Financing ERPAs: A Case Study of the Nova Gerar Landfill Gas Project

Bruce Usher, CEO

EcoSecurities Group Limited

Carbon Finance Risk Mitigation Workshop

Public-Private Infrastructure Advisory Facility & CDCF-Plus

19 November 2003

Paris

Offices in Oxford, New York, Los Angeles, Rio de Janeiro, Sydney, The Hague

Nova Gerar (“New Generation”) is a joint venture between SA Paulista and EcoSecurities

SA Paulista, a Brazilian engineering and waste management company, with the concession to manage the Marambaia and Adrianopolis landfills on the outskirts of Rio de Janeiro

• SA Paulista’s core business is in traditional heavy construction sectors such as highways, railways, airports, ports, industries and sanitation.

• SA Paulista manages the largest domestic waste transfer station in South America (Transbordo Ponte Pequena) responsible for 60% of all domestic waste from Sao Paolo

EcoSecurities, a multinational environmental finance company, specializing in greenhouse gas mitigation

• 28 employees devoted exclusively to the GHG market, currently working on 32 CDM projects

• Exclusive cooperation agreement with Standard Bank in Africa, Russia and the Middle East

What is Nova Gerar?

The objective of the Nova Gerar joint venture is to develop the landfill gas collection system on the landfills managed by SA Paulista, called Marambaia and Adrianopolis.

This involves investing in a gas collection system, leachate drainage system, and a modular electricity generation plant at each landfill site (with expected final total capacity of 12 MW), as well as a generator compound at each site.

The generators will combust the methane in the landfill gas to produce electricity for export to the grid. Excess gas, and all gas collected prior to a grid connection will be flared. Combustion and flaring combined reduce emissions of 11.8 million tons of CO2 equivalent over 21 years.

Currently, 76% of the total waste generated in Brazil is disposed in ‘rubbish dumps’ with no management, gas collection, or water treatment whatsoever.

Marambaia is a typical case, where the previous operators have deposited waste for more than 15 years without any environmental licensing or following any environmental regulations.

The remaining 24% of waste is disposed in ‘controlled’ landfills and subject to regulation by the environmental authorities. Current Brazilian legislation, though, does not require that landfills collect and dispose of landfill gases. Adrianopolis is one of the first in Brazil designed to collect and utilise all the gas generated.

Methane Production at Marambaia and Adrianopolis

Project Description

Waste production (households, industry etc)

Waste collection, sorting and transportation

Landfill

Landfill gas production

Fugitive emissions

Flaring

On site use of electricity produced on-site

Electricity generation

Electricity to grid

End use

Landfill gas collection

NovaGerar Project has Two Phases

Phase 2, refers to electricity generation in both landfills. Modular electricity generation plants will be installed in the Marambaia and Adrianopolis landfills to start producing and selling electricity in early 2005.

– Marambaia plant capacity starting with 1MW expected to produce electricity until 2010.

– Adrianopolis plant capacity, starting with 2MW will evolve towards 12 MW in 2016 by the addition of 1 MW units and is expected to produce electricity beyond 2021.

Phase 1, to be initiated in December 2003 refers to the flaring of the biogas generated in the Marambaia and Adrianopolis landfills. Flaring will generate emissions reductions of 2.5 millions tons of CO2 equivalent from 2004 to 2012.

Nova Gerar is negotiating an ERPA with the World Bank to purchase all of the emissions reductions generated by the Nova Gerar project up to 2012, and a right of first refusal for emissions reductions generated beyond that date. The World Bank is purchasing the emissions reductions as trustee for the Netherlands Clean Development Facility (NCDF), a CDM project facility.

How attractive is carbon financing in Landfill Gas projects?

Country Project Type % IRR w/o% IRR w/cer's

IRR Increase [% points]

% IRR Increase

Romania District heating 10.5 11.4 0.9 9Costa Rica Wind 9.7 10.6 0.9 9J amaica Wind 17.0 18.0 1.0 6Morocco Wind 12.7 14.0 1.3 10Chile Hydro 9.2 10.4 1.2 13Costa Rica Hydro 7.1 9.7 2.6 37Guyana Bagasse 7.2 7.7 0.5 7Nicaragua Bagasse 14.6 18.2 3.6 25Brazil Biomass 8.3 13.5 5.2 63Latvia Methane 11.4 18.8 7.4 65India Methane 13.8 18.7 4.9 36Source: World Bank, J uly 2001

Nova Gerar Pro-Forma Cash Flows

PHASE II: POWER GENERATION 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Reciprocating engine generator rating (kW) 1000

N° of Engines, Marambaia 0 0 1 1 1 1 1 1 0 0

N° of Engines, Adrianopolis 0 0 1 2 3 4 5 6 7 8

Total installed capacity (MW) 0 0 2 3 4 5 6 7 7 8

Estimated On-line availability of Equipment (%) 90%

Annual power output Marambaia (MWh) 0 0 7,884 7,884 7,884 7,884 7,884 7,884 0 0

Annual power outputAdrianopolis (MWh) 0 0 7,884 15,768 23,652 31,536 39,420 47,304 55,188 63,072

Total Annual power output (MWh) 0 15,768 23,652 31,536 39,420 47,304 55,188 55,188 63,072

Tariff (US$/MWh) 50.00

Rate of increase (%) and evolution of tariff 0% 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00

Gross Electricity Sales (US$) $0 $0 $788,400 $1,182,600 $1,576,800 $1,971,000 $2,365,200 $2,759,400 $2,759,400 $3,153,600

Expenses 0 (16,000) (256,034) (361,621) (466,847) (572,794) (678,380) (783,967) (755,105) (860,692)

Net Electricity Sales 0 (16,000) 532,366 820,979 1,109,953 1,398,206 1,686,820 1,975,433 2,004,295 2,292,908

Power Plant O&M + Capital Costs 0.00 0 0 (567,648) (851,472) (1,135,656) (1,419,120) (1,702,944) (1,986,768) (1,991,150) (2,276,171)

POWER GENERATION CASH FLOW (U$) 0 (16,000) (35,282) (30,493) (25,703) (20,914) (16,124) (11,335) 13,145 16,737

PHASE I: FLARING 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Projected ERs Marambaia sold to World Bank (tCO2/yr) 86,708 79,622 72,791 66,313 60,285 54,737 49,659 45,024 40,802

Projected ERs Adrianopolis sold to WB (tCO2/yr) 38,292 75,738 127,209 168,687 214,715 265,263 310,341 354,976 409,198

TOTAL Projected ERs sold to World Bank (tCO2/yr) 0 125,000 155,360 200,000 235,000 275,000 320,000 360,000 400,000 450,000

Net price of carbon (U$/tCO2) $3.78 $3.78 $3.78 $3.78 $3.78 $3.78 $3.78 $3.78 $3.78 $3.78 $3.78

Gross Carbon Sales (U$) $0 $472,500 $587,262 $756,000 $888,298 $1,039,500 $1,209,600 $1,360,800 $1,512,000

% of carbon sales due to Municipalities 10% 0 0 (47,250) (58,726) (75,600) (88,830) (103,950) (120,960) (136,080) (151,200)

% of Carbon Credits due to EnerG (US$) 0 (132,141) (164,235) (211,425) (230,680) (249,180) (265,792) (271,832) (271,832)

Net Carbon Sales (US$) 0 0 340,359 423,027 544,575 657,618 790,320 943,808 1,088,968 1,240,168

Other Costs (16,000) (118,168) (118,308) (118,510) (118,669) (118,851) (119,056) (119,238) (119,420)

FLARING CASH FLOW, with Carbon 0 (16,000) 222,191 304,719 426,065 538,949 671,469 824,752 969,730 1,120,748

Nova Gerar Financing

USES

WORKING CAPITAL: $250,000

CAPITAL INVESTMENT

Phase 1 Flaring: $620,000 for flaring equipment and gas plant works

Phase 2 Electricity Generation (8 MW)

• $350,000 for grid connection and telemetry system

• $4,800,000 for power generators

SOURCES

SENIOR LOAN SECURED BY ERPA: $1,220,000

LEASING: Modular power generators will be leased as needed.

Monetisation of the ERPA

PRE-LOAN: Emissions Reduction Purchase Agreement

CERs (125,000 to 450,000 pa) Nova Gerar [9 years] World Bank

(Brazil) (US)$472,000 to $1,701,000 pa

LOAN: Monetisation of ERPA

CERs (125,000 to 450,000 pa) Nova Gerar [9 years] World Bank

(Brazil) (US)

$243,000 to $1,220,000 $1,472,000 pa $472,000 to

lent today $1,701,000 pa

Lender Debt Reserve $229,000 pa for 9 years Account

(12% discount rate, declining principal balance)

Lender Risks: The List is Long

Project Specific Risks

Operational• construction• operating performance• underproduction of CERs

Counterparty • buyer breaks ERPA contract • seller breaks ERPA contract• PPA contract broken• bankruptcy by developer• fraud

Carbon Financing Risks

Political• Kyoto Protocol ratification• Host country approval• CDM

Country Risk

• Sellers are located in developing countries

• Currency risk

Timing risk

Gray Market

Real Risks versus Perceived Risks: The List is Shorter

Project Specific Risks

Operational• construction• operating performance• underproduction of CERs

Counterparty • buyer breaks ERPA contract • seller breaks ERPA contract• PPA contract broken• bankruptcy by developer• fraud

Carbon Financing Risks

Political• Kyoto Protocol ratification• Host country approval• CDM

Country Risk

• Sellers are located in developing countries

• Currency risk

Timing risk

Gray Market

Mitigating Risks Operational Risks – classic project finance issues for mature technologies

Counterparty Risks – mitigate with strong deal structure and documentation• ERPA survives bankruptcy by developer (risk is low for RE projects)

• ERPA payments flow into a debt reserve account or directly to the lender

• ERPA is fixed price, hard currency contract coming from developed country buyer

Political Risks• Kyoto Protocol, Host country approval and CDM – mitigate with contingent documentation

or with VER structure (World Bank PCF)

• Hedge with third party option

Country Risk• Country risk insurance (if necessary given very low risk of impact)

Timing Risk • confirm completion of CDM approval process and ERPA documentation prior to loan

disbursement.

Gray Market Risk – not a risk, but an opportunity

Constraints

Complexity • lack of standardization under Kyoto Protocol and CDM mechanism• documentation and back office procedures

Deal Size • “Trash to cash” LFG projects are the most attractive emissions reduction projects, but are still relatively small (financing <$10 mm)

Market Structure• CDM has multiple, conflicting objectives (GHG reduction + sustainable development)• Conflicts created through participation of non-profits and multilaterals (crowding out, competitive issues)• Time pressure, or lack thereof• No incentives for early participation / creation of liquidity.

Real Opportunity

High yield / low risk investments:

• Developed country project finance type risk

• Mezzanine, developing country type returns

High value-added financial service – complex, differentiates banks, rapid growth

Requires financial institutions with both local & international expertise

Compare to derivatives market in 1980’s

Financing ERPAs: Conclusions

CDM is moving from concept to reality, creating an arbitrage opportunity for aggressive financial institutions to earn emerging market yields with developed market risks

Risks are overstated: most risks are not real and/or can be mitigated

Market constraints are understated

Financing ERPAs: A Case Study of the Nova Gerar Landfill Gas Project

Bruce Usher, CEO

EcoSecurities Group Limited

Finance Risk Mitigation Workshop

Public-Private Infrastructure Advisory Facility & CDCF-Plus

19 November 2003

Paris

Offices in Oxford, New York, Los Angeles, Rio de Janeiro, Sydney, The Hague