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Module 9a: Buying and Selling Carbon CreditsDay 2 (16 October 2007)
Prepared and Presented by Marina Olshanskaya and Robert Kelly
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Presentation Overview
1. Emission Reduction Purchase Agreement (ERPA): role and key issues, clauses and terms
2. Obligations of buyer and seller
3. Types of agreement, prices and delivery
4. Balancing risks, price and contractual terms
5. Special case of non-permanence: how do expiring CERs work and who bears the replacement risk?
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Emission Reduction Purchase Agreement (ERPA)
Contracts form the basis of the market. For a well-functioning
market, contracts should:• Define the product • Set out rights and responsibilities• Allocate risks
Buying carbon poses unique challenges and specific risks• The product does not physically exist • Purchased in immature markets• From people who do not know what/whether they can sell• Where the rules are constantly changing/do not exist
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Role of ERPA for the Seller
Define future value of CERs to integrate in project financial model
Use ERPA as collateral to obtain project finance
Receive upfront payment for CERs to cover start-up costs
Maximize future revenues from CERs
Minimize project financial risks (e.g. non-payment for main project deliverables)
Mitigate non-market project risks (e.g. DNA approval)
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ERPA: key clauses
Definitions: what is to be sold (VERs, CERs, ERUs)
Determining legal title to the CERs and modalities for its transfer
Key terms: volume, price and delivery
Appropriate warranties, conditionalities, force majeure
Miscellaneous:
Communication with Executive Board
Payment of share of proceeds, taxes, etc
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ERPA: obligations
Sellers’ Obligations Buyer’s Obligations
• Complete Validation and obtain Registration for the Project• Develop and Implement Monitoring Plan• Carry out Verification and Certification to ensure issuance of CERs and• Deliver CERs to the buyer
• Ensure they have an account ready to receive delivery of the CERs• Pay for the CERs• Replace tCERs and lCERs with CERs
• Communicate with the CDM Executive Board as the Focal point (can be Seller/Buyer or both)
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ERPA: type of agreement Type I: Spot Agreement (becoming popular)
Status of CERs: issued, ready for delivery
Payment: immediate, on delivery
Risk to buyer/seller: negligible
Type II: Future Delivery Agreement (most common) Status of CERs: non-issued, to be delivered in the future
Payment: future on delivery OR advanced
Risk to Buyer: Small → large (upfront payment)
Risk to Seller: Small → very large (guaranteed delivery)
Type III: Call/put Options Buyer/Seller has the right, but NO OBLIGATION to buy/sell CERs
at a certain point in the future for a fixed price
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ERPA: type of pricing Fixed price More confidence in ERPA values
Hedge against market downfalls
Good when Seller wishes to use the CER revenue to leverage project finance
Indexed price (EUA –X%) Reassures Seller that they have a
buyer while allow to retain upside potential in bull market
Difficult to calculate ERPA value
Combination of fixed and floating: Enable the Seller to secure
minimum price, but also share in any rises in the market value of CERs
Floating P
Fixed/Indexed P
Fixed P
Price (P)
Time
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ERPA: delivery Definition: CERs: receipts into a registry account nominated by the Buyer
VERs: submission of Verification report
ERUs: transfer of ERUs from a seller country’s to buyer country’s accounts
Time: Mostly annually, but shorter or longer periods are also possible
Normally before 30 April – compliance day in EU ETS
Delivery guarantee: Normal when upfront payment is provided by the Buyer
Appropriate for larger projects supported by financially stable companies
Otherwise can turn ERPA from an asset into a liability and undermine the usefulness of ERPA to secure debt financing
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Legal Agreements in CDM Project Cycle
(1) Identifying CDM
project (PIN) - PPs
(2) Preparing Project Design Document (PDD)
- PPs
(3) Getting approval from each Party involved - DNA
(4) Validation - DOE (5) Registration – CDM EB
(6) Monitoring - PPs
(7) Verification and Certification - DOE
(8) Issuance of CERs – CDM EB
(9) Distribution of CERs - PPs
PPs – project participants; DNA – Designated National Authority
• The buyer is essentially deferring his compliance to a future commitment period
• Lower market price than ‘normal’ CERs
• Conservative approach
• Many projects will lead to long-term climate benefits that extend well beyond the project crediting period, but the associated credits expire nonetheless
• 2 types:
– temporary CERs (tCERs)
– long-term CERs (lCERs)
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tCERs
tCERstCERs
• Valid for one commitment period only• Expire at the end of the subsequent
commitment period• With every successful re-verification,
new tCERs are issued for the entire quantity of carbon sequestered
• Valid for one commitment period only• Expire at the end of the subsequent
commitment period• With every successful re-verification,
new tCERs are issued for the entire quantity of carbon sequestered
Essentially, good for 5 years.
Buyer knows the time limit.
The interest of the seller is to maintain storage and sell new
tranches of tCERs.
Essentially, good for 5 years.
Buyer knows the time limit.
The interest of the seller is to maintain storage and sell new
tranches of tCERs.
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lCERs
lCERslCERs
• Only expire at the end of the project’s last crediting period – potential 60-year validity
• lCERs are issued every 5 years for the net increase in sequestered carbon
• Only expire at the end of the project’s last crediting period – potential 60-year validity
• lCERs are issued every 5 years for the net increase in sequestered carbon
Theoretically, good for up to 60 years.
But must be replaced within 1 month of a reversal being detected.
Buyer bears replacement risk.
Theoretically, good for up to 60 years.
But must be replaced within 1 month of a reversal being detected.
Buyer bears replacement risk.
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tCERs vs lCERs
• Theoretically, lCERs are more valuable
• lCERs need only be replaced at the end of the crediting period (potentially 60 years)
• tCERs are likely to have additional fees and taxes associated with their 5-yearly renewal
• BUT…the buyer bears replacement risk for lCERs – lCERs come with uncertainty
• Seller may not wish to be locked-in to a 60-year contract with a buyer
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Why buy expiring CERs?
• Lower cost than permanent CERs
• Buyer might believe that the cost of permanent CERs will fall in the future (i.e. future replacement is cheaper than purchase now)
• Buyer might believe that there won’t be any future commitment periods
• Stop-gap measure: buyer may be cash-constrained
• Buyer may not be interested in expiring CERs per se, but in the underlying project
• E.g. the buyer may be targeting the forestry sector for its sustainable development benefits
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