Standard Bank EcoSecurities Carbon Emissions Conference: a financial markets perspective Financing E

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Standard Bank EcoSecurities Carbon Emissions
Conference- a financial markets perspective
Financing Emission Reductionsa Banks
perspectiveColin King8 February 2005
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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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What is the opportunity?
The owners of more environmentally sustainable
assets in energy, natural resources, and
environmental technology have the potential to
develop, capture and sell rights to the positive
environmental performance they engender. The
monetization of these environmental benefits is a
rapidly growing business opportunity.

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An additional value from clean sector projects
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Capturing Emission Value Requires New Components
in the Project Finance Process

• Emission Trading Assets require investment in
  additional aspects of analysis
• Generally, best undertaken in the stages prior
  to project financing and groundbreaking
• Relevant documentation, verification
  requirements and transaction negotiations all
  require specialised services
• For many parties, outsourcing will be the answer

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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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Assessing Risk

• How do commercial banks assess and respond to
  risk when appraising carbon and energy projects?
• What are the risks and rewards from a
  financiers perspective?

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Assessing Risk (Continued)

• What Risks?
• Generic project risks
• Demand (off-take)
• Technology
• Construction
• Operations Maintenance
• Supply (fuel, water, spares)

• Political risk
• Environmental
• Force Majeure
• Funding mismatch
• Collections

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Assessing Risk (Continued)

• What Risks?
• Specific Carbon Market project risks
• Currently, there is no spot market for CERs
  they are bought forward into a project i.e.
  purchasing with the hope/expectation that the
  project will deliver credits
• Set volume delivered over a number of years is
  bought (a vintage stream) i.e. you cant choose
  the volume you want to purchase, nor the year of
  delivery
• While there are standardised contracts, the
  contracting process is time consuming it also
  requires specific expertise and partners who are
  CDM Consultants and Designated Operational
  Entities
• A portion of risk payment (upfront unrecoverable
  payment is usually made)
• The purchase is for physical delivery (not
  financially settled)

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Assessing Risk (Continued)

• What Risks?
• Specific Carbon Market project risks
• Registration risk the possibility that a
  project is not registered as a CDM project in the
  UNFCCC database
• Political / Country risk the possibility that
  the host country DNA does not issue the letter of
  approval or that the country establishes barriers
  for the CER transaction
• Project risk the possibility that the project
  does not generate the expected amount of CERs.
  There are basically three reasons for
  non-performance on a project
• Force majeure
• Financial risk
• Performance risk

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Risk Structuring
How to improve the risk profile of carbon
energy transactions?
Overriding principle Risks to lie with party
best able to manage them!

• Combine Grant funding with DFI financing and
  Commercial bank debt
• Grant funding assumes first loss position
• DFIs assume the riskier elements of quasi
  equity and/or subordinated debt
• Commercial lenders provide the senior debt
• Allows grant funds to have largest impact using
  multiplier effect

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Risk Structuring (Continued)
Combine Grant funding with DFI financing and
commercial bank debt
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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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Challenges for Developing Country Developers

• CDM process is complex
• Lack of clarity at international level (CDM
  Executive Board)
• Documentation and project baselines produced on
  an ad hoc basis
• Room to streamline (standardisation of documents
  baseline benchmarks internationally)
• Transaction costs high
• Policy Risk evident
• Fear market is not real
• Signals from host nations and investor nations
  not clear enough
• Project Developers generally unwilling to risk so
  much in absence of any clear indications from
  host nation of potential eligibility

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Challenges for Developing Country Developers
(Continued)

• Institutional
• Inability to secure Host Nation Approval
• Lack of clarity/transparency as to process lead
  agency
• Often no clear indication of host nation
  priorities
• Sustainable development objectives, projects and
  technologies
• Developers taking risk, and developing in the
  dark
• Support
• Lack of an Enabling Environment
• Institutional capacity to support project
  development (projects office)
• Limited engagement of financial community
  domestically
• Limited Operational Entity capacity in country
• No ability to support developer in identifying
  buyers and contracting

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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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Monetizing carbon credits increases project IRRs
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The Economics of waste to energy projects are
especially attractive
Wind farm project 20 MW installed
capacity 50,000 t CO2 ERs p.a.(10
years) Project costs US20m () Carbon
value _at_ 3/ t CO2 1.72m _at_ 5/ t CO2
2.87m Proportion of project costs _at_ 3/ t CO2
8.6 _at_ 5/ t CO2 14.35
Waste to energy project 2 MW installed
capacity gt50,000 t CO2 ERs p.a.(10
years) Project costs US3.5m Carbon value
_at_3 /t CO2 1.72m _at_5 /t CO2 2.87m
Proportion of project costs _at_ 3/ t CO2
49.1 _at_ 5/ t CO2 82.0
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Certified Emission Reductions (CERs) Can Help
Improve Project Annual Debt Service Coverage
Ratios (DSCRs)

• Sale of CERs involve minimal costs therefore is
  essentially Free Cash Flow
• This cash flow can be readily applied to Debt
  Service
• Direct Payments on Annual Debt Service
  Requirements
• Funding Debt Service Reserve Accounts
• Using Forward ERPA Sales as Collateral
• Funding an Account to supplement variations in
  EBITDA
• Applying Carbon Cash Flow to Debt Service Can
  Result in more favorable Capital Structures
  (Higher DE ratios)
• Higher DSCR (More Debt Carrying Capacity) means
  less Equity Requirement Thereby Increasing ROE
• Allows Project to be Financed Because Increases
  DSCR past Predetermined Threshold set by the
  Lender
• Either Way, Both Project Developer and Project
  Lender are Better Off.

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A Wind Project Example

• This Simplistic Example Assumes
• US82m Capital Outlay 300GWh
• 75 EBITDA Margins 0.7 tCO2e/MWh Coefficient
• 4 Price per CER D/E of 50
• 40 Price per MWh 15 yr Term, 7 interest Rate
• CER Cash Flow Can Increase DSCR by up to 0.2, or
  roughly 4m (10) in additional debt carrying
  capacity.
• If CER price is increased to 8 (current
  forecasts are between 8-12 in 5 years) this
  could mean up to 8m LESS equity investment a
  full 20 reduction.
• At price of 4 CER sales represent 19 of
  annual debt service
• At price of 8 CER sales represent 37 of
  annual debt service
• In jurisdictions with high carbon coefficients (gt
  1) or in methane (CH4) projects these benefits
  are significantly enhanced

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DSCR Matrix
Extra Debt Capacity
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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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NovaGerar Landfill Gas to Energy Project, Brazil

• Project Capture of landfill gas currently
  venting to the atmosphere for electricity
  generation, Rio de Janeiro, Brazil. Expected
  capacity 10 MW.
• Carbon credits generated 10.7 M tonnes CO2 over
  21 years
• Regulatory status Approved by Brazilian
  Government
• Value of carbon Carbon contract agreed with
  World Bank Prototype Carbon Fund for 2.5 M tCO2
  (up until 2012). Price paid 3.33/tCO2. Value of
  contract 8.3 M.

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VM do Brasil, Fuel Switching Project, Brazil

• Project Switching from coke to sustainably
  produced charcoal for steel manufacture, Minas
  Gerais, Brazil.
• Carbon credits generated 15 M tonnes CO2 over 21
  years.
• Regulatory status Approved by Brazilian
  Government.
• Value of carbon 5M tonnes sold to the Dutch
  government at US3/tonne, another 400,000 tonnes
  of 2002-03 vintage reductions sold to Toyota
  Tsusho, a Japanese trading house.

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Holcim Cement Project, Costa Rica

• Project Energy efficient process, co-firing with
  alternative fuels, higher proportion of mineral
  components i.e. lower clinker factor
• Carbon credits generated 627 kg CO2 to 542 kg
  CO2/t cement, 0.5 M tCO2 2005-2011
• Regulatory status Approved by Costa Rican
  government.
• Value of carbon Contract negotiations on-going
  with Dutch Government as part of CERUPT. Price
  4.3/tCO2.

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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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Opportunities in SA

• Mining sector (coal mine methane, coal bed
  methane, co-firing, clean-coal technology)
• Landfill gas sector (methane capture,
  gas-to-power)
• Pulp and paper (sinks, fuel switching)
• Energy sector power, oil and gas (including
  energy efficiency and DSM programmes)
• Renewable energy sector (bagasse, solar, wind,
  fuel cells, biofuels, etc.)

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What are the Markets for CDM Projects?

• The CDM links Emerging Market Opportunities with
  Developed Market Demands
• Origination Market (project finance)
• Carbon trading represents a new component of
  traditional project finance for infrastructure
  energy projects with green credentials
• Projects will be found in clean energy, energy
  efficiency and waste management
• Successful carbon transactions enhance project
  debtequity ratios or give the client better debt
  service coverage ratios than they might otherwise
  enjoy
• Secondary market (commodity trading)
• Trading in Credits in Emission Capped
  Jurisdictions in the EU, Canada, Japan . . . .
• Strong linkages to other traded energy products
  (electricity, coal, gas, oil)
• Potential Development of synthetic green energy
  exports
• Investment opportunities

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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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The Standard Bank EcoSecurities alliance

• Objective to work together to offer carbon
  trading deals to Standard Banks client base and
  beyond
• To become the Premier provider of Financial
  Services for Green assets that can gain from
  Emissions Trading
• A series of leads and deals already originated
  around the world

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Who are EcoSecurities?
EcoSecurities has been rated as the worlds
leading greenhouse gas advisory firm.
Environmental Finance Magazine Reader
survey December 2001, 2002 and 2003
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What will Standard Bank and EcoSecurities offer?

• Project Baselines Analysis and Monitoring and
  Verification Protocols
• Project Design Document Development
• Negotiations with 3rd party validators
• Negotiations with Government for export agreement
  of Carbon Credits
• Sourcing Buyers for carbon credits and
  structuring origination transactions
• Enhanced Debt and Equity Project Finance using
  Green House Gas (GHG) values as a Cornerstone
• More Sophisticated Trading Derivative Services

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Outline of the Presentation

• Introduction
• Assessing Risk and Risk Structuring
• Challenges for Developing Country Developers
• Economics of Emission Projects
• Case Studies
• Opportunities in South Africa and Markets for CDM
  Projects
• The Standard Bank-EcoSecurities alliance
• Conclusion

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Conclusions Points to remember

• Most projects involving cleaner energy
  technologies will create this additional carbon
  value - essentially free cash flow
• It is imperative that we develop the CDM project
  documentation before the project becomes
  operational otherwise it is not eligible for
  participation in these mechanisms
• Skilled carbon/financial advisers and arrangers
  can manage virtually the entire process for
  clients either as part of conventional
  commercial/financial relationships or strictly
  on a carbon project development basis

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Conclusion
QUESTIONS?