CDM Projects:Risks and Contracts

charlotte streckpcf

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 ResourceCompletion 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 Assessment PCF Mitigation

COUNTRY RISKMacro stabilityKyoto 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

2012Time 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

2012Time 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

2012Time 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 2Actual 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 2Actual 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

www.carbonfinance.org