Components of cash flow(costs and revenues) in CDM projects

1. Components of cash flow(costs and revenues) in CDM projects 1.Capital costs – all capita expenditures to estabish the project. These include general investments and the purchase of equipment required to reduce GHG emissions. Future replacement and rehabilitation costs are also part of capital costs. 2.Operating Costs – i.e. fixed and variable costs: Fixed or overhead costs are incurred irrespective of how many units are produced e.g. salaries, rentals etc. Variable costs are costs that vary with the project output e.g. cost of more fuel to produce more units of electricity. 3.Revenues – depend on the nature of tariffs and other product and service prices. Income from the sale of CERs is also part of revenues. 4.Interest payments – If the discount rate used reflects the cost of capital(debt servicing costs + returns to equity investors), then interest should be included in the discount rate.

2. Sources of financing Range of possible investors • national governments of industrialised countries • regional multilateral development banks • international financial institutions such as the World Bank • environmental non-governmental organisations • private companies from industrialised countries • philanthropic organisations and international foundations • local commercial banks

3. Marketing toinvestors • To win investors project developers should know which parameters are critical for investors viz: • Assess needs and timeframe adquately • Identify reasonable price parameters for the carbon credits • Develop a selling strategy with an ideal transaction volume and selling price • consider appointing a consultant, lawyer, or market agent who can act in good faith on your behalf i.e develop plans and facilitate complex transactions • Establish a methodology to calculate emission reduction and project and project base lines i.e. a methody that conforms to evolving rules of the CDM.

4. Financing Models • Conventional Project Financing : • Corporate financing by project host • Equipment lease financing • Up-front payments • Low interest loans or debt • Micro-credit (1) Conventional Project Financing (e.g. banks): i.Advantages - from point of view of project sponsor: (a) Ability to raise large amounts of capital (b) Improved rate of return for equity providers (c) Limited or no recourse to the assets of the project sponsors ii.Disadvantages: (a) Cost and time to obtain project finance (b) Contracts must be with credit worthy counterparties (c) Delayed returns on equity

5. Financing Models (2) Corporate financing by project host(100% equity financing by developer) i.Advantages: (a) Project retains all the CER revenue from project (b) Financing may be raised more rapidly ii.Disadvantage: (a) Lack of expertise – unlikely that the project host has all elements of specialised expertise required. This would require outsourcing some elements of the project e.g. installation of plant and equipment. (3) Equipment lease financing – depends on type of equipment etc i.Advantages: (a) Reduced up-front expenditure and closer match between lease payments and project revenue (b) Management of equipment performance risk ii.Disadvantages: (a) Limited ability to modifications to equipment ( b)Relatively high cost of capital

6. Financing Models (4) Supplier Credit – financing provided by suppliers of goods and services i.Advantages: (a) Widespread availability (b) Deferred payment for up-front capital expenditure ii.Disadvantages: (a) Relatively high cost of capital (5) Up-front payments i. Advantages: (a) Repayment of up-front capital expenditure can be brought forward (b) Relatively rapid and low cost due to dilligence by CRE buyers (c) (Possibly) less conservative view of CDM-specific risks ii.Disadvantages: (a) Risk allocation towards buyer (b) Lower net CER revenue for project host/developer (c) May not solve problem of obtaining finance for construction

7. Financing Models (6) Low interest loans or debt – e.g. development banks with lending programmes i. Advantages: (a) Stable currency (b) Support with CDM component ii.Disadvantages: (a) Loans must fit the objectives of the lending programme (b)Stringent due dilligence (7) Micro-credit- aimed at providing small amounts of credit to lenders with limited ability to pay i. Advantages: (a) Access to finance – often no collateral ii. Disadvanatages: (a) Limited scale (b) High interest rate

8. CDM project risk profile and its impact on CER price

9. Types of risks in CDM projects 1.Generic project risks: • Counterparty risk – Can the counter party be relied upon to deliver? In CDM, the counter party is the CER seller when entering into a forward contract with a CER buyer. • Baseline risks: It is the sum of carbon stock changes on the project area in the project’s absence and subject to external influences(e.g. price variations of timber or alternative land use products or migration). PDD should explore the likelihood of occurence of baseline-related risks.

10. Generic risks(cont’d) (iv) Commercial risks:these risks are under the control of the project developer; it is prudent for the project developer to mitigate them. Risk mitigation should be guided by standards and criteria for good practice guidance in the forestry sector.High initial costs can be recovered by increased project permanence and credibility - both of these lower commercial risks. (v) Institutional Risks: e.g. unplanned events in host-country: Radical changes in government may lead to a risk of all types of foreign direct investment. For example, social unrest leading to invasion and sequestration losses. This could be mitigated if the investor issues a list of countries whose institutional risks will not be covered by the investor. (vi) Host country takes over commitment in the land use sector: Host country may undergo a change of status within the climate regime i.e becoming Annex I. The effect on A/R projects is a conversion of expiring CERs issued to permanet reduction units with the subsequent risk of the release of sequestered carbon residing in the host country. This could be avoided through an MOU exante.

11. Generic risks 2. Plannig phase risks: • Feasibility risk: Risk that feasibility studies do not find a project feasible. • Permit or licence risk: Risk that permit or licence for the operation of the project is not granted 3. Construction Phase risk: (i) The risk that the project is not commisioned on schedule. (ii) Capital cost over-run risk: The risk that the costs involved in implementing the project are higher than expected. This can be managed through entering into fixed price contracts for the principal components of the project.

12. Construction phase risk(cont’d) 4. Operational phase risks: • Market risk: The risk of price fluctuations for the outputs of the project i.e prices may be lower that expected due to lower demand or increased supply from competitors. • Financial risks: The risk that interests rates, inflation, exchange rates or any other financial variables may adversely affect the financial performance of the project.

13. Risk(cont’d) Project sponsors usually undetake risk assessment early in the project planning process. Risk assessment steps: • Risk identification: Identificcation of all the risks associated with the project. Project sponsors and lenders may commission studies from independent experts. • Risk matrix: A matrix that plots each risk against the phase of the project in which it occurs, its likely impact and how it can be mitigated. • Quantitative risk assessment: Quantitative estimate of the total value at risk or a comparative value index i.e. comparing with other projects.

14. Risk Matrix Risk matrix increases confidence of investors if the developer demonstrates a proactive attitude towards mitigating risks. The matrix should contain the following: (i) categories of risks in question (ii) exact nature of the risks (iii) which are most affected by risks (iv) all mitigation strategies adopted to counter those risks (v) the financial or other consequences of any mitigation instruments and strategies

15. Risk Matrix