The carbon market From a Carbon Price to Carbon Finance

1. The carbon marketFrom a Carbon Price to Carbon Finance Patricia Rosenthal, Environmental Markets Originator CO2, CH4, N2O, HFC, PFC, SF6= UZS, EUR, JPY, USD? Designator | author

2. Agenda Fortis Carbon Banking Overview of Carbon Markets Origination – Kyoto Mechanisms Financing with carbon Assets Final Remarks

3. Fortis Carbon Banking

4. Fortis – Global Leader in Carbon • Fortis is a global leader in the carbon markets with a wide array of offering and has been involved since the inception of the carbon markets.Today we serve more than 200 clients in their carbon needs • We have a dedicated team of specialised sales and analysts in carbon who can give you specialised market insight and intelligence • As a major investor in the European Carbon Fund (investing 15 million Euros), we have built up considerable experience combining commercial and legal expertise in the CDM & JI approval processes and the associated risks

5. Carbon Financial Services • Trading Services • Accepting returns in carbon • Including carbon value in financing and due diligence • Clean Development Mechanism project financing • Trading on demand or to order • Index based procurement/divestment • CER purchasing and sales • Delivery date swaps (quasi repos) • Administration and Trust • Investing in and developing funds • Managing customers carbon accounts • Custody of other Kyoto Compliance Units • Fund custody and administration • Co-sponsorship of the European Carbon Fund to ensure reliable deliveries of Kyoto Compliance Units for customers • Clearing • Eliminate counterparty risk and guarantee trades • Cross commodity correlation model Fortis: new products for the emerging carbon markets CDP Climate Leadership 2006 – Top 50 Global Co-sponsor and guaranteed placement CP for European Carbon Fund Initiated index based position management contracts for customers Trading on behalf of >100 customers Cross selling successfully with trust, custody, escrow & settlement

6. FORTIS BANK SUITE OF PRODUCTS FOR THE EMERGING CARBON MARKET

7. Overview of carbon Markets • Kyoto Protocol • EU ETS • Voluntary Market • Difference – CER/ERU, EUA, VER

8. Kyoto protocol and global greenhouse gas emissions • In 2008, the greenhouse gas market becomes a lot bigger

9. Kyoto Market ANNEX I ANNEX I ERU CER Non ANNEX I

10. CDM current statusprojects in the pipeline (volumes)

11. JI current status • February saw the first JI project submitted for determination • In May Russia’s prime minister signed the country’s JI procedure, but no LoA have been given yet • JI potential in the new EU ETS member states is limited due to double-counting rules • For those countries JI potential is concentrated in non-CO2 projects • JI host countries remain non-EU members as Russia and Ukraine

12. After the validation by a Designated Operational Entity and the approval by a Designated National Authority, the project is submitted to the United Nations’ CDM Executive Board for registration. Primary CERs Price of ERPA (Emission Reduction Purchasing Agreement) depends on remaining risks procedure normally takes 6 to 10 months,can occasionally go up to 18 months If the project gets officially registered at the UN CDM EB, it is recognized as a CDM project. Following that, verification & certification occurs every 1-3 years. CERs can be imported in the EU-ETS by transferring them from the International Transaction Log (ITL) managed by the UN to a registry account on the Community Independent Transaction Log (CITL) managed by the European Commission. The link between the ITL and the CITL has not yet been established but the European Commission has guaranteed the link will be ready before April 2009. Upon verification, a corresponding number of CERs will be issued by the UN CDM EB. This quantity will vary compared to the planned quantity in the PDD. Secondary CERsProject origin matters - bilateral CDM project cycle, different levels of CERs Secondary CERs Project origin does not matter (if it is EU-ETS compliance)

13. EU Emission Trading Scheme • To help Member States comply with their Kyoto obligations, the EU established the EU Emissions trading scheme (EU ETS) • First International Emission Scheme ever • Industry from 27 EU countries under cap and trade ~12,000 installations from ~5,000 companies • EU ETS ~ 45% of EU emissions • Large emitters of CO2 must monitor and report their CO2 emissions. Every year these companies are obliged to surrender a certain amount of emission allowances to the government

14. EU Emission Trading Scheme • Compliance Mechanisms: • Get allowances for free from the government (this may change in the future) • Purchase allowances from other installations • Internal abatement • Reducing emissions outside: Kyoto Credits • 2 Phases: 2005 - 2007 (pilot phase) • 2008 - 2012 (Kyoto period) • EU has already indicated that a scheme after 2012 will be in place giving more confidence the market • The use of Kyoto Credits (CER/ERU) are restricted to a limit set by member states and European Commission. • On average companies can use up to 13% (~) of their allocated certificates in the form of CERs-ERUs for compliance purposes – arbitrage potential

15. EU-ETS Fundamental Signals • Distance between cap and physical emissions • Physical emissions not known: forecasts, estimates, predictions / NEWS SENSITIVE • Cap set by European Commission and member states: NEWS SENSITIVE • Weather • Precipitation impacts hydro power generation and compensation by fossil fuel fired plants • Wind impacts wind power generation and compensation by fossil fuel fired plants • Temperature impacts energy demand (heating in winter, cooling in summer) and corresponding emissions • Primary energy prices – fuel switch • If gas is cheaper than coal, gas is preferred = low emissionsIf coal is cheaper than gas, coal is preferred = high emissions • Depends on the balance gas/coal/CO2 prices • Supply from Kyoto projects • Other countries outside EU also demand CERs for compliance • Supply and Demand of CER/ERU uncertain

16. EU-ETS Success to DateDoes emissions trading work? • Q1 : Is the market sufficiently liquid? YES! • daily volumes increased by a factor 50 in two years • Q2 : Are EUA prices justified? YES! • market responds logically to fundamental signals weather, news, allocations, fuel prices • Q3 : Does the ETS lead to emission reduction? YES! • about 150Mton CO2 emission reduction in the EU power sector throughout 2005 and 2006

17. Voluntary Market • Non-regulatory purpose. Usually for marketing purpose, carbon neutrality programs or companies’ strategy to be front runners in future compliance schemes • VER (Verified Emission Reduction) • There is no unified watchdog. The process to generate those credits is not standardized • Market is developing new standards in order to secure carbon credit quality and to avoid double count of credits: e.g. Gold Standard Foundation, Voluntary Carbon Standard • Those credits are traded with a premium compared to other VERs • There is no real market price. Only one future contract available from CCX (Chicago Climate Exchanges). Other exchanges are planning to launch more VER contracts as for example Nymex in 2008 • Great Increase Potential!

18. Price Dynamics EUA CER ERU VER

19. Today’s Carbon Markets: CER/ERUs versus EUAs EUA CER/ERU

20. EUA and CER/ERUsMarket opportunity (arbitrage) • Why the price difference? • link ITL-CITL not yet established operators like to physically own what they buy • Phase Two allocations not yet finalised • Why is this arbitrage? • import limits not yet known • as long as there is a price difference, a company can exchange EUAs for CERs and cash in the price difference • not enough CERs available to cover all needsexpected supply < expected global demand • Window of opportunity • Price difference is expected to disappear before Mid2009 • CITL-ITL linked • Phase Two allocation and import limits fully known

21. JapanBAU short >1,000Mt CanadaBAU short ~1,500Mt ?(100)1,000 ? (700) 1,000 Post 2012 ??? ~1,400 ? OTHERSUS states, Australia, NZ,voluntary, … Global potential demand outlook EU non ETS>50% emissions CER & ERU 2,400M Phase II total ~1,400Mt short

22. Origination – Kyoto Mechanisms

23. Assistance, Guidance, Support CER/ERUs or interest Exchange Fee ER issuance Advice Equipment payment Brokerage Fee Order CER/ERUs Order Validation, registration, verification FinancingRisk advice Financial Package Registration Buyers Buyers Plants construction CER/ERUs CER/ERUs or fees Order CDM / JI Players Government DNA Financial Institutions Government ministries DOE Support/approval Application CDM/JI project developers Financier/Funds Multilaterals Compliance Buyers Trading house Plant manufacture Carbon broker Equipment manufacture Energy company Construction Carbon Exchanges Consultant /Aggregator Operator Construction firm Other players (law firm) EB/Supervisory Board

24. Main Financial Players and Buyers CDM/JI • Financial Institutions (EU): Fortis Bank, Merrill Lynch, Morgan Stanley, Barclays, Deutsch Bank, Dresdner, KfW, Credit Suisse • Brokers: TFS, Evolution, CO2e • Exchanges: Noordool, EEX, ECX • Compliance Buyers: Utilities, Cement, Glass, chemical, petrochemical, oil refineries, coke ovens iron and steel plants; energy-intensive industry, lime, brick, ceramics, pulp and paper industries. • Multilateral: World Bank, EBRD, ADB

25. Origination Process • Contact Client or Prospect • Project Identification • Screening Process • Term Sheet • Due Diligence and Client Acceptance • Emission Reduction Purchase Agreement • Administration Process – project participant, monitoring, transfer of credits Origination process does not stop after agreement has been achieved

26. An example of screening criteriaFortis Carbon Desk • Project size: The project should generate an expected quantity of at least 500,000 tonnes of CERs up to and including 2012. We accept bundled smaller scale projects. There are no upper limits to the project size. We could consider smaller projects based on other merits such as sustainability advantages. • Technology: The project should use an approved methodology by the United Nations • Sectors: Renewable energy, energy efficiency, methane recovery and utilization, industrial processes, waste management and fuel switch • Start date: Usually projects that have already started or plan to start operation over the next 1-2 years

27. CDM project’s risk assessment • - Fortis Bank Environmental Markets has undertaken significant research in the field of CDM project risk assessment. • - A thorough understanding and assessment of the CDM project’s delivery risk will enable us to maximize our investment return by constructing a diverse CERs portfolio in terms of technology, stage, size and geography. • - Fortis Environmental Markets’ desk has developed a highly objective and auto-improving Delivery Risk Model to screen most CDM projects. • - This model combines a serie of quantitative and qualitative metrics to help us gauge a potential CDM project’s expected performance.

28. Delivery Risk Model applied to a biomass CDM project in China

29. Financing with carbon Assets

30. Factors that influence CER/ERU price • Prices of CER/ERUs depend on a number of key factors, including: • EU carbon allowance benchmark price • Scope and methodology. Some buyers are willing to pay a premium for credits with great environmental and social track record • Credit of the Seller • Existing relationships with buyer-seller • Stage of project development: PIN, PDD, Registered, issuance • Project Size • Does the counterparty want advance payment? • Local investment climate • Delivery guarantee and damages for non-delivery

31. CDM project’s IRR and its enhancement drivers IRR calculation from a CDM project will very much depend on the CER price convened between the project sponsor and the CER buyer: • CDM projects distinguish themselves from other projects due to the enhanced cash flows generated by CERs sales. These additional cash flows could significantly enhance the IRR. • Depending on the technology used, a CDM project’s IRR could be doubled due to CERs sales. The carbon revenue of the project thus significantly increases the project’s financial viability. • - It is easy to understand that the extra IRR from a CDM project will also depend on the effective quantity of CERs issued to this project by the UN CDM EB (project Performance).

32. CDM/JI Project Financing

33. Project Financing CDM/JI • - Financial Models CDM/JI projects • Equity: a company finances part of a CDM/JI project in return for shared financial returns and CERs • Loan and Advance Payment: a company provides loan at concessional rates in return for CERs • ERPA: a company agrees to buy CER/ERUs from the project • - The main factors that affect successful closing of financing are: • The cash flow of the business to be purchased enables the business to comfortably service the proposed debt; • a strong management team • A strong business model (a profitable history and an ability to generate a predictable cash flow) • The accounts of the business which is being purchased/built shows steady growth in revenue and in profit margin • The purchaser is committing their own personal finance to the transaction and if the business is not a success, they will personally suffer a financial loss. • Financing CDM projects would be further facilitated, if • Offtakers commit to purchase credits for a long term • Country Risks are covered by the ECAs.

34. Nature of carbon finance for a typical CDM/JI project Capital Markets (Financial Institutions, Private Equity, Hedge Funds...) Equity and/or Debt Ownership + Dividend and/or Principle + Interest Power Purchase Agreement CERs Global Carbon Market Cash Cash By-product: CERs Main product: Electricity

35. Final Remarks

36. Beyond 2012… ? ? ? • Some observations • The EU-ETS has no sunset clause; it will continue after 2012. Currently, this commitment has only been given concrete form up to 2012. • Europe has already announced its determination to cut emissions further by up to 30% of 1990 emissions by 2020; (20% if other global regions don’t take on similar targets). • Players outside the EU have already expressed interest and are likely to start similar (compatible?) schemes soon. • As the emission reduction target becomes more ambitious, it is very likely that high CO2 price signals will be maintained in order to facilitate the necessary emission reductions. • To date, many of the world’s premier institutional investors have invested in CDM projects. This strong interest is mainly due to CDM projects’ unique return profile and superior diversification benefits due to its total lack of correlation with traditional securities market. • The next wave of carbon reduction projects will need to account for the value of carbon abatement in their discounted cash flow models, and in part rely on the carbon credits for repayment. “Investment in clean technology is risky, as CO2 may not have a value beyond 2012” Not including a value for CO2 in investment projections will become increasingly hazardous

37. Thank you patricia.rosenthal@nl.fortis.com Designator | author

38. EU-ETS Success to Date Logical response to fundamental signals • Market Fundamental : Phase One Policy & News market responds logically and consistently to policy & news on - allocations (number of allowances put in the market)- verified emissions (number of allowances needed)