Developments in International CDM Markets Implications for ASEAN Countries

1. Developments in International CDM MarketsImplications 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.

2. Outline of the Presentation • 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

3. Buy Side: Who is Buying 2004 brings the first real sense of a formal market • Europe • Government Purchase Programmes • EU ETS beginning 2005-2007 • 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

4. 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 75-100M 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!!!!

5. 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 3rd Party CDM CERs from that country Expectation should be for MNC’s presenting their own CDM projects to host nation DNAs – 3rd party project finance will give way to balance sheet corporate finance as the dominant paradigm

6. 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?

7. Ranking Target Countries in Asia Tier 3 Tier 4 Abundance of Opportunities Tier 1 Tier 2 Commercial & Political Risk 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 3rd party support ( eg UN, World Bank or ODA)

8. Determinants of Country Attractiveness • Can a country be competitive in the CDM ifit 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

9. 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

10. Next Stages • 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 • 3rd 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

11. What Can ASEAN nations do to improve their position • 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