Carbon Finance Risk Management Marina Olshanskaya Regional Energy/Kyoto Protocol Specialist RBEC Energy and Environment Practice Meeting Wednesday 27 th September, 2006 Bratislava, Slovakia

1 RBEC Energy and Environment Practice Meeting: Carbon Finance September Presentation Overview 1.Overview of carbon finance risks 2.Steps in MDG Carbon due diligence processes 3.Senegal Case Study

2 RBEC Energy and Environment Practice Meeting: Carbon Finance September Managing Carbon Finance Risks CDM and JI projects involve the creation of assets through projects located in emerging markets, over a period of many years, and which result in the absence of invisible gases, where the host country must consent to transfer the asset to the buyers, and the activity is measured using methodologies that are not yet fully established.

3 RBEC Energy and Environment Practice Meeting: Carbon Finance September Carbon Finance Projects PROCESS PROJECT MARKET COUNTRY Risk Nature of Risk Mitigation Approach Established Methodologies Reliance on fully developed methodologies during start-up phase; Partnership with key DOEs Due Diligence CDM/JI eligibility appraisal by UNDP Carbon Methodology Advisers (MA). Host Country Carbon Appraisal (DNA, legal framework, etc.) Policy/Cap. Dev. to DNA Monitoring and pre-verification of CERS by UNDP COs and MAs DNA refusal to approve the project/change in DNA policy Failure to comply with rules and requirements for validation and registration under the CDM Inaccurate validation/verification by DOEs Failure to correctly monitor ERs

4 RBEC Energy and Environment Practice Meeting: Carbon Finance September Carbon Finance Projects PROCESS PROJECT MARKET COUNTRY Risk Nature of Risk Mitigation Approach Due Diligence Project design and Developer Appraisal leveraging UNDP GEF project risk management system Enhanced development benefits Carbon Certification of COs EFPs and RTAs Independent assessment of project performance criteria Buffer of ERs retained Time/cost overrun Miscalculated ER project performance Project operation not up to technical specs Changes to project assumptions making project unviable Facility management Damage to equipment Project proponent default Interest rate/currency fluctuation Natural catastrophes Financial Instruments Standard Insurance

5 RBEC Energy and Environment Practice Meeting: Carbon Finance September PROCESS PROJECT MARKET COUNTRY Risk Nature of Risk Mitigation Approach Market and Product Diversification Compliance and voluntary markets (market hedge) Basic & premium carbon products uniquely differentiated and appeal to different buyers Financial Risk Mgmnt Partnership with existing Financial Firm Cost Recovery upon project registration Demand/Price risk – evolution of ER markets Failure to negotiate optimal terms for project participants in an ERPA Failure to pay ERs/breach of contract owning to fall in market prices for ERs Post Kyoto risks Carbon Finance Projects

6 RBEC Energy and Environment Practice Meeting: Carbon Finance September PROCESS PROJECT MARKET COUNTRY Risk Nature of Risk Mitigation Approach Due diligence Host Country Investment Appraisal Drafting of contracts by UNDP counsel Contract enforcement Currency inconvertibility Nationalization of assets/host Country Gov. claiming title to ERs Weak Governance Host Country non compliance with KP. UN Country Presence Mainstreaming of Carbon Finance into UNDP Country Programming SBAA Carbon Finance Projects

7 RBEC Energy and Environment Practice Meeting: Carbon Finance September Due Dilligence Process for MDG Carbon: Due Diligence of Underlying Project: Need to check that the proposed project is technically, financially and institutionally sound Group exercise (today): Senegal Case Due Diligence of CDM/JI layer: Need to confirm that the project is in line with CDM/JI requirements and that GHG emissions are quantifiable at reasonable cost (relative to expected income), so that carbon process risks and costs do not become a threat to the viability of the underlying project Group exercise (tomorrow): Several PINs from RBEC

8 RBEC Energy and Environment Practice Meeting: Carbon Finance September Due Dilligence Process for MDG Carbon: Due Diligence of MDG layer: Need to ‘measure’ in a standardized and credible way how much a project impacts the MDGs, allowing for project comparison and prioritization, and potentially for differentiated pricing of CERs/ERUs Work in-progress: presentation (Matt – tomorrow), Friday – group exercise (voluntary) Managing “Process” Risks: Need to ensure the project is in line with National CDM requirements and get a Letter of Approval from DNA Host country carbon appraisal and capacity building for National Institutional Framework (tomorrow presentation on Host Country requirements)

9 RBEC Energy and Environment Practice Meeting: Carbon Finance September UNDP’s Due Diligence in Carbon Finance Under the partnership with the World Bank, UNDP aims to ultimately be responsible for due diligence with respect to the development of projects, while the World Bank will be responsible for due diligence related to the market for carbon credits. UNDP’s capacity to deliver supply aggregation benefits to project developers will also depend on MDG Carbon capacity to demonstrate to commercial carbon funds that its due diligence substantially reduces the risks and transaction costs of dealing directly with individual project developers.

10 RBEC Energy and Environment Practice Meeting: Carbon Finance September Review of Senegal Case Study: Risk Assessment Key Outputs: Preliminary assessment of the general attractiveness of the project for MDG Carbon What is the missing key information to conclude the assessment? What are the main risks?

11 RBEC Energy and Environment Practice Meeting: Carbon Finance September Review of Senegal Case Study: Risk Assessment Feasibility of the underlying project: Technical feasibility: Is the proposed project technically sound? Is there a credible feasibility / pre-feasibility study available? Financial feasibility: Can you assess financial feasibility of the proposed project and its proponents? Institutional feasibility: Is the ownership of the project and resulting emission reductions clear? Could there be competing claims? Have the key stakeholders identified and the related consultations undertaken? Are they supportive? Does the project fit with national policies, legal and regulatory framework? What is the expected social, economic and environmental impact of the project?

12 RBEC Energy and Environment Practice Meeting: Carbon Finance September Review of Senegal Case Study: Risk Assessment Feasibility of the carbon layer: Is the GHG reduction significant enough (preferably over 25kt CO2eq a year) ? Timeframe for project implementation? (by 2008, btw , after 2010) Are there any laws or regulations that would oblige the proposed project activities or which would give a comparative advantage (such as subsidies, tax breaks etc.) either for the envisaged baseline or proposed project activities? If so, when they have come into force? What are the financial indicators of the proposed project compared to the baseline action? Can the proposed project be considered as a common practice in the country? Has the project a clearly defined baseline, against which the emission reductions can be calculated?