The World Bank Pricing Approach visvis Market Trends

1
The World Bank Pricing Approach vis-à-vis Market
Trends
(This information is confidential until the
official release Of the State and Trends of the
Carbon Markets 2006)

• HCC Meeting, Cologne,
• April, 2007
• Alexandre Kossoy, Philippe Ambrosi, Eduardo Dopazo

2
Outline

• Updated Market Trends
• DECRG State and Trends of the Carbon Market 2006
• 2007 preliminary trends
• The World Bank Pricing Approach
• Methodology (transparency and coherence)
• Price adjustment factors (risk allocation and
  broader commercial conditions)
• Bank competitive advantages
• Consistency between the WB and the Market
• Deals Signed by the WB (prices paid vs. approach)
  
• Evolution WB Prices (vis-à-vis market prices)

3

• Updated Market Trends

4
Latest Market Evolution

• Carbon is mainly a financial trading market
• US30 billion in 2006 (US11 billion 2005),
  mainly from EUA trading
• Market value arises from trading sale, re-sale
  for hedging, arbitrage compliance
• Project-based market still growing
• Higher volumes and prices in 2006 CDM and JI
  doubled in value
• Biggest Primary CER Sellers China (61) and
  India (12)

US 10.4 /tCO2e
CER I 10.9
US 7.2 /tCO2e
ERU 8.7
US 5.2 /tCO2e
Source State and Trends of the Carbon Market
2007, The World Bank
5
Prices Up across the Board
6
Prices Up across the Board

• Primary CERs traded on average at US 10.87
• strong impact of EU-ETS (Q1) and Chinese floor
  price (second half of 2006)
• fixed forward contracts dominate
• non-firm deliveries coupled with zero-premium
  call options for additional V/CERs - US 8-10
• Secondary CERs market grew rapidly in H206
• standardization of CERs guaranteed-delivery
  CERs, with almost all risks to the seller (ITL)
• financial institutions, large compliance buyers
  and speculators
• fixed and indexed fwd at a 10-20 discount to
  EUAs
• reacts financially to developments in the EU ETS
  (for instance swaps bet. EUA08 and 2ndary CERs)
  and to LT expectations (limit on imports or CERs
  origin)
• Eastern enthusiasm ERUs traded at US 8.62
• financing the key to a successful negotiation up
  to 50 upfront not uncommon, backed-up by LoG by
  reputable banks
• some convergence w/CERs expected but upfront
  implies a discount and uncertainty re issuance
  rules may also translate into a discount
• 5-yr crediting period limits full potential

52
43
58
7
EU-ETS disconnection PhI / PhII

• Ph I is long pushing EUA prices
• Fundamentals of utilities
• mild weather patterns low gas prices helped
  push prices down last winter
• position hedged for Phase I
• Compliance players buying PhI EUAs and banking
  CERs for Ph II (Ph II expectations and China
  price floor drive CER prices)
• PhII expected to be short (1,000-1,500 MtCO2e)
• EU decision on 19 NAPs, representing 80 of PhI.
  allowances cut of proposed caps by 9.4 (5.8
  below 2005 emissions).
• Not-so-strict supplementarity limits (?) imports
  of CERs ERUs 1,000-1,300 MtCO2e
• Ph II from balanced to marginally short
• trade-off CER/ERU vs coal to gas switch
• Extension of other sectors, notably aviation
  (2011) marginally change demand-supply balance
• And beyond? A strong signal to the market from EU
• industrialized countries to 30 below 1990 levels
  by 2020
• or a unilateral target of -20 within EU (EU-ETs
  operational)
• RGGI and California demand underwhelming in early
  years rules regarding import of offsets unclear

8

• The World Bank Pricing Approach

9
The World Bank pricing approach

• W.B. used to be price maker in early Kyoto
  stages new approach leads to a fast follower
  positioning in the market
• focus on transparency and consistency in setting
  prices for projects across the portfolio (2
  Billion)
• assures equitable benefit sharing for sellers and
  buyers
• Selection of appropriate transaction
  (benchmark)
• Benchmark price should be in line with prices
  recently paid by other market players for similar
  deals
• Selected benchmark requires relatively complete
  market information for key price determinants
• Benchmark shall be representative (volume)
• Adding/subtracting adjustments for different risk
  components and risk allocation in ERPAs
• Goal obtain price ranges for typical risk
  profiles
• Price ranges set limits which apply to each deal
• Values within the range for each transaction

10
Adjustments vis-à-vis the Benchmark

• Risk Factors
• Project risk (projects construction and
  operation, financial closure, creditworthiness of
  seller/guarantor, sponsors experience,
  technology, )
• Kyoto regulatory risk (up to registration -
  methodology, validation and project delay,
  issuance - verification, review by the CDM EB,
  crediting period renewal - baseline robustness)
• Purchase beyond 2012
• ERPA Terms (seniority, first right of refusal,
  call option, sweeping clause, overcollateralizatio
  n, )
• Additional price premia / discounts (buyers
  willingness)
• Additional community and/or environmental
  benefits
• Market premium/discount for technology, and
  region/country
• Price adjustments
• Upfront payment (25 ERPA or CAPEX, guarantee)
• Costs and expenses (lump sum recovery or price
  reduction)

11
Adjustment Ranges
Pari-pasu delivery
12
Banks Competitive Advantage (vs. higher prices
in the mkt)

• Purchase beyond 2012 higher ERPA value and
  important for underlying finance (i.e. longer
  revenue streams for debt service coverage
  consistent with RE/EEs investment payback
  profile)
• Fixed prices no fluctuation for lenders debt
  service coverage (parallel purchase allowed for
  sellers access to upside)
• Upfront payment provides minimum cash
  requirements for underlying finance normal
  standards (30 / 70)
• Capitalization of preparation costs supports
  implementation
• No delivery guarantee in ERPA terms improves
  projects bankability (i.e. ERPA as equity, not
  liability)
• VERs ensures flow, increase bankability (no
  KP-related risks)
• Monetization with payment abroad (escrow)
  eliminates Country risks (i.e. currency
  convertibility and transfer risks)

13
Underdelivery in LFG projects is a new commercial
issue
Sellers start to recognize the risk involved in
delivery guarantee
27.7
Source UNFCCC webpage
14

• Consistency between the WB and the Market

15
Increasing consistency between Pricing Approach
and ERPAs signed
Deals evaluated show increasing consistency
between prices paid after negotiations and
recommended prices based on the Pricing Approach
(6.6 since July 2006, from 20.3 in 1H06)
16
Consistent Path, with short gap
10.4
10.0
5

• Global prices for project-based ERs include
  issued CERs and ERPAs with delivery guarantee
  (traded at prices from US6.8 to US24.7 per
  tCO2e)

17
Dutch Auction as Market Tool

• All bidders pay the auction clearing price ( P4)
• Lowest price bid does not receive requested
  quantity
• All bidders have same seniority in delivery of
  the allocated quantity
• Annual CERs are distributed on pro-rata basis,
  for e.g. Buyer 1 gets Q1/Qavailable

Price, /tCO2e
P4 Auction clearing price
Qavailable
Quantity of ERs
18
Thank you!www.carbonfinance.org
HCC Meeting, Cologne, April, 2007
akossoy_at_worldbank.org pambrosi_at_worldbank.org
edopazo_at_worldbank.org