natsource at a glance

1Some new thinking from Natsource.

More growth. Less pollution.

The State of the Carbon MarketThe State of the Carbon Market - Overview and market - Overview and market

characteristicscharacteristics

CDM WorkshopCDM WorkshopMexico City – April 22Mexico City – April 22ndnd 2005 2005

Neil Cohn- Senior Director

Natsource



Natsource at a GlanceNatsource at a Glance

Natsource’s Global Offices Europe

– London– Oslo

Asia– Tokyo

North America– Calgary– New York– Ottawa– Washington, D.C

South America– La Paz

Corporate Focus Emissions Markets Renewable Energy

Markets

Three Business Units Asset Management

Services Transactional Services Advisory & Research

Services



Natsource ExperienceNatsource ExperienceGHG Asset Management:

Development of the Greenhouse Gas-Credit Aggregation Pool (GG-CAP)

Representation of World Bank Carbon funds and Dexia-FondElec funds in Asia

Manage account for Fortune 100 Company in North American and UK Markets

Emissions Brokerage and Project Structuring Experience:

In 2004, brokered over 10 million tonnes of candidate CERs to European & Japanese buyers

Early pioneer in GHG transactions– Brokered the first transactions of U.K., Danish national allowances and first swap

– In 2000, brokered early transatlantic and transpacific transactions

In 2002 – 2004, largest broker in UK ETS & ROCs markets

A leading broker of US SO2 allowances, NOx allowances and credits, renewable energy certificates (RECs) and renewable obligation certificates (ROCs)

Strategic Services:

Provide market intelligence, policy expertise and assess risk to assist asset managers, Fortune 500 multi-national energy and manufacturing firms and governments

Advisors to developers on project structure

GHG project screening and portfolio modeling

Advisors to governments on emissions trading system design

Staff developed the first project-based mechanism designed to reduce GHG emissions and participated in the negotiations to develop the rules governing the project-based mechanisms in the Kyoto Protocol



Greenhouse Gas Greenhouse Gas Credit Aggregation Pool (GG-CAP)Credit Aggregation Pool (GG-CAP)

The world’s first private-sector mechanism to assist entities manage their compliance with the EU ETS and Kyoto Protocol

Strategy and benefits

– Pool large-scale demand to allow for purchase of high-quality, cost-effective compliance units

– Use proprietary model to screen and score projects

– Utilize risk management techniques to guard against under delivery

– Acquire a diverse portfolio to achieve a more favorable risk profile

Currently €98.6 million (approximately US$130 million)

– Nine Japanese, European and Canadian firms committed

Electricity Supply Board (Ireland), The Chugoku Electric Power Company., Inc., Hokkaido Electric Power, Company, Inc, Cosmo Oil Japan, Tokyo Gas…



GGGG--CAP – CAP – StructureStructure

Allows buyers to purchase tonnes collectively Large diversified portfolio Extensive risk management Reduced transaction costs

Risk

Management

GG CAP

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Seller 2

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More sellers

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Seller 5

Seller 6

More sellers

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Risk

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GG CAP

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Seller 1

Seller 2

Seller 3

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Seller 5

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More sellers

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GG CAP

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Greenhouse Gas Market Greenhouse Gas Market OverviewOverview



Estimates of GHG Market DemandEstimates of GHG Market Demand Market driven by Kyoto Protocol entry into force

– Requires developed countries to reduce their GHG emissions to approximately 5% below 1990 levels by 2008-2012

– Much of obligation will be devolved to private firms

Approximately 3.5 billion tons emissions shortfall in 2008-12 under BAU emissions estimates

– Japan is estimated to be short by approximately 0.8 billion tons during the five year commitment period *

– Canada is estimated to be short by over 1.2 billion tons during the five year commitment period **

– Europe is estimated to be short by approximately 1.6 billion tons during the five year commitment period ***

Modest demand in Europe from 2005-07* Japan’s Second National Communication to the UNFCCC (based on existing measures)

** Climate Change Plan for Canada, 2002

*** European Environmental Agency, GHG Emissions Trends and Projections 2003 (based on existing

measures)



Market Development Through 2004Market Development Through 2004 Traded volume more than doubled from 02-03 to 78 million tonnes

and doubled again to well over 150 million tonnes traded in 2004

Buyers purchasing high quality, potential compliance instruments

– Pre-compliance instruments trading for $3.00-$6.50 per tonne

HFC destruction projects created 31% of traded reductions

Reductions created by power sector projects account for 50% of traded volume

30% of traded ERs are created by renewable projects

Over 75% of traded ERs created by projects in Latin America and Asia

Japanese private sector has become most prominent market participant

* Lecocq, F. (2004) “State and trends of the carbon market 2004,”

Washington, DC: World Bank, based upon data and analysis provided by Natsource



Buyers Purchasing Higher Buyers Purchasing Higher Quality ERs Quality ERs

Buyers purchasing for compliance – 95% of reductions likely to count Projects with approved baselines reduce uncertainty

Source: World Bank Carbon Report



2003 Market Buyer’s Delta Region2003 Market Buyer’s Delta Region

Canada Falls From 1Canada Falls From 1stst to 4 to 4thth

In 2003 Canada Falls from top buyer to 4th place




2002/3 ER Volume Supply by 2002/3 ER Volume Supply by RegionRegion

Latin America Gains Early Lead

Transacting CER Supply

Latin America Gains Early

Lead Transacting CER Supply




2003/4 ER Volume Supply by 2003/4 ER Volume Supply by RegionRegion

Asia Surpasses

Latin America as

Largest CER

Supplier




CFB =World Bank Carbon Finance

Canada has big latent

Kyoto demand and

Brazil is favored for proximity

2004 Japan Doubles 2004 Japan Doubles ParticipationParticipation

Canada’s Share Falls AgainCanada’s Share Falls Again




2003 Volume by Technology 2003 Volume by Technology TypeType

MSW was the initial leading

technology




2004 Volume by Technology 2004 Volume by Technology TypeType

Huge HFC Projects

Alter Market Dynamics




Current Compliance Market Current Compliance Market PricingPricing

Source: Natsource, April 2005

Commodity Type Vintage YearPrice range (Offer) per tonne

CO2e

Kyoto Compliance Tools

CDM - CERs 2000 - 2012 EUR 4.00 - 6.50

JI - ERUs 2008 - 2012 EUR 4.00 - 7.00

Commodity Type Vintage Year Bid / Offer per allowance

National Compliance Tools

UK Allowances - Bid / Offer 2002 - 2003 GBP 2.80 / 3.30

EU Allowances - Bid / Offer 1st period (2005-2007) EUR 17.50 / 17.85



EU Market OverviewEU Market Overview



Status of National Allocation PlansStatus of National Allocation Plans European Commission has carried out 3 rounds of review against

Annex III allocation criteria In total 11 NAPs approved unconditionally:

– 1st round—Denmark, Ireland, Netherlands, Slovenia, Sweden. – 2nd round—Belgium, Estonia, Latvia, Luxembourg, Portugal and

Slovakia.– 3rd Round - formally adopted the national allocation plans (NAPs) of

Spain, Hungary, Lithuania, Malta and Cyprus – 4 Partially rejected and required further clarification – now received

final approval - Austria, Germany, Finland and France Poland asked for a 16.5% Cut (286m to 239m) by the EC -

deciding on how to respond Czech republic agreed a 9.4% Cut with EC (108m to 97.6m) UK resubmitted NAP for approval—adding 19.8mt over 2005-

2007 to their original draft NAP citing changes in emissions projections. Revisions rejected by European Commission and UK agreed to go on July NAP target (736m) whilst initiating legal action

Ongoing talks with Italy proving “difficult”. Only the Greek NAP has NOT yet been submitted.



Market SettlementMarket Settlement Transactions Transactions Emissions markets function like any commodity

market (Energy, gas, coal) Immediate settling (Spot market)

– Transfer is immediate. Seller’s account is debited and buyer’s account is credited. Buyer makes payment within 2-5 business days of receipt.

– Need Registries functioning and allowances issued Only Finland, Denmark, Sweden, Netherlands to date

Forward trades:– Credit and Contract issues important – Terms (price, quantity, vintage, delivery) agreed now and

payment can be made in two ways:1. Immediate settling: up front money paid to seller 2. Forward Settlement Transactions: current EU allowance

trades



EU ETS – The MarketEU ETS – The Market

Market characterised by forward trades of 10,000 – 25,000 allowances (larger trades reported)

– Traded contracts for 1 Dec 05, 1 Dec 06 and 1 Dec 07 Delivery– Credit and contract major issues with forward trades– Current minimum deal size 1,000 allowances

Ever Increasing activity in trades of EU allowances. – Over 30 million allowances have traded for all delivery years– Over 70% for 2005 Delivery

Market liquidity growing – Market still lacks depth and susceptible to sudden price

changes– Development of spot market will give more flexible credit

and contract issues



2004 – NAP effects dominate2004 – NAP effects dominate

UK, Germany to set tone with tough NAPs

Other NAP Announce loose targets + Linking Directive

Russian ratification+ EC accepts 2nd set of 8 NAPs

EC tightens, accepts 1st 8 NAPs



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1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

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Jan-05

Jan-05

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Feb-05

Feb-05

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Mar-05

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Mar-05

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Total weekly traded volume (2005, 06, 07) 2005 Contract Price

Natsource Europe Ltd, March 2005

Mild winter, High rainfall in Scandinavia

Oil, Gas, Power price all rise & coal use up

Polish NAP tighter, UK allocation to occur at lower NAP. Cold snap across Europe

2005 – Market driven by fundamentals2005 – Market driven by fundamentals



EU Market Pricing Factor:EU Market Pricing Factor:Dark Spread vs. Spark SpreadDark Spread vs. Spark Spread

Spark Spread = Difference between the Power price and the cost of Natural Gas

Dark Spread = Difference between the Power price and the cost of Coal + additional Carbon Allowances

Pricing Effects: When dark spread exceeds the spark spread, it makes

sense to prefer the coal over the gas plant. EU Pricing is currently driven by the economic dispatch of

power plants. The high price reflects the relative prices of fuels for power generation including natural gas, coal, and oil.

EU Allowances will adjust in value as – Dark Spread widens or narrows (i.e. expensive gas)– Price of power moves– Supply changes



EU Market Pricing Factor:EU Market Pricing Factor:Lack of Spot Market SupplyLack of Spot Market Supply

EU Utilities hedge “Dark Spreads” at time of generation

Current EUA market is only “forward” basis– Allocation of EUAs not yet facilitated (only 4 registries so far)

Large generators only current market participants– All need to buy EUAs– Not able to accept many potential seller’s credit risk

Registries finalization will allow Allocation– Will create ability for spot market to develop– Will decrease importance of credit risk concerns– Should bring supply to market and decrease price swings



EU: Currently a Restricted MarketEU: Currently a Restricted Market

Current Bids, offers and traded prices reported in the current EUA market are limited to large companies, such as utilities, oil companies and banks, with agreed contracts and approved credit lines in place - the “wholesale” market

Time and effort to put in place the infrastructure to allow them to freely trade with each other.

Without the necessary credit or contracts, companies are not able to enter this “wholesale” market and access the bids and offers reported. No natural sellers in wholesale market

Most industrial, “compliance driven” and Eastern European companies do not have the appetite, credit or resources to enter the wholesale market.

– Will develop bespoke trades– Natural buyers and sellers – How can they access the wholesale market?



Price: EU Allowances vs. Price: EU Allowances vs. CERsCERs

CERs trade at a discount to EUA, because of: Timing – CERs not issued or available

– Only EUAs available during tight market (Dark Spread) CER Risks

– Kyoto process risk Methodology changes (aggregated renewables, AMOO1 HFC)

– Host country risks Political, Taxation

– Project risks Technology failure, Financial, Improper calculations, Monitoring

– Seller Risks Credit, Fraud

– Transfer Risk Market will pay for risk-free compliance Market must pay for compliance when needed



CDM: The Art of the DealCDM: The Art of the Deal



CDM: Buyer’s PreferenceCDM: Buyer’s Preference LOW PRICES!!! Guaranteed compliance tools Consistent delivery schedule from Sellers Damages for non-delivery Creditable seller (Strict credit checks) Ability to move CERs, easily, around the EU and ITL

– May have multiple sites covered in EU or Annex I

Ability to become a Project Participant Prefer Payment on Delivery Ability to “Mark to Market” (may restrict contract

length)



CDM: Seller’s PreferenceCDM: Seller’s Preference

HIGH PRICES!!! Possible funding for PIN/PDD preparation Equity and/or debt participation from investors Upfront or partial upfront payments for CERs Transfer project risks/CER creation to Buyers Sales of CERs pre-PDD validation, approved

methodology and EB registration Clarity of rules from Meth Panel, EB & DNA Ability to, easily, deliver CERs to Annex 1 Parties

via the ITL



Carbon Market TrendsCarbon Market Trendsand Issues to Watchand Issues to Watch

Carbon Carbon Market EvolvesMarket Evolves

Post RatificationPost Ratification



Carbon: Supply & DemandCarbon: Supply & Demand Upward price pressure:

– Canadian buying has not yet begun– Japanese buying will continue– US regional programs are creating demand– EU tightness will seek CERs to fill needs

Downward price pressure:– No CERs have used Linking Directive yet to enter into the EU– EB is ramping up activity – more approved CDM projects– Corporations with excess allocation have withheld from market

pending institutional reasons (board approval, lack of credit and legal infrastructure, not professional traders, etc.).

– Russia, Ukraine (and New Zealand) supply is not been priced into the market

– Green Investment Schemes (GIS) will bring additional supply – Potential for huge non CO2 CDM projects including HFC, SF6 and

N2O– Canada may face a new election soon. If the Conservatives take over,

process could slow down demand for 1.3 billion tons of compliance.



What Happens Post What Happens Post 2012?2012?

Second commitment period of Kyoto is up for negotiation

Current demand is only for vintages up to 2012

Limited window for projects to be developed and viable with current short-term economics

China and India have indicated resistance to post 2012 commitments

Bush administration makes US Federal participation less likely



Mexico: Advantages & Mexico: Advantages & ChallengesChallenges

Buyers will pay for preferred CDM countries– A known and stable investment and crediting regime– A defined and speedy process for approvals (Established

DNA)– A known unchanging tax regime for credits. – Rule of law for adjudicating disputes in an impartial way – No investment rules that require state owned or in country

owned enterprises sharing of projects or credits

Mexico’s Advantages– Strong legal system exists for carbon contracting – Financial infrastructure in place– Strong sustainable development factors– Proximity to Canada

Challenges– Relatively late entry into CDM supply market



Natsource’s Recent CER Natsource’s Recent CER Transaction ExperiencesTransaction Experiences

Natsource has successfully finalized commercial terms for over 10 million CERs in late 2004 using a variety of innovative structures to best suit the specific profile of each project.

Projects located in India, S Korea, Bolivia and China and cover 5 different technologies (Hydro, Wind, HFC, Landfill & Waste Heat Recovery).

Active project clients include Ineos Fluor, Grontmij, Xinwen Mining Transactions signal growing strength that the CDM market offers

environmental service companies in launching successful emissions control projects.

Transaction structures involve a mix of techniques to address credit, counter-party and carbon-related delivery risks in a way that balances buyer and seller interests.

Recent deals have provided a range of financial arrangements, including upfront payment, part pre-payment part payment on delivery and the more traditional payment on delivery.



NATSOURCE TRANSACTION SERVICES:NATSOURCE TRANSACTION SERVICES:

Provide up-to-date market, price and trading information Devise suitable strategies for marketing and selling ERs through

forward, derivative and immediate settlement transactions; Develop the appropriate transaction structures and draft term-sheets

for potential transactions; Market sellers’ offer(s), negotiate with potential buyers and confer

with sellers regarding the risk profile of potential transactions to assist the seller to make an informed decision on which transactions to pursue;

Provide the seller, where suitable, with a draft of an Emission Reduction Purchase Agreements (“ERPAs”);

Assist in selecting and contracting with a suitable legal advisor to conclude the ERPA with buyer(s), where required;

Assist in obtaining approval, where required, from Annex 1 Countries; Manage the settlement of payment between buyer and seller,

assisting in the establishment of trustee accounts, where desired; Manage the transfer of the ERs to the buyers’ registry account

according to the terms agreed between seller and buyer.

Some new thinking from Natsource.More growth. Less pollution.

www.natsource.com

Neil CohnTel: +1 212 232 5305

Email: [email protected]

natsource at a glance

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