Pricing and Cost Evaluation of CERs

What types of financing are there ?

The process of developing a CDM project is elaborated on in the CDM Project Cycle, which covers the stages from Project Idea through to Development, Approvals, Validation, Registration, issuance of CERs, and ongoing monitoring protocols.

At various stages in the process, and given the right conditions, a project owner may secure investment in the underlying project, or a reliable source of revenue through the forward sale of CERs in agreements with Annex 1 (and some non Annex 1) parties.

Agreements may combine many kinds of financing, including:

• Debt – loans can be arranged with terms and conditions to reflect prevailing project finance interest rates, possibly at a preferential rate if an option to purchase certified emissions reductions (CERs) resulting from the project is included

• Equity – equity stakes can be agreed whereby the investor receives revenue from the proceeds of the project, including certified emissions reductions (CER) revenues or the CERs themselves. An option to purchase CERs may be included.

• CER sales which will generate revenue – depending on the status of the project, it can generate a secure revenue stream through the sale of forward contracts, where payment is made by the Buyer upon delivery of CERs on agreed future dates, or it may chose to wait until the CERs are generated, reducing delivery risk for the Buyer and increasing value risk but also potential gains for the Seller.

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What are the common pricing structures ?

CER prices are quoted in euros (€) or U.S. dollars (US$) for sale on the global market. Pricing structures offered are typically 'Fixed', 'Floating', or a combination of the two:

• Fixed price: This is an agreed price per CERs which will not change if the EUA allowance market moves against the Seller. This structure is often preferred by those requiring more certainty of the revenue stream for future budgeting plans, rather than being exposed to market fluctuations. A fixed price may also be preferable to lock-in current market conditions if perceived to be advantageous to both parties. Usually a fixed price will be lower than the equivalent Floating price, because the Buyer is taking all market risk.

• Floating price: This is a percentage of the average EUA price over an agreed number of days. A floating price allows Sellers exposure to potential gains in the EUA market, but also to potential loses should the market fall. This structure generally only works for European Buyers who have an exposure to the EUA market – Japanese Buyers who are not involved in the EU ETS tend not to link CER prices to the EUA market.

• Combination of Fixed and Floating: Buyers and Sellers may choose to specify a price based on fixed and floating components, in order to reduce exposure to either structure. For example, 50% of the agreed CERs may be at a fixed price, while the other 50% may be at a floating price. Or, a Fixed minimum price may be agreed, with an additional Floating payment.

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What is the price of CERs ?

CER prices are derived from the evaluation by both Buyer and Seller, of the various risk factors involved in a project and prevailing market forces. A CER Seller willing and financially able to take on project risk is likely to reap the benefits of an enhanced CER price, whereas a CER Buyer willing to invest in a riskier project will benefit from lower prices. Not all risks may be managed by the either Buyer or Seller, such as Sovereign risk. It is important to have a good feel of the market in order to maximize value from a CER contract.

Current market updates can be obtained from TFS, please contact us at +44 207 198 1600 for the latest prices and news.

Factors affecting CER prices include:

• EUA market price: For many Buyers, the value of CERs is benchmarked to the EUA price, the most established trading system for emissions. Volatility in EUA prices is typically reflected in the CER market. It is therefore important to have a strong understanding of the underlying market dynamics of EUAs.

• Credit: Due to the typical long-term nature of the CER contract, the financial position of both the Seller and Buyer are important. Given that parties in developing countries best suited to developing CDM projects may not have the requisite credit rating, and that both parties are often reluctant to foot the additional expense of a Letter of Credit (in many cases with good reason), it is not surprising that price negotiations often depend on how this issue is approached and managed. A good credit rating by an recognized agency is often beneficial, as it is perceived as an indication of the effectiveness of the Seller in successfully executing project activities outside of the CDM.

• Terms and conditions of the sale: the CER price in a contract is dependent on, for example, delivery guarantees offered by the Seller, volumes likely to be generated, the use of an established methodology, who bears the costs of developing CDM documentation (the PDD), project validation and registration, and any upfront payments which may be required. How much these terms affects the final price very much depends on the give-and-take negotiation conducted on behalf of both the Buyers and Sellers, and the eventual agreement reached.

• Sovereign risk – related to the development of political and legal infrastructure, currency volatility and perceived risk by investors. This also refers to the status of local infrastructure developed to encourage CDM activities, as this will determine how efficiently projects obtain national approval, and whether they are likely to meet the standards required for eventual project registration with the CDM Executive Board. The most pro-active countries such as India, Brazil and China have approved many projects, and have developed a streamlined and effective process for facilitating future projects. China, for example, has set up several provincial CDM centers to encourage progress, as well as developing an online facility listing all nationally approved projects as well as projects looking for investment or technology partners.

• Stage of project development: The more developed a project is, in terms of approvals and documentation as well as physical construction, the less likely it is in theory to fail in generating CERs. It is also likely to have overcome hurdles such as obtaining the relevant licenses for operation, getting host Government approval etc.

• Quality risk - Value-enhancing standards such as the CDM Gold Standard are gradually being adopted, leading the market in the direction of high-value, high-quality projects. These standards address key issues early on in the project development cycle, highlighting and resolving potential problems which may otherwise have led to e.g. a review at the registration stage, or a failure to register completely due to sustainability or additionality concerns.

• Delivery risk – a project can fail to generate the expected volumes of CERs for many reasons, for example the delayed commissioning of the project, lower than expected project efficiency, or lower levels of methane than expected, resulting in an under-delivery of committed volumes.

• Registration risk – despite best efforts, the CDM approval process (and changes to it) can still lead to projects being rejected for approval, or not even passing the validation stage, despite the good intentions of the Seller

• Access to market - generally, a wider access to market results in higher bids, due to the competitive nature of Buyers. For this reason, going through a CER broker might be attractive to both Buyers and Sellers – Buyers for the convenience, quality, range and access to projects, Sellers for the broad network of Buyers available, and expertise in negotiating contracts.

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What are the main costs ?

In addition to project development costs, there is also the "Share of Proceeds" payable to the UNFCCC when CERs are issued by the CDM Executive Board. The Share of Proceeds consists of:

• A levy to fund global adaptation, which is applied to all projects except those hosted by Least Developed Countries. The Share of Proceeds for Adaptation is 2% of issued CERs taken at the point of issuance.

• A levy to fund the administrative costs incurred by the CDM Executive Board. The Share of Proceeds for Administration was revised at the 23rd meeting of the Executive Board to be USD 0.10 per CER for the first 15,000 CERs issued annually, and USD 0.20 for any CER in excess of this. The SOP-Admin is levied annually at the point of issuance.

There is also a Registration fee which is payable at the point of requesting registration. The Registration fee is a one-off fee, and is calculated as per the SOP-Admin but using the average annual CERs across the crediting period. There is no registration fee payable for projects generating less than 15,000 CERs on average annually, and the fee is capped at USD 350,000. This registration fee is essentially an advance payment of the first year's SOP-Admin, and is subsequently deducted from the SOP-Admin payable when the first year's CERs have been issued.

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