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The carbon market
From a Carbon Price to Carbon Finance
Patricia Rosenthal, Environmental Markets Originator
20 April 2010 Designator | author 1
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 2
Agenda
Fortis Carbon Banking
Overview of Carbon Markets
Origination – Kyoto Mechanisms
Financing with carbon Assets
Final Remarks
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 3
Fortis Carbon Banking
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 4
Fortis – Global Leader in Carbon
Fortis is a global leader in the carbon markets with a wide array of offering and has been involved since the inception of the carbon markets.Today
we serve more than 200 clients in their carbon needs
We have a dedicated team of specialised sales and analysts in carbon who can give you specialised market insight and intelligence
As a major investor in the European Carbon Fund (investing 15 million Euros), we have built up considerable experience combining commercial
and legal expertise in the CDM & JI approval processes and the associated risks
– March 2004: Executed first trade under the EU ETS
– June 2004 Executed first trade under the ISDA agreement winning Carbon Deal of the Year
2004 – November 2004: Became co-sponsor of and investor in the European Carbon Fund
– May 2005: Started offering carbon clearing services
– October 2005 Won best diversified financial and launched its Climate Change Leadership Index
2005 – November 2005: Signed landmark deal with European Carbon Fund for placing over 50 million tonnes
– December 2005: first index-based carbon compliance trade
– January 2006: European Carbon Fund awarded Most Promising investment Opportunity
– February 2006: Structured and executed first ever CER call option deal
2006 – April 2006: Concluded first complete second phase strip transaction from 2008-2012
– September 2006 „Best in Class‟ for our excellent approach to climate change (Carbon Disclosure Project survey report)
– Launch of Carbon Neutrality Programme
– June 2007: selected by the United Nations as the Financial Services Provider (FSP) to the UN Millennium Development Goals
2007 (MDG) Carbon Facility which will deliver 15 million Kyoto Credits. Fortis provides carbon services including custodian, financing,
purchase of credits and credit marketing tools
– September 2007: Fortis wins the first ever carbon auction in Brazil and acquires 808,000 CER‟s from the Sao Paulo government
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 5
Fortis: new products for the emerging carbon markets
Carbon Financial Services Trading Services
Accepting returns in carbon Trading on demand or to order
Including carbon value in financing Index based
and due diligence procurement/divestment
Clean Development Mechanism CER purchasing and sales
project financing Delivery date swaps (quasi repos)
Administration and Trust Investing in and developing
Managing customers carbon funds
accounts Co-sponsorship of the European
Custody of other Kyoto Compliance Carbon Fund to ensure reliable
Units deliveries of Kyoto Compliance
Fund custody and administration Units for customers
Clearing
CDP Climate Leadership 2006 – Top 50 Global
Eliminate counterparty risk and Co-sponsor and guaranteed placement CP for European Carbon Fund
Initiated index based position management contracts for customers
guarantee trades
Trading on behalf of >100 customers
Cross commodity correlation model Cross selling successfully with trust, custody, escrow & settlement
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 6
FORTIS BANK SUITE OF PRODUCTS FOR THE EMERGING
CARBON MARKET
Fortis has been trading the EU ETS for 3 years and offers a wide Liquidity access
range of products
Spot contracts Fortis has market access via 10
All standardised Forwards brokers, 3 exchanges and a large
Listed Futures and Options number of actively trading
companies throughout Europe
Delivery date swaps (quasi-repo) allowing to offer competitive pricing
Bespoke cross commodity solutions including CER structures
Index based products On demand purchases and Contracts
sales
The customer buys or sells a
Fortis uses the standard ISDA
predetermined quantity of EUAs over The simplest form of market master agreement annex, the IETA
a specified period of time at the access. The customer simply calls master agreement and the IETA
average ECX closing price for the Fortis for the market price and single trade agreement. Examples
period. This has the advantage of decides whether to deal or not can be obtained on request.
smoothing out the inter and intra day
Recently adopted the GRV
volatility seen in the market.
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 7
Overview of carbon Markets
- Kyoto Protocol
- EU ETS
- Voluntary Market
- Difference – CER/ERU, EUA, VER
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 8
Kyoto protocol and global greenhouse gas emissions
30,000
million ton CO2
25,000 Rest
of the
20,000 World
15,000
10,000
Annex I
Kyoto
5,000
Ratified
EU25
0 ETS
World Annex I Kyoto Ratified EU25 ETS
In 2008, the greenhouse gas market becomes a lot bigger
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 9
Kyoto Market
ANNEX I ANNEX I
ERU
CER
CO2 1
CH4 (methane) 21
Non N2O 310
ANNEX I HFCs 150-11700
PFCs 6500-9200
SF6 23900
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 10
CDM current status
projects in the pipeline (volumes)
Global already issued
at least 1 issued, yet to be issued
registered, before issuance
China
LoA obtained, before registration
PDD written, before LoA
India
Brazil
Rest
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 11
JI current status
- February saw the first JI project submitted for determination
- In May Russia‟s prime minister signed the country‟s JI procedure, but no
LoA have been given yet
- JI potential in the new EU ETS member states is limited due to double-
counting rules
- For those countries JI potential is concentrated in non-CO2 projects
- JI host countries remain non-EU members as Russia and Ukraine
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 12
CDM project cycle, different levels of CERs
CDM project identification
Project Design Document
Validation starts After the validation by a Designated Operational
Entity and the approval by a Designated National
Letter of Approval Primary CERs project is submitted to the United
Authority, the
Nations‟ CDM Executive Board for registration.
Price of ERPA (Emission Reduction Purchasing
Validation ends procedure normally takes 6 to 10 months,
Agreement) depends on remaining risks
can occasionally go up to 18 months
Registration
Monitoring If the project gets officially registered at the UN CDM
EB, it is recognized as a CDM project. by transferring
CERs can be imported in the EU-ETS Following that,
Verification + Certification them from thecertification occurs every 1-3 years.
verification & International Transaction Log (ITL)
Upon verification, a to a registry account on CERs
managed by the UNcorresponding number ofthe
Issuance Community Independent Transaction Log (CITL)
will be issued by the UN CDM EB. This quantity will
managed by the
vary compared European Commission. the link
Secondary CERsto the planned quantity in The PDD.
CER Distribution between the ITL and the CITL
Project origin matters - bilateral has not yet been
established but the European Commission has
CER for compliance
Secondary CERslink will be ready before April 2009.
guaranteed the
in EU-ETS
Project origin does not matter (if it is EU-ETS compliance)
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 13
EU Emission Trading Scheme
-To help Member States comply with their Kyoto obligations, the EU
established the EU Emissions trading scheme (EU ETS)
-First International Emission Scheme ever
-Industry from 27 EU countries under cap and trade ~12,000 installations from
~5,000 companies
-EU ETS ~ 45% of EU emissions
-Large emitters of CO2 must monitor and report their CO2 emissions. Every
year these companies are obliged to surrender a certain amount of emission
allowances to the government
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 14
EU Emission Trading Scheme
-Compliance Mechanisms:
-Get allowances for free from the government (this may change in the future)
-Purchase allowances from other installations
-Internal abatement
-Reducing emissions outside: Kyoto Credits
-2 Phases: 2005 - 2007 (pilot phase)
2008 - 2012 (Kyoto period)
-EU has already indicated that a scheme after 2012 will be in place giving more
confidence the market
-The use of Kyoto Credits (CER/ERU) are restricted to a limit set by member
states and European Commission.
-On average companies can use up to 13% (~) of their allocated certificates in
the form of CERs-ERUs for compliance purposes – arbitrage potential
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 15
EU-ETS Fundamental Signals
Distance between cap and physical emissions
– Physical emissions not known: forecasts, estimates, predictions / NEWS SENSITIVE
– Cap set by European Commission and member states: NEWS SENSITIVE
Weather
– Precipitation impacts hydro power generation and compensation by fossil fuel fired plants
– Wind impacts wind power generation and compensation by fossil fuel fired plants
– Temperature impacts energy demand (heating in winter, cooling in summer) and corresponding
emissions
Primary energy prices – fuel switch
– If gas is cheaper than coal, gas is preferred = low emissions
If coal is cheaper than gas, coal is preferred = high emissions
– Depends on the balance gas/coal/CO2 prices
Supply from Kyoto projects
– Other countries outside EU also demand CERs for compliance
– Supply and Demand of CER/ERU uncertain
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 16
EU-ETS Success to Date
Does emissions trading work?
Q1 : Is the market sufficiently liquid?
YES!
– daily volumes increased by a factor 50 in two years
Q2 : Are EUA prices justified?
YES!
– market responds logically to fundamental signals weather, news, allocations, fuel prices
Q3 : Does the ETS lead to emission reduction?
YES!
– about 150Mton CO2 emission reduction in the EU power sector throughout 2005 and 2006
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 17
Voluntary Market
– Non-regulatory purpose. Usually for marketing purpose, carbon neutrality
programs or companies‟ strategy to be front runners in future compliance
schemes
– VER (Verified Emission Reduction)
– There is no unified watchdog. The process to generate those credits is not
standardized
– Market is developing new standards in order to secure carbon credit quality and
to avoid double count of credits: e.g. Gold Standard Foundation, Voluntary
Carbon Standard
– Those credits are traded with a premium compared to other VERs
– There is no real market price. Only one future contract available from CCX
(Chicago Climate Exchanges). Other exchanges are planning to launch more
VER contracts as for example Nymex in 2008
Great Increase Potential!
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 18
Price Dynamics
Variables Price Range
(Direct and Indirect)
Weather, fuel switch (coal- Delivery Dec08-22.18€
EUA gas), politics, supply of Kyoto
credits, bankability
Politics, EUA price, ITL link, Primary Market – 8-13 €
CER project status, guarantees Delivery Dec08 -17.10 €
Establishment of procedures, Only Primary Market
politics, EUA price, ITL link, 6-10€
ERU project status, guarantees
Label, quality (environmental 2-10 €
and social)
VER
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 19
Today‟s Carbon Markets: CER/ERUs versus EUAs
EUA CER/ERU
Value right to emit 1ton CO2 right to emit 1ton CO2eq.
Validity EU-ETS global
primary, secondary,
Market one market, EU-ETS
different prices
(1)import limit and
Use in EU-ETS Phase Two YES
(2) ITL-CITL link
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 20
EUA and CER/ERUs
Market opportunity (arbitrage)
Why the price difference?
30
– link ITL-CITL not yet established
25 operators like to physically own what they buy
prices [€/tCO2]
20 – Phase Two allocations not yet finalised
15
10 Why is this arbitrage?
5 – import limits not yet known
0 as long as there is a price difference, a
Jul 07 Aug 07 Sep 07 Oct 07 Nov 07 Dec 07 Jan 08
company can exchange EUAs for CERs and
EUA Dec08 CER Dec08
cash in the price difference
– not enough CERs available to cover all needs
Window of opportunity
expected supply < expected global demand
Price difference is expected to disappear
before Mid2009
– CITL-ITL linked
– Phase Two allocation and import limits
fully known
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 21
Global potential demand outlook
Japan
Canada
BAU short
BAU short
>1,000Mt
~1,500Mt
?
EU non ETS (100)
>50% emissions 1,000 ?
(700) 1,000
CER & ERU
2,400M ??? Post 2012
MtCO2
2,400
~1,400
2,300
2,200
2,100 ?
2,000
1,900
1,800
OTHERS
2005 2006 2007 2008 2009 2010 2011 2012
emissions allocations
US states,
Australia, NZ,
Phase II total ~1,400Mt short
voluntary, …
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 22
Origination – Kyoto Mechanisms
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 23
CDM / JI PlayersFinancial Government
Institutions DNA
Government
DOE ministries
Financier
Compliance
Multilaterals /Funds
Buyers
Trading house Plant manufacture Equipment
Carbon broker Equipment
CDM/JI project developers manufacture
Order
Energy company Construction
Carbon Exchanges Consultant
Operator
/Aggregator
Construction
firm Other players EB/Supervisory
(law firm) Board
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 24
Main Financial Players and Buyers CDM/JI
– Financial Institutions (EU): Fortis Bank, Merrill Lynch, Morgan Stanley,
Barclays, Deutsch Bank, Dresdner, KfW, Credit Suisse
– Brokers: TFS, Evolution, CO2e
– Exchanges: Noordool, EEX, ECX
– Compliance Buyers: Utilities, Cement, Glass, chemical, petrochemical, oil
refineries, coke ovens iron and steel plants; energy-intensive industry,
lime, brick, ceramics, pulp and paper industries.
– Multilateral: World Bank, EBRD, ADB
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 25
Origination Process
Contact Client or Prospect
Project Identification
Screening Process
Term Sheet
Due Diligence and Client Acceptance
Emission Reduction Purchase Origination process
Agreement does not stop after
agreement has been
achieved
Administration Process – project
participant, monitoring, transfer of
credits
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 26
An example of screening criteria
Fortis Carbon Desk
– Project size: The project should generate an expected quantity of at least 500,000 tonnes
of CERs up to and including 2012. We accept bundled smaller scale projects. There are no
upper limits to the project size. We could consider smaller projects based on other merits
such as sustainability advantages.
– Technology: The project should use an approved methodology by the United Nations
– Sectors: Renewable energy, energy efficiency, methane recovery and utilization, industrial
processes, waste management and fuel switch
– Start date: Usually projects that have already started or plan to start operation over the
next 1-2 years
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 27
CDM project‟s risk assessment
Technological - Fortis Bank Environmental Markets has
Risk undertaken significant research in the field
of CDM project risk assessment.
- A thorough understanding and assessment
of the CDM project‟s delivery risk will
enable us to maximize our investment
return by constructing a diverse CERs
portfolio in terms of technology, stage, size
Country Delivery Counterparty
and geography.
Risk Risk Risk
- Fortis Environmental Markets‟ desk has
developed a highly objective and auto-
improving Delivery Risk Model to screen
most CDM projects.
Operational - This model combines a serie of quantitative
Risk
and qualitative metrics to help us gauge a
potential CDM project‟s expected
performance.
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 28
Delivery Risk Model applied to a biomass CDM project
in China
Expected Expected
Project Number CCF001
Performance in
Country Name CHINA
2007 Performance in % tonnes of CERS
Country risk exposure 1
Base Case 78.95% 23,684
Country Default 0.18%
Pessimistic Scenario 68.67% 20,602
Probability
Optimistic Scenario 94.08% 28,223
Adjusted Country 0.18%
Default Probability
30,000 28,223
Counterparty Name N/A
25,000 23,684
20,602
Fortis/International BB+ 20,000
Credit Rating
15,000
Implied Counterparty 0.74%
Default Probability 10,000
Project Stage After
Registration 5,000
Base Case operational 10%
0
failure probability
Expected Performance in tonnes of CERS
Project Type Renewable -
Biomass Base Case Pessimistic Scenario Optimistic Scenario
2007 2008 2009 2010 2011 2012 Total
Planned CERs Quantity 30,000 40,000 50,000 60,000 60,000 60,000 300,000
% of total 10% 13% 17% 20% 20% 20% 100%
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 29
Financing with carbon Assets
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 30
Factors that influence CER/ERU price
- Prices of CER/ERUs depend on a number of key factors, including:
- EU carbon allowance benchmark price
- Scope and methodology. Some buyers are willing to pay a premium for credits with
great environmental and social track record
- Credit of the Seller
- Existing relationships with buyer-seller
- Stage of project development: PIN, PDD, Registered, issuance
- Project Size
- Does the counterparty want advance payment?
- Local investment climate
- Delivery guarantee and damages for non-delivery
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 31
CDM project‟s IRR and its enhancement drivers
IRR calculation from a CDM project will very
much depend on the CER price convened
between the project sponsor and the CER buyer:
Fixed Indexed Hybrid
-CDM projects distinguish themselves
from other projects due to the enhanced Description Price agreed in Percentage of Floor plus a
term sheet level EUA portion of EUA
cash flows generated by CERs sales.
benchmark positive
These additional cash flows could movement
significantly enhance the IRR. Benefits Stable and Possibly higher Minimum
-Depending on the technology used, a easier to cash flow income known
CDM project‟s IRR could be doubled due secure finance in advance
to CERs sales. The carbon revenue of the Disadvantage -- Market has Still very
project thus significantly increases the large volatility difficult to
project‟s financial viability. and very secure finance
difficult to
- It is easy to understand that the extra secure finance
IRR from a CDM project will also depend Target People Risk averse Risk Taker Conservative
on the effective quantity of CERs issued Risk Taker
to this project by the UN CDM EB (project
Performance).
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 32
CDM/JI Project Financing
Risks Mitigation
Technology Risk – Proven Technology
Sponsor Risk – Equity First
–Track Record
Feedstock Supply Long Term Supply Contract (Volume &
Price)
Market Risk (other than CER/ERU) Offtake Contract
Country Risk ECA Insurance/Transfer
CDM/JI Market Risk STRONG Offtake Contract (Volume &
Price)
CDM/JI Regulatory Risk Non
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 33
Project Financing CDM/JI
- Financial Models CDM/JI projects
– Equity: a company finances part of a CDM/JI project in return for shared financial returns and CERs
– Loan and Advance Payment: a company provides loan at concessional rates in return for CERs
– ERPA: a company agrees to buy CER/ERUs from the project
- The main factors that affect successful closing of financing are:
- The cash flow of the business to be purchased enables the business to comfortably service the
proposed debt;
- a strong management team
- A strong business model (a profitable history and an ability to generate a predictable cash flow)
- The accounts of the business which is being purchased/built shows steady growth in revenue and in
profit margin
- The purchaser is committing their own personal finance to the transaction and if the business is not
a success, they will personally suffer a financial loss.
– Financing CDM projects would be further facilitated, if
– Offtakers commit to purchase credits for a long term
– Country Risks are covered by the ECAs.
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 34
Nature of carbon finance for a typical CDM/JI project
Capital Markets
(Financial Institutions, Private Equity,
Hedge Funds...)
Equity Ownership + Dividend
and/or Debt and/or Principle +
Interest
Power
CERs Purchase
Agreement
Cash
Global Carbon
Cash
Market
By-product:
Main product:
CERs
Electricity
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 35
Final Remarks
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 36
Beyond 2012…
???
“Investment in clean technology is risky,
Not including a value for CO2 in investment projections
CO may not have a value beyond 2012”
as will 2become increasingly hazardous
Some observations
– The EU-ETS has no sunset clause; it will continue after 2012.
Currently, this commitment has only been given concrete form up to 2012.
– Europe has already announced its determination to cut emissions further by up to 30% of 1990
emissions by 2020; (20% if other global regions don‟t take on similar targets).
– Players outside the EU have already expressed interest and are likely to start similar (compatible?)
schemes soon.
– As the emission reduction target becomes more ambitious, it is very likely that high CO2 price
signals will be maintained in order to facilitate the necessary emission reductions.
– To date, many of the world‟s premier institutional investors have invested in CDM projects. This
strong interest is mainly due to CDM projects‟ unique return profile and superior diversification
benefits due to its total lack of correlation with traditional securities market.
– The next wave of carbon reduction projects will need to account for the value of carbon abatement
in their discounted cash flow models, and in part rely on the carbon credits for repayment.
Thank you
patricia.rosenthal@nl.fortis.com
20 April 2010 Designator | author 37
UNDP Regional Workshop | Istanbul, January 21-22, 2008 | 38
EU-ETS Success to Date
Logical response to fundamental signals
Market Fundamental : Phase One Policy & News
price [EUR/ton]
30
EC demands cuts in Italy publishes
first verified emission
Czech Rep. Italian NAP adapted NAP
25 increases
reports reveal lower
emissions than forecast
allocation limit UK accepts
smaller NAP
20
EC demands cuts
in Polish NAP Phase One unanimously
15 EC accepts 5 NAPs
EC demands forecast long
cuts in Czech
unconditionally
NAP
10 UK "wins" law suit
agains EC
5
NAP drafts EC likely to official start of EC rejects revised
generous reject NAPs EU-ETS UK NAP
0
Jan 04 Jul 04 Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 Jul 07
market responds logically and consistently to policy & news on
- allocations (number of allowances put in the market)
- verified emissions (number of allowances needed)
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