Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm. Trading Carbon as a Commodity Sale and Purchase of Carbon Credits CCLaw Assist Workshop South African National Climate Change Conference 18 October 2005 Paul Curnow Senior Associate Global Climate Change Practice Group Foreign & Commonwealth Office CCLaw Assist

©2005 Baker & McKenzie 2 Overview What motivates buyers? What are the different types of carbon credit? Different contracting approaches and emergence of standards Dealing with CDM risk in emission reduction purchase agreements

CCLaw Assist ©2005 Baker & McKenzie 3 What motivates buyers? What are the different types of carbon credit?

CCLaw Assist ©2005 Baker & McKenzie 4 Market for Carbon Credits Projected 5 billion by end 2005 What motivates buyers? Market for Carbon Credits Projected 5 billion by end 2005 Compliance markets Targeted offsets Voluntary or retail schemes Mandatory legal obligation to reduce greenhouse gas emissions Offset real or contingent risks that regulatory barriers may arise due to significant greenhouse emissions of a project Voluntary compliance targets for public relations purposes or to promote products as climate-neutral

CCLaw Assist ©2005 Baker & McKenzie 5 Types of carbon credits Voluntary corporate and retail schemes Buyer motivation Contractually-based credits No govt-approved or other standard Associated rules Govt-approved verification or other standard Emissions reduction Species of credit Approved Abatement Unit or Verified Emission Reductions Early corporate to corporate carbon trades Example Greenhouse Friendly 500 PPM Kyoto pre-compliance

CCLaw Assist ©2005 Baker & McKenzie 6 Types of carbon credits Regulatory-based credits Buyer motivation Created under mandatory (sometimes voluntary) rules or regulatory framework Associated rulesSpecies of creditExample Voluntary rules-based trading exchange Mandatory cap & trade scheme Mandatory baseline & credit scheme Exchange Allowance or Exchange Offset Allowance or Unit Abatement certificate, Project-based credit or Offset Chicago Climate Exchange EU Allowances under the EU ETS Certified Emission Reductions under Clean Development Mechanism

CCLaw Assist ©2005 Baker & McKenzie 7 Structure of the carbon market Allowance-based transactions UK ETS EU Emission Trading Scheme Chicago Climate Exchange NSW Greenhouse Gas Abatement Scheme Project-based transactions JI and CDM Voluntary Retail Other Compliance

CCLaw Assist ©2005 Baker & McKenzie 8 Different contracting approaches

CCLaw Assist ©2005 Baker & McKenzie 9 Emerging contracting approaches Standard sale agreement for contractually-based credits Emission Reduction Purchase Agreements for Verified Emission Reductions Emission Reduction Purchase Agreements for Kyoto Protocol credits or other statutory-based credits Commodity and derivative market- style agreements

CCLaw Assist ©2005 Baker & McKenzie 10 Factors influencing the adoption of different approaches Type of carbon credit Carbon credits from forestry sequestration Type of tradeType of buyer

CCLaw Assist ©2005 Baker & McKenzie 11 Dealing with CDM risk in emission reduction purchase agreements

CCLaw Assist ©2005 Baker & McKenzie 12 Key legal issues Defining the commodity CERs delivered into a registry account? VERs delivered through provision of Verification Report? Establishing and transferring legal title Warranties and indemnities Default, Termination and Compensation On delivery or on payment? CDM-specific or in relation to project generally? Events of default and termination events Compensation amount – market price, liquidated damages?

CCLaw Assist ©2005 Baker & McKenzie 13 Managing and mitigating CDM risk Risk Failure to register or non- approval of methdology Inaccurate validation/ verification Legal title disputes CERs or VERs Conditions precedent / Suspensive conditions Delivery shortfall provisions Back-to-back with DOE agreement Mitigation Strategy Back-to-back with third party contracts Warranties and representations regarding legal title

CCLaw Assist ©2005 Baker & McKenzie 14 Managing and mitigating Kyoto risk Risk CER market risk Delivery risks Registry delays and failures Different pricing structures Floors and ceilings Direct issuance into buyers account Undertakings regarding communicating with CDM EB Mitigation Strategy Undertakings regarding adding project participants Alternative delivery accounts

CCLaw Assist ©2005 Baker & McKenzie 15 Closing comments Range of motivations for buyers leads to complex markets No one standard contract can accommodate range of market variables (beyond price, quantity, delivery) not common to all transactions Pioneering of standards demonstrate potential reduction in complexity and hence increase in market efficiencies But different risks for different projects – still need to tailor standards

Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm. Questions? Paul Curnow Senior Associate