MDG Carbon Facility: what it is and how it operates

1. MDG Carbon Facility: what it is and how it operates Presented by Marina OlshanskayaTuesday, 25 September RBEC Energy and Environment Community of Practice Meeting 24-26 September 2007, Bratislava

2. Presentation Overview • Carbon market: latest update • MDG Carbon Facility Services • MDG Carbon Facility Business model & offer • MDG Carbon roles for COs • MDG Carbon Due Diligence (group work)

3. Current status of carbon market: volume • Market capitalization reached $ 30 bln • Near 3-fold increase in 2005-2006 • CDM/JI – 18% of the total market volume • Voluntary markets: insignificant share, but rapid growth

4. Current status of carbon market: location of CDM/JI projects (share of volume) • China continues dominating CDM market, with India and Brazil coming 2nd and 3rd • RBEC non-Annex I countries remain largely unrepresented • RBEC Annex I countries more equally represented with Russia, Ukraine and Bulgaria on the top of the list

5. Current status of carbon market: prices • Average prices for primary CERs in 2006 - US$10.90 (€8.40), a 52% increase over 2005 • ERUs average price in 2006 increased to US$8.70 (€6.70), a 45% year-on-year rise • But ERUs remained cheaper than CERs on average

6. More information on carbon market • State and trends of the carbon market 2007, World Bank at www.carbonfinance.org • Pointcarbon, www.pointcarbon.com • Prices and carbon market news service (free) • JI/CDM Monitor (subscription available - let Marina know if interested) • Climate-L:news and announcement list service on climate change policy and issues • UNEP Riso Centre: www.cd4cdm.org • Publications and CDM/JI pipe-line

7. UNDP’s Challenges in Developing Carbon Projects • As a technical assistance agency, UNDP does not have the mandate to trade carbon emission reductions and take on carbon market risks • UNDP will need to mobilize some working capital to meet start-up costs; • MDG Carbon supports commercial project developers and operates on a full cost-recovery basis. This is a major departure from UNDP’s traditional business model; • MDG Carbon fee policies must be supported by an ongoing, rigorous and transparent financial modeling process.

8. Overview of the MDG Carbon Facility Partnership with Fortis 2 Year Agreement (15M tCO2) Fortis UNDP II. Delivery of Carbon Credits ??? Payment of Cost Recovery Fee I. Project Development Services III. Payment for Credits Project Proponents

9. MDGCF services Services Offered by the Facility

10. UNDP - Project Development Services Registration 1st CreditIssuance ERPA • Part 1: • Due • Diligence • Part 2: • Project • Documentation • Part 1: • Due • Diligence • Part 3: • Establish • Monitoring System • Part 2: • Project • Documentation • Five Tools • Carbon Layer • Technical Feasibility • Finance & Legal • MDGs and Environment • Country risk • Two step process • Initial screening • In depth evaluation • Implementation and oversight of monitoring system in project’s first year • Preparation of documentation • Approval by host country and CDM Board • Review by 3rd party auditors 2nd installment: 142K 3rd installment: 72K 1st installment: 71K

11. Overview of the MDG Carbon Facility Partnership with Fortis 2 Year Agreement Fortis UNDP II. Delivery of Carbon Credits I-II-III Payment of Cost Recovery Fee I. Project Development Services III. Payment for Credits Project Proponents

12. Fortis – Carbon Banking Services • Carbon Market Price • Features • 15 million credits • Key feature: one price across the portfolio, irrespective of project characteristics • Benefits for project proponents • Fixed price protects against market downside • Advance payment for UNDP’s Cost-Recovery Fee • Fortis as a solvent counterparty MIN Source: European Climate Exchange, as of 6/25/07

13. Business Model: RFP Pricing • RFP Pricing Approach • Standardized price for all projects across the portfolio • Fixed purchase price per credit for all credits delivered under ERPA • Pricing formula • Price determined at ERPA signing • as HIGHER of • Floor component (10 EURO/tCO2) • OR • Rolling component (% discount to EUA Phase 2 Price one year ahead)

14. Business Model: RFP Pricing • Pricing Formula Example • Illustrative FSP Pricing • Floor: €10 • Rolling Component: e.g. 50% discount • Example at two market prices: MIN • EUA Phase 2 • at €12 • EUA Phase 2 • at €22 • Floor • Component • €10.00 • €10.00 • Rolling • Component • €11.00 • €6.00

15. What Price Will Fortis Pay for Carbon Credits? • MAIN BENEFITS OF FORTIS DEAL: • Standardized price for all projects across the portfolio • Guaranteed minimum price of 10 euros • “Rolling” component to take advantage of market upturns • Pricing formula • Has a floor of 10 euros – this is an excellent hedge against market volatility • Cannot reveal the “rolling” component discount • But if it was applied today, the price would be substantially higher than 10 euros • Reveal price when they enter into Letter of Exclusivity • This is standard practice for commercial confidentiality • Need to screen the proposal before revealing the price • Bank will offer to market (for free) credits beyond the 80%

16. Business Model: Host Country MoU • Objectives • Key Provisions • Host Country MOU is entered into with the government, covering all UNDP’s activities regarding MDG Carbon in that country; • Host Country MOU is an obligatory requirement in every country in which MDG Carbon will operate. This is because MDG Carbon’s Cost Recovery Fee is unique to UNDP and the Host Country MOU effectively ensures UNDP is acting within its financial rules and regulations. • UNDP signatory to the Host Country MOU should be the RR or his/her designate based on Delegation of Authority from HQ • Host country government authorizes UNDP to provide JI/CDM project development services to project proponents on a cost recovery basis • Host country should refer to this MoU in each Letter of No Objection and Letter of Approval issued to MDG CF Project Proponents

17. Business Model: UNDP Documents & Agreements with PP • Memorandum of Understanding • Information Note • Service Agreement • Informational / marketing • Manage liability from exclusive relationship with FSP • Manage risk and costs in performing due diligence, negotiating Service Agreement • Manage risks and ensure payment for services delivered • UNDP’s • Objective • Sets out UNDP objectives in carbon • Sets out rationale for exclusive FSP, including RFP process • Sets out “one-stop-shop” approach • Overview of UNDP services and payment terms • Establishes PP freedom of choice • Disclaimers on PP risks and securities laws • Mutual, non-binding intent to enter into Service Agreement • Exclusivity period of [3-6] months • Overview of due diligence activities and early termination • Contingency on FSP’s LoE • PP disclaimers regarding UNDP’s liability for FSP actions • Details scope and nature of services • Details payment terms and milestones • Limits UNDP liability • Defines Events of Default, including contingency on ERPA • Key • Content/ • Terms • Document is only delivered, not signed • Document later incorporated as annex in MoU and Service Agreement • Exclusivity agreement in “UNDP language” • Signed by Country Office and PP • Consists of two core components • (i) Cost-sharing agreement • (ii) Project document • Signed by Country Office (DoA from BDP) and PP • Government involvement via DNA Letter of Approval • Document • & Signatories • First contact. Prior to DD screening • Prior to/beginning of DD evaluation • Parallel to signing of FSP’s LoE • Prior to PDD development • Parallel to signing of ERPA • Timing

18. Overview of the MDG Carbon Facility Partnership with Fortis 2 Year Agreement Fortis UNDP Delivery of Carbon Credits Payment of Cost Recovery Fee Project Development Services Payment for Credits A) LoE B) Emissions Reduction Purchase Agreement (ERPA) A) MoU B) Cost Recovery Service Agreement Project Proponents

19. UNDP - Cost Recovery Fee • Cost Recovery Fee • Payment Approach • Projects lack capital, Fortis advances the costs • Payment in 3 installments on meeting pre-defined milestones • Full cost-recovery for direct costs • Cost recovery fee based on ongoing, rigorous modeling exercise Amount • Central Support • Regional Tech Advisers • Country Office • Consultant • Travel/Other • 3rd Party CDM Costs • TOTAL %age Milestone $39k $71k $52k $53k $30k $41k $285k ERPA 25% $71k Registration 50% $142k 1st CreditIssuance 25% $72k

20. MDGCF projected pipeline Initial Project Pipeline - Regional Distribution of Projects

21. UNDP - Team Structure • MDG Carbon Facility Team • Country Office Role • Part 1: • Due • Diligence • Part 2: • Project • Docs. • Part 3: • Monitoring System Project 1 Project n RTA CO Conslts RTA CO Conslts • Assist in identifying/sourcing projects • Assist in due diligence and • gathering of documents • Assist in project documentation formulation • Liaise with local authorities and actors • Oversee collection of operational data • Desk top review and site visits Carbon Projects Technical Central Support Finance & Legal Execution

22. Roles for Country Offices • Working closely with RTAs • Initiation: • Using GEF projects to remove barriers to private sector investment in emitting sectors • Where appropriate, capacity development in host country that leads to project opportunities • Assist host government to ensure efficient and effective DNA processes and project approvals • Canvassing opportunities for carbon finance • Identifying projects undertaken through GEF that have the potential for replication with CDM • Recognising project opportunities that come forward that are better suited to CDM than to GEF • Assisting Project Proponents to develop an effective PIN

23. Roles for Country Offices (cont’d) • Project development: • Facilitating host country Letter of Approval and other requirements for projects • Assisting RTAs and HO staff to gather necessary due diligence documents, in particular in assessment of country risk • Providing in-country ‘reality check’ of projects under development • Country level input to MDG assessment • Implementation: • Where necessary and feasible, provide technical assistance to project design &construct • Where necessary, facilitate government-project interaction • Where necessary, provide oversight of governance of project • Monitoring: • With RTAs, ensure monitoring is undertaken as required in the PDD

24. MDG Carbon due diligence • Commercial banks buying ‘product’ (emission reductions) – they need to be sure they are committing to a stable, safe partner in project proponent • requirement for formal due diligence process • MDG Carbon due diligence process that all projects must undergo: • Phase 1: Screening • CDM eligibility, financial and technical feasibility etc. • early elimination of ineligible or unviable projects • low cost to screen • Phase 2: Evaluation • in depth • May require additional studies or info collection • Recommend either for commitment or rejection. • Risk areas are identified and risk management strategies developed.

25. Due diligence Aspects • Due diligence on 5 aspects: • Carbon layer • Technical feasibility (engineering) • Financial/Management/Legal viability • Compliance with environmental & social principles + MDG impacts • Country risk

26. SCREENING Carbon layer Technical feasibility Financial and Legal Country risk E&S compliance + MDG impacts EVALUATION Commitment Due diligence aspects in Screening and Evaluation • Intensity of due diligence varies between screening & evaluation depending on aspect • e.g. carbon layer due diligence performed mainly at Screening while MDG impact assessment requires more effort and is conducted at Evaluation • Due diligence applied in coordination and iteratively • e.g. if Carbon layer assessment reveals low volume of CERs, the underlying financial security is analyzed before continuing with other aspects

27. www.undp.org/mdgcarbonfacility/ • www.mdgcarbonfacility.org/

28. Group work: Kazan Biogas Project • Group 1: Carbon layer (Anita) • Group 2: Technical feasibility (Dima) • Group 3: Financial/management/legal (Jamila) • Group 4: Env & social safeguards + MDG impact (Katalin) • Group 5: Country risk (Aleksandar)

29. Group work: results (5 min per group) • Key Project strengths and benefits (A-B) • Key identified risks (C-D) • Risk management strategies for identified risks • Overall recommendation (A-D)