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Q _ A on ERPA Pricing


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									                      QUESTIONS AND ANSWERS

           The World Bank Carbon Market Pricing Policy
1.     What is the current World Bank pricing policy?

To help determine fair market price, the World Bank has set up a bank-wide pricing
committee, and through that and dialogue with fund participants and host countries, and
its own market research (e.g. annual State of the Carbon Market report) the World Bank
has developed an approach by which it will seek to establish transparent, fair and
consistent pricing. The approach is expected to achieve three objectives:
         Offer project sponsors a fair price for their emission reductions;
         Improve transparency in the market for greenhouse gas emission reductions,
            thereby contributing to the second strategic objective outlined in the Carbon
            Finance Approach Paper—assisting in building, sustaining and expanding the
            international market for greenhouse gas emission reductions; and
         Seek to attain the Bank’s objective of fully committing the resources placed in
            our trust by carbon fund Participants.

The World Bank buys either Certified Emission Reductions (CERs) or Verified Emission
Reductions (VERs) using the same pricing approach of offering fair and coherent prices
that ensure equitable benefit sharing between buyers and sellers. In addition to offer fair
prices, the process needs to be transparent to ensure credibility from the Host Countries’
perspective and to promote durability of the ERPA contracts.

Prices are defined taking into consideration the different allocation of risks assumed by
the Bank and the sellers.

With the carbon market yet to mature into a regular competitive market, imperfections in
supply and demand are pervasive. In the absence of a well-informed market, the World
Bank proposes to develop a proxy for ―market‖ price for each transaction by pricing off a
benchmark (or reference price) adjusted for risk. The representative ―benchmark‖
transaction is identified as one for which the market has relatively complete information
regarding the key determinants of price, notably the riskiness of the underlying project,
the eligibility of the emission reductions under the Kyoto Protocol and the EU ETS, and
the structure of the Emission Reductions Purchase Agreement contract. The World Bank
will review the price benchmarks and spreads periodically.

2.     What factors are considered when setting the price?

Price is adjusted for the following risks:
               Project risk is related to the riskiness of the underlying project and the
        likelihood that the project will be constructed on time and will remain fully
        operational during the contract period;

              Risk associated with the registration of the project: these are risks related
       to project validation and registration, including risks associated with CDM
       regulatory risks;
              Risk associated with the issuance of the CERs: this risk includes the
       verification risks, including possible clarifications regarding the methodology,
       monitoring and ability to properly verify the achieved ERs, and potential delays
       regarding the issuance of the CERs into purchasers’ accounts;

Please note, the abovementioned three risks explain the big difference between the prices
of CERs and VERs.

               Crediting renewal risk: this risk addresses the robustness of the project’s
       baseline after the first period of generation of emission credits (crediting period,
       typically 7 years) and the likelihood that the crediting period is renewed and, if so,
       the risk that future volumes of emission may decrease with future crediting
               Additional community and/or environmental benefits presented by the
       project and of buyer’s interest;
               Market premium/discount for technology, region, country: the market has
       higher willingness to pay for certain classes of projects;
               Upfront payments: if part of the ERPA contract is paid in advance, the
       buyer is assuming project sponsor’s credit risk in case the project is not completed
       and does not deliver any emission reductions. The value of assuming such risk is
       a function of the riskiness of the project and any guarantees provided by the
       sponsor or other guarantor;
               Costs and expenses: under normal circumstances, the World Bank’s
       carbon funds recover preparation costs from carbon revenues. In contracts where
       the project sponsor wishes to accept a discount in return for not deducting the
       preparation cost, the deduction in price is indicated based on contracted volume
       and the estimated preparation costs;
               Purchase beyond 2012: with the first commitment period of the Kyoto
       Protocol ending in 2012 there is little demand from buyers to purchase beyond
       2012. Currently, the Bank is the only buyer of emission reductions generated after
               Structured pricing or indexation: features such as seniority (e.g. receiving
       the first tons delivered by a project) and price indexation (vis-à-vis a benchmark,
       or using caps or collars)

3.     What steps is the World Bank taking to move towards more transparent
       pricing in the carbon market?

With the carbon market yet to mature, current market imperfections are pervasive.
Transactions are few (though increasing), heterogeneous, and usually private, so there is
limited transparency of information on the structure and terms of specific transactions
and their underlying projects.

Given the relatively early state of development of the carbon market and the high degree
of uncertainty, and given the World Bank’s role as a forerunner in the carbon market and
its mandate to help its developing country clients, it is important to explore all viable
options for pricing that will help move towards more transparent pricing in the carbon
market.     This includes innovations such as the Umbrella Carbon Facility and the
possibility of auctions for carbon assets.

4.     What is the Umbrella Carbon?

The Umbrella Carbon Facility aggregates multiple sources of funding, including from the
Bank’s existing carbon funds, to purchase very large volumes of carbon emissions from
pre-identified projects on behalf of governments and private firms. Under current pricing
scenarios, some of these purchases could reach $200 to $600 million, particularly in East
Asia, South Asia and Latin America.

The new facility helps ensure that a part of the capital now accumulating in the OECD
countries to meet emission reductions obligations flows to developing countries.
Purchases of emission reductions from the Facility would help bring more liquidity to the
market and ensure that industrialized country governments and companies can meet their
emission reduction obligations.

The kinds of projects that could benefit from the umbrella facility include capping of
industrial gases like HFC-23 in China. HFC-23 is one of the most powerful greenhouse
gases and is a byproduct in the manufacturing process of HCFC-22 which is used as a
refrigerant. Other projects would include coal mine methane recovery and use,
hydropower facility rehabilitation, programs for landfill gas capture and use from existing
landfill sites, and nitrous oxide capture from nitric acid and adipic acid production.

The Umbrella Carbon Facility contributes to transparency in the market by opening
participation to market players on a first come first serve basis as was the case in the
HFC-23 project recently negotiated through the Facility in China.

5.     Does the World Bank have different pricing policies in different regions?

The market has higher willingness to pay for certain classes of projects. For instance,
there is currently a high demand for renewable energy projects in low-risk Latin-
American countries, implying the need to pay higher prices for emission reductions.
Projects certain to be eligible under the EU-ETS would also command a higher price. The
initial premium ranges will be assigned based on a confidential survey of current WB
Carbon Fund participants’ preferences or ―willingness to pay‖.

As market information becomes available and our own project portfolio evolves, the
resulting premia/discounts will be adjusted and refined through further analysis of project
experiences by the Policy and Methodology and by the Operations Teams within the

6.     Why has the World Bank paid lower prices in the past?

The World Bank’s involvement in the carbon market predates the coming into force of
the Kyoto Protocol and the EU ETS by several years. The Bank was the forerunner in the
carbon market when there was no market and few other buyers. The Bank, with the
participants in the very first carbon fund, the Prototype Carbon Fund, was a market maker
when there was no market, and took the risk that the emission reductions the fund was
buying would eventually be certified as Kyoto compliant, and that there would even be a
protocol in force. The prices paid at that time reflected the uncertainty of the situation
and the risk taken in the pre-Kyoto time-frame.

Historical prices for ERs have ranged broadly from pennies per tCO2e in early deals in
the voluntary market, to $10/tCO2e and higher in some more recent trades. With both the
European Union Emissions Trading Scheme which began on January 1, 2005 and the
Kyoto Protocol which came into force on February 16, 2005, carbon emission reductions
became international commitments by most industrialized countries thus driving the
demand for quality ERs, and therefore the current prices up.

7.     Why does the World Bank pay fixed prices as opposed to market based

The fixed prices protect host countries against the risk of prices going down in a market
that is still new and can be very unpredictable. The April 2006 price fluctuations on the
EU ETS carbon market have demonstrated how unstable the prices in the carbon market
can be.

Additionally, the fixed price is a certainty that can help make the project bankable, as for
instance demonstrated by Abanico Hydro Plant project in Ecuador. The project sought
financing from the Inter-American Investment Corporation (IIC) but despite having
strong fundamentals, the power purchase agreements fell short of IIC’s investment
criteria, which required over 50 percent of sales to be under contract and assigned to the
lender to secure the loan’s deft service. With the involvement of the World Bank carbon
financing, IIC agreed to consider the proceeds of Hidroabanico’s CERs sales in its
investment analysis, allowing the borrowing to comply with the IIC’s covenant. Fixed
prices give added confidence to the financial institutions which funded the project.

8.     If the market prices increase is it possible to renegotiate the existing ERPA?

No. An ERPA is a legally binding contract that fixes the price for the specified time.

9.     Why is it not possible to renegotiate the existing ERPA?

The emission reductions purchase agreement is a legal contract. Any attempt to
renegotiate an ERPA would create too much uncertainty for buyers who might then be
inclined to look for their carbon reductions in a more reliable setting …in their own

10.     Why are the CER/VER prices not the same as the EU Allowances (EUA)

There are several key reasons for differing prices in the two markets:
   1) EU Allowances traded in the EU Emissions Trading Scheme (EU ETS) do not
       carry delivery risks unlike VERs or CERs – by virtue of them being issued by
       national governments under a cap and trade system.
   2) CERs and ERUs are generated by projects that produce measurable reductions in
       greenhouse gases. To qualify, these projects must be registered by the CDM
       Executive Board or the JI Supervisory Committee, and ERs issued by the
       respective regulatory bodies. Unlike EU Allowances, there is significant lead
       time, cost and uncertainty involved with the generation of CERs/ERUs as
       projects need to be implemented, made operational and continuously monitored.
       These risks relate to the fact that they involve the seller’s commitment to deliver
       an asset that does not yet exist, so there is substantial risk that the project will fail
       to actually deliver the expected CERs/ERUs.
   3) Delivered CERs/ERUs eligible for crediting under the EU ETS are likely to trade
       at prices competitive with EUAs. There remains significant uncertainty, however,
       with regard to the eligibility of CERs/ERUs in the EU Emissions Trading
       Scheme, and their conditions for transferability into the EU ETS, as many
       national governments have yet to clarify these rules.
   4) Like CERs and ERUs, VERs are also project-based, but unlike CERs or ERUs,
       they have not undergone registration (e.g. by the CDM Executive Board). Buyers
       of VERs assume the same risks as those of CERs/ERUs, but in addition, they also
       assume ―regulatory‖ risks associated with the possibility that they may not be able
       to use the VERs against their regulatory or international targets if they are deemed
       not to be in compliance with national or international standards (i.e. if the VERs
       are not ultimately registered as CERs or ERUs).

11.     Why does the World Bank do up-front payments in some carbon finance

One of the key constraints to implementation of CDM and JI projects is the lack of
underlying finance. The standard business practice of the World Bank is to pay on
delivery for emission reductions; however in some specific projects, an up-front payment
may be considered in order to relieve the financing constraint.

12.     Does the World Bank use up-front payments to make their offer for emission
        reductions more attractive?

Up-front payments are not used to make the Bank’s offers for emission reductions more
attractive, but to cover project's investment gaps. They usually represent the last source of
financing required for the project to reach its financial closure. Specific requirements and
guarantees may be requested by the CFU in order to provide up-front payments.

13.    What mechanisms does the World Bank use to minimize risks that funds’
       participants become exposed to by providing up-front payments if the
       project fails to generate the necessary amount of emission reductions?

The World Bank mitigates the risk exposure of the Funds' participants:
 cap the amount of up-front payment to be provided in each ERPA
 cap the period for up-front payment recovery (with the equivalent emission
 reduce the price of the emission reductions according to acceptable discount rates
 request an acceptable letter of guarantee to cover the risk until the full recovery (with
   the equivalent emission reductions)


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