Developments in International CDM Markets Implications for ASEAN Countries Marc Stuart, Director CDM-ASEAN Disclaimer This document has been produced with the financial assistance of the European Community. The views expressed herein are those of CDM-ASEAN Project and can therefore in no way be taken to reflect the official opinion of the European Community.

 Market Developments - Who is buying ?  Volume and Pricing Projections  Does Geography matter?  ASEAN country competitiveness – to the outside world and among themselves  What is important in determining CDM attractiveness?  Project Transaction Issues  Conclusions and Next Steps Outline of the Presentation

2004 brings the first real sense of a formal market  Europe  Government Purchase Programmes  EU ETS beginning  Japan  Utilities and Trading Houses fairly active  DBJ and JBIC setting up purchase funds  International Institutions  World Bank Funds  Other  Wild cards – Canada, New Zealand  Sidelines – US and Australia  CDM MARKET IS AN ARTIFICIAL, POLICY DRIVEN MARKET – RISK OF REVERSAL WILL NEVER GO ENTIRELY AWAY Buy Side: Who is Buying

Pricing: Today and forthcoming?  EU ETS begins in 2005 – right around the corner – Emission rights allocations currently underway – 15,000 impacted entities  Significant shortfall to projected compliance – Import potential of M tonnes per year  Multiple National Purchase Programmes on the Way  Very likely that Europe will Set the Price and Japan will follow  Currently CERs are about 4-5 while EUAs are 8-12 – Mechanisms for transferring CERs into EU Allowances is not yet finalized  PLEASE Treat all price speculation with extreme caution!!!!

Does Geography Matter in CDM transactions?  For most commercial buyers, price and risk sensitivity outweighs geographic strategy  For government buyers, there are geographic preferences – Denmark is targeting Malaysia, Thailand, South Africa and Central America – PCF funds looking for a global approach with sectoral distribution – Forthcoming DBJ fund is expected to be “Asia weighted” – Does this mean ASEAN or India/China  For multinational “buyer/sellers” internal CDM opportunities are very attractive – However, exposure to a country does not equate desire for exposure to 3 rd Party CDM CERs from that country – Expectation should be for MNC’s presenting their own CDM projects to host nation DNAs – 3 rd party project finance will give way to balance sheet corporate finance as the dominant paradigm

Country “friendliness” to the CDM  CDM process is not sufficiently developed ANYWHERE to truly rank countries for CDM “friendliness”, except in the most simplistic fashion – Few countries would rank above “neutral” by purchasers - many would be ranked as either negative or “I don’t know”  No country has yet demonstrated a seamless pipeline of project development, financing and CDM approval – Moreover, Host nation Issues are only part of the equation – there is still Methodology Panel and Executive Board Approval to be gotten – Governments change and individuals transfer out of CDM responsibilities – Loss of institutional memory can be significant, because CDM complexities can take a while to master  Other commercial considerations are probably much more important, especially in project finance based power projects – Are there achievable opportunities? – Can a project get a power purchase agreements? – What is the business environment for investment?

Abundance of Opportunities Commercial & Political Risk Ranking Target Countries in Asia Hierarchy of Preference: Initially focus on Tier 1 countries, with consideration of Tier 2, if sufficient risk mitigation is present. Be opportunistic in Tier 3 countries. Avoid Tier 4 countries unless there is significant strategic support from buyer or other 3 rd party support ( eg UN, World Bank or ODA) Tier 1Tier 2 Tier 3Tier 4

 Can a country be competitive in the CDM if it chooses to;  Fix prices at levels not supported by the broader market (suggested by China and others)??  Enforce a mix of CER purchase across different project types (suggested in the past by Brazil)??  Enact significant CER sharing (tax) requirements, beyond conventional corporate tax regimes (suggested by many countries)??  Make Transaction Approval processes opaque and challenging??  BUY SIDE OF THE MARKET CAN ADAPT VERY QUICKLY TO UNFRIENDLY MARKET CONDITIONS  THERE ARE NO “NATURAL” SUPPLIERS OF THIS COMMODITY Determinants of Country Attractiveness

If countries are relatively “equal”, how are projects assessed by buyers?  Likelihood of Project Approval at HNA and EB level  Credibility of Counterparty  Price, price, price and price  Who covers upfront costs prior to ERPA?  Divisions of risk between buyer and seller – Underlying project risks (technology risk, political risk, market risk, etc) – Kyoto Risk – if Kyoto is not ratified, what happens – Will seller deliver even if it experiences underperformance?  Willingness to give buyers options for residue at; – Same price or discount to market price

 Certain CDM DNAs and CDM developers will get more experience and will be able to bring assets to market faster  With Liquidity and market certainty, new financial instruments will emerge  3 rd Parties Present Valuing ERPA contracts  Spot Market trading and a variety of options  Possibility that more speculative capital will enter the market (possibly in the form of higher risk project equity)  Greater Price Transparency and the gap between CER prices and EUA will converge  WILL THE BALANCE OF POWER FLIP FROM BUYERS TO SELLERS?  Could happen – with significant demand coming forward, may be a market reversal Next Stages

 Assuming the DNA office is competent and knowledgeable, keep individuals in position as long as possible  Continuity is key  Domestic capital for asset finance (either project or corporate) must understand that these cashflows are bankable  CDM enhances project economics,still requires underlying capital and domestic is the most realistic source  CDM alone cannot overcome other cross border investment biases but can create interest in new opportunities from unconventional sources What Can ASEAN nations do to improve their position