Introduction of International Law Related to the CDM Development Process

1
Introduction of International Law Related to the
CDM Development Process

Peter Corne China Business Group Eversheds
LLP November 2007
2

• I.
• Overview of the International Legal Framework

3
Basic International Treaties on CDM

• United Nations Framework Convention on Climate
  Change (UNFCCC) was signed in 1992 and came
  into force on 21 March 1994
• Kyoto Protocol (the Protocol), aimed at
  reducing greenhouse-gas (GHG) emissions, was
  signed in 1997 and became a legally binding
  treaty on 16 February 2005
• The Marrakesh Accords were adopted in 2001 to
  flesh out the Protocol rulebook and further
  advance implementation of UNFCCC
• To-date, 175 countries have ratified the Protocol

4
Inside the Kyoto Protocol

• The Protocol sets up quantitative objectives
  for reducing GHG emissions up to 2012
• Annex I countries are obliged to reduce their
  collective emissions by at least 5 during
  2008-2012
• Credits obtained from 2000 to 2008 may be used to
  achieve compliance

5
Three Flexible Mechanisms

• Three mechanisms set out in the Protocol for
  emission reduction
• JI Joint Implementation (Article 6)
• (Annex I countries Annex I countries)
• CDM Clean Development Mechanism (Article 12)
• (Annex I countries Non Annex I
  countries)
• IET International Emission Trading (Article
  17)
• (Annex B countries Government Annex B
  countries Government)

6
Implementation of Kyoto

• EU launched the European Climate Change
  Programme in 2000
• UK successful emission control and a centre of
  emission trading
• Canada behind target - recent legislation

7
Different Approaches China Vs India

• India has the most issued CERs
• China has the highest overall projected CER
  volumes
• Unfettered competition Vs government regulation

8
Indian Vs Chinese Project Development

• More than 50 (11 out of 20 projects) rejected by
  the CDM Executive Board until August 2007 are
  from India, none from China
• 55 out of 136 projects that have been available
  for public comment before the end of 2005 but not
  been registered so far are from India, but only
  three from China
• Most of the Indian projects have not been
  developed on account of the CDM incentive and
  thus do not fulfil the additionality criterion

9
Indian Vs Chinese Project Development (ii)

• Indian DNA thus far does not seen its role as
  providing a PDD quality check
• Indian DNA supports principle of unilateral CDM
• China's DNA has a list of far-reaching
  requirements that project developers have to
  fulfil
• Unilateral CDM is now allowed but only takes up a
  small proportion of Chinese submissions
• ?? Which approach is more efficient to encourage
  environment-friendly projects?

10

• II.
• Fundamental Legal Principals of CDM

11
Key Rules Affecting CDM

• The use of CERs must be supplementary to domestic
  action
• The requirement of additionality
• The Baseline scenario
• CDM projects are defined by reference to strict
  conceptual boundaries
• CDM projects must account for Leakage

12
Supplementarity

• The Marrakesh Accords demand that emission
  reduction targets of Annex B Countries cannot be
  met solely through JI, ET or CDMs (Flexible
  Mechanisms)
• At present there is no numerical definition of
  supplementarity
• Although not directly binding on private sector
  participants in CDM projects, the supplementarity
  requirement raises commercial risks both on the
  supply and purchase side of CDM trades

13
Supplementarity Risks of Infringement

• Annex I Governments purchasing CERs may seek to
  impose contractual terms on a project permitting
  them to reduce or terminate purchasing
  commitments where they have a supplementarity
  problem

14
Supplementarity Risks of Infringement (ii)

• Annex I Governments may unexpectedly withdraw
  support for a project in development (which
  otherwise meets requirements) on these grounds.
• This poses a development risk to sponsors

15
Supplementarity Risks of Infringement (iii)

• Inability of individual Annex I investors to
  manage this risk (as they cannot control the
  activities of other investors of the same
  country) may dampen demand from the private
  sector for CERS

16

• III.
• Recent Negotiations and Discussions
• On International Rules

17
Negotiations on Post-2012 Arrangements

• Negotiations on-going
• Participants all recognize achievements through
  UNFCC and the Protocol
• Abandonment of the Protocol post 2012 will be a
  global tragedy
• CDM a good tool to mobilize climate-friendly
  policies and investments, but need to be improved
• Further discussion in Bali next month

18
Difficulties

• Commitments from developing countries?
• India
• China

19
Difficulties

• Voluntary vs Compulsory

20
Difficulties

• Energy resources are limited
• Energy policy is strategic for national economy
• Energy consumption countries and energy
  production countries have different perspectives
• Internationally, there are different interest
  groups, e.g., OPEC and IEA
• Even within a country, there are different
  interest groups
• Difficult to reconcile positions of different
  countries, difficult to reconcile positions
  within a country, US withdrawal from the Kyoto
  Protocol is an example
• Difficult to established a international
  mechanism after UNFCCC was signed in 1992, it
  took 5 years for the Kyoto Protocol to be signed
  in 1997, and another 8 years for it to be
  approved and took effect in 2005
• Wise to stick to the established Kyoto mechanism
  and aim to improve it

21
Discussions on Post-2012 Arrangements

• Pending formal agreement, there are discussions
  about
• Unilateral declaration by Annex I countries to
  extensively utilize post-2012 CERs
• Extension of the period of the next commitment to
  10 years or more
• Goal for developing countries pledge to reach
  intensity level in given sector, rewarded if
  achieved, no penalty if not achieved
• Proactive support for post-2012 CERs by
  multilateral financial institutions
• Post-2012 Carbon Fund launched by EIB

22
EU ETS Discussion on Post-2012 Improvement

• Post-2012 cap consistent with 2020 reduction
  target of at least -30 compared to 1990 levels
• Allowances to be auctioned as from 2013
• Limits to set quantitative and qualitative limit
  on the use of CDM/JI credits in the EU ETS
• Expansion of coverage sector (e.g., aviation)
  and GHG (e.g., N2O and CH4 from coal mine)
• No inclusion of domestic offsets and JI credits
  from EU countries into the EU ETS

23

• IV.
• Key Documents in CDM Project Transaction

24
Key documents in CDM Project transaction

• Traditional project documents construction
  agreement, purchase agreement, project finance
  agreement, power purchase agreement etc.
• Contract with CDM project consultant
• Contract with DOE
• ERPA

25
Key features of an ERPA

• International sale and purchase agreement
• Subject matter a special type of good
• Different degrees of risks at different stages
  approval, construction, cost overruns, project
  underperformance, delays, DOE fails to verify GHG
  emission reductions, rejected by CDM EB, changes
  in laws

26
Allocation of risks in an ERPA
Risks Seller to assume the risks Buyer to assume the risks
Project Registration/ DNA Approval/ Project Participation Status Conditions Precedent - Seller to apply for Registration Conditions Precedent - Buyer to obtain DNA approval to project participation
CERs shortfalls Seller guarantees minimum purchase quantity negotiate amended delivery schedule Pay cost of purchasing replacement CERs or market value of CERs Terminate contract - Buyer purchases actual quantity - Buyer has first right of refusal to purchase excess CERs
Failure to pay Payment on delivery Upfront payment standby L/C
Legal title to CERs Seller warrants full title to CERs delivered Seller warrants full authorisation to dispose of CERs (in an agency scenario)
27
Allocation of risks in an ERPA (continued)
Risks Seller to assume the risks Buyer to assume the risks
Creation of a security interest, transfer of assets Seller will not create security interest over project/assets Seller does not transfer project-related assets No corporate restructuring which may affect the Sellers ability to perform its obligations - Seller to notify Buyer when creating security interest on project or assets or when transfer any project-related assets Seller to notify Buyer in scenarios of corporate restructuring
Share of costs Seller bears project operation and monitoring costs, PDD fees, DOE validation fees, verification fees, EB registration fees, share of proceeds Buyer bears PDD fees, DOE validation fees, verification fees
Post 2012 credits Seller grants to Buyer first right of refusal and exclusive period for negotiation Buyer has no first right of refusal and no exclusive period for negotiation
Change in law/ failure of central systems Change in law provisions/ Force majeure provisions/ Change in law provisions/ Force majeure provisions/
Focal point Buyer / CDA acts as focal point Seller acts as focal point
28
Eversheds China Business GroupAn integrated team
of experts delivering the advice you need

• Experienced China practitioners in both London
  and Shanghai
• Strong Renewable Energy / CDM focus
• Work for both foreign companies pursuing deals in
  China and Chinese corporations in transactions
  outside the PRC
• Advice across time zones

29

• Eversheds LLP Shanghai Office
• Peter Corne
• Managing Director
• 86 (21) 6137 1001
• 86 138 1818 3382
• petercorne_at_eversheds.com