections

Mitigating Risk Baseline risk: –Baseline study, assessment of “carbon asset” risk –Reasonable but conservative estimate of ERs –Rigorous monitoring Market risk: –Purchase of call options –Conservative pricing –Seniority through: Legal seniority Overcollateralization – purchase less than 100% of ERs Structural seniority – purchase early vintages Policy/compliance risk: –LoA/Host Country Agreements in JI countries

Mitigating Risk II Project Risk: –Seniority: also protects against project risk –Sharing of ERs: provides incentive to perform –Capitalization of costs: PCF costs deducted from payment –Payment on delivery (“commodity” model) PCF faces reinvestment risk only. –Limitation on up front payment (extraordinary circumstances, 25% limit) –Price discounted to reflect risk

Exercising Seniority in PCF Projects Theoretical maximum ER output Anticipated ERs from Validated Baseline 2012 Time in Years Volume of ERs PCF’s Contracted Annual ER Purchase ERs Available for Parallel Purchase Year 1 PCF Takes First ERs up to its Agreed Annual Volumes

Exercising Seniority in PCF Projects Theoretical maximum ER output Anticipated ERs from Validated Baseline 2012 Time in Years Volume of ERs PCF’s Contracted Annual ER Purchase ERs Available for Parallel Purchase Year 1 PCF Takes First ERs up to its Agreed Annual Volumes Parallel Purchaser Contracts rest up to Validated Asset Level

Exercising Seniority in PCF Projects Theoretical maximum ER output Anticipated ERs from Validated Baseline 2012 Time in Years Volume of ERs PCF’s Contracted Annual ER Purchase ERs Available for Parallel Purchase Year 1 PCF Takes First ERs up to its Agreed Annual Volumes Parallel Purchaser Contracts rest up to Validated Asset Level PCF Sweeps any annual surplus

Shortfall Make Up Rights for PCF Theoretical maximum ER output Anticipated ERs from Validated Baseline 2012 Volume of ERs Year 1 PCF Takes First ERs up to its Agreed Annual Volumes Parallel Purchaser Contracts rest up to Validated Asset Level Year 2 Actual Year Two Production Falls below PCF Annual Contracted Volumes

Shortfall Make Up Rights for PCF Theoretical maximum ER output Anticipated ERs from Validated Baseline 2012 Volume of ERs Year 1 PCF Takes First ERs up to its Agreed Annual Volumes Parallel Purchaser Contracts rest up to Validated Asset Level Year 2 Actual Year Two Production Falls below PCF Annual Contracted Volumes PCF is made whole in next year before Parallel Purchasers Get ERs

Elements of ERPA Parties: PCF Trustee – Project Entity Content of ERPA: Obligations of the Parties –Purchase of ERs: Price – Exclusive Right / [Transfer] –Additional obligations of the PCF Trustee –Additional obligations of Project Entity Events of Default Remedies Conditions of Effectiveness

Purchase of ERs Purchase of an agreed amount of ERs Agreed payment of $US [___] per ton of CO2 Payment on delivery [annually] Delivery: Submission of certificate issued by an independent third party Biennial certification possible [payment annually/biennally] All ERs /Minimum Amount of ERs /Additional ERs

Recovering of Costs Project preparation costs Initial validation, verification, certification, periodic certification, supervison Deduct from payment: Estimate [not more than ____]

Obligations of the Trustee Pay the installments of the purchase price (net of costs) Arrange for the initial verification, and periodic verification and vertification Others (e.g. exchange of information)

Obligations of the Project Entity Carry out the project with due diligence Monitoring and data collecting according to the MP Grant the PCF the exclusive right to arrange for initial and periodical verification and certification Grant the validator, verifier and certifier access to the project [Facilitate] transfer of ERs

Events of Default Project Entity Failure to deliver ERs Significant delay in project construction Other project financial not in place by a certain date Trustee Failure to pay purchase price in time Failure to arrange for validation, initial and periodic verification, and certification

Questions ?

Conclusions Carbon finance can: –Improve IRRs (at zero cost to project) –Help secure financing, reduce project risk PCF assumes most carbon-related risks in carbon purchase transactions Price depends on residual risk Building carbon finance into projects can make them bankable We are here to help, as part of your team. Risk Mitigation in PCF Transactions