* * EBRD leading renewable energy revolution >> New 4 Energia plant in Latvia >> New projects agreed by WGBC and EBRD >> Poland hosts EBRD meeting >> Armenia to benefit from EBRD loan >> EBRD provides loan to Kobuleti >> New sewage systems brought to parts of Slovenia >> Businesswomen receive welcome boost in Croatia >> Big boost for Lithuanian e-communications market >> Regional Energy Market should be established in Baltic Region >> Czech government announces new efficiency programme >> Renewable energy hits Croatia >> EBRD investment ensures green future >> €11 million loan to provide clean water to Bosnia and Herzegovina >> Romania set for daily fines of €38,000 >> CIMC opens production plant in Poland >> Slovenia aim to reduce building’s energy usage by 30% by 2030 >> Mapei announces HUF 1bn (€3.2m) investment in Hungary >> Mátrai Erőmű opens HUF 6.5 bln. solar power plant >> Elektroprivreda Srbije (EPS) receives €200 million loan from EBRD >> Mátrai Erőmű opens HUF 6.5 bln. solar power plant >> Hungarian government, Grundfos signs strategic partnership agreement >> GVH greenlights Veolia’s purchase of GDF Suez’s plant >>Bulgaria opens new gas transmission pipeline >> EU gives Romania a due date to close and/or restore 109 landfills > Bulgaria Expects to Choose Builder of Gas Link to Romania > EIB extends backing to SME and mid-top undertakings through BS in Slovenia >WOOD-TEC 2015: 14th International Fair for Wood and Furniture Industry in Brno > Laesti raises more capital for Sauga sawmill in Pärnu, Estonia > Poland’s BZ WBK Lease gets loan of €50 million for sustainable energy projects >Bosch invests HUF 9.3 billion in plant expansion > EBRD increases backing for sustainable energy in the Slovak Republic > EBRD targets increased energy savings in Ukraine >> EBRD and EU aim to and develop the water and wastewater services in Romania’s Ilfov County >> Enea to purchase an additional wind farm in CEE >> UPB Energy to build a EUR 30 biomass energy plant in Latvia >> REC celebrates 25 years, embarks on route for the foreseeable future >> Low-carbon city forum focuses on green development >> WIL has many years of expertise in the tyre recycling business >>EBRD and EU look to improve Kazakhstan’s long term source of water >> REC celebrates 25 years, embarks on route for the foreseeable future >> WIL has many years of expertise in the tyre recycling business > RWE to expand wind power portfolio in Poland > Environment : EU Commission brings POLAND and SLOVENIA to The court for e-waste failings >EUR 35 mln will be invested in a Romanian eco-residential complex >> Brodosplit Shipyard in the Adriatic port of Split >> EBRD Transition Report 2013: Emerging economies can break through reform stagnation >> Finish company Fiskars thanks MOL for 350% increase in sales >> Ikea largest store in Poland is completed in Wrocław >> EBRD extends extra €15 million to Raiffeisenbank (Bulgaria) for energy efficiency projects >> Growth returns to Central Europe as eurozone exits recession >> EBRD considers financing first major wind farm in Kazakhstan >> Immochan plans to build shopping centers in CEE >> Swiss electric giant LEM opened a new high-tech factory in Bulgaria >>EBRD lends Rb 1.7 billion to UniCredit Leasing Russia for energy efficiency >> Water supply and wastewater treatment in mid-sized municipalities in Serbia funded >> EBRD strengthens drive for energy efficiency >> Agreements with close Kazakhstan , Agreements with Taiwan developing >> Taiwan working closer with the EBRD on investments in Central Eastern Europe to help find Partners >> EBRD and Ministry support small business in Russian Far East >> Germany building a lead in Ukraine >> Enel Green Power builds a new interconnected PV plant in Romania >> Joint IFI Action Plan for Growth prepares emerging Europe for “competitive and prosperous future” >> China and Poland now connected by new Cargo Train links >> Poland the best economic performer in Europe during the last 20 years >> Poland:luxury goods sales increasing in Poland >> IFIs on track to deliver on investments for growth in Central and South Eastern Europe >> EBRD hails success of St. Petersburg clean river project >> EBRD channels €15.5 million to support major biomass project in Ukraine >> E-Commerce giant investing in Poland >> EBRD co-finances expansion of PEPSA wind farms in Poland >> Is Emerging Europe becoming a “new safe haven”? >> Eastern Partnership transport ministers meet at EIB >> EIB continues to support the upgrading of Sofia’s municipal infrastructure >> EIB supports more efficient power generation and emissions reductions in Russia >>EBRD backs Russian oil-field services company’s Eurobond >> EBRD supports renewable energy project in southern Ukraine >> EBRD President seeks more Asian investment in EBRD region >>New Trade and Banking deals between China and Hungary >> Taiwan Taipei China and the EBRD >> China Invests more into Bulgaria >> EBRD steps up support for energy efficiency investments in Belarus >> Clean water for Romania’s Bihor county >> EBRD issues US$ 250 million “Green Bond” >> Water and wastewater modernisation in Dolj >> EBRD supports bottled water producer in Azerbaijan >> Report: The Waste Water Industry of Poland >> Hyundai looking to invest in Waste Treatment in Serbia >> EBRD invests in Russian IT outsourcing provider MAYKOR >> Joint investment with the Russian Direct Investment Fund and CapMan Russia II Fund >> €10 million loan for Albania’s Credins Bank >> Garbage Management Is a Problem in Russia >> Eastern Europe countries must invest in the economic upturn-GfK >> EBRD supports energy efficiency lending and trade >> Serbia’s economy reindustrialization strategy includes the development of IT >> Rompetrol wins US$1.1bn contract to modernise Kazakh refinery >> EBRD helps Ecoprod generate power from biogas >> The largest oil and gas mine in Poland launched >> Ukraine government approves Energy Strategy until 2030 >> Romania aims to raise €600m from Romgaz IPO in November 2013 >> Non-residents’ direct investment in Romania estimated at EUR 666 million >> EBRD helps Ecoprod generate power from biogas Ukrainian agribusiness firm turns waste into electricity >> US-based AECOM and South Korea’s Hyundai Engineering & Construction are interested in developing major Romanian infrastructure projects >> Energy efficiency investments to boost Podravka’s competitiveness >> Alstom was awarded a €100 million contract to supply 6 Francis turbine-generator units and auxiliaries in Albania >>> €190 million in loans for wood processor Kronospan Funding for facilities in Belarus and Russia to develop forestry sector >> EBRD boosts COSMOTE in Romania’s 4G race €225 million loan for better infrastructure in telecoms sector >> Improving the sustainability of SPAR Slovenija EBRD to provide to €40 million loan to support retailer’s development >> Germany will provide EUR 35 million in support for two energy projects of FYR Macedonian Power Plants >> New EBRD loan encourages Romanian SMEs to invest in energy efficiency €10 million to UniCredit Tiriac Bank to help the private sector cut energy bills >> EBRD finances water supply improvements in Yerevan €5.4 million to rehabilitate water supply infrastructure operated by Yerevan Djur CJSC >> EBRD 10-year loan for main city on Sakhalin island First major investment in decades for district heating system EBRD is driving energy efficiency in Moldovan households >> Romania passes law backing Nabucco gas pipeline project >> Hungary, Austria, Romania and Bulgaria back Nabucco West over TAP rival >> EDF plans €300m investment in Rybnik plant modernisation (Poland) >> Romania approves cut in green certificates and renewable incentives >> EBRD President Sir Suma Chakrabarti says corruption is deterring investment >> FYR Macedonia investment opportunities presented in Malaysia >> GE is Helping Europe to Improve Grid Efficiency, Enable Optimum Asset Management and Enhance Active Network Control >> 6 million Euro Albanian gas power plant will export 70 % of the plants production >> Serbia, Czech Republic start environmental protection cooperation >> An integrated biorefinery for processing crustacean shell waste into specialty and fine chemicals underway > Gasmet: Advanced Gas Detection Technology Supports Arctic Greenhouse Gas Research >> EBRD steps up support for Romanian SMEs >> EBRD supports Montenegro’s power grid upgrade, link to Italy >> EBRD energy efficiency funding for Russian homes >> Financing sustainable energy investments for Bulgarian business EBRD supporting energy efficiency in Slovak Republic >>> €10.3 million extra for Shymkent wastewater modernisation in Kazakhstan >>> Warsaw and Vienna exchanges discuss merging to create CEE share trading hub >>> Donor funding for environmental investments in Belarus >> EU-funded project will reduce electromagnetic field exposure by 50% >>Serbia's industrial production increases by 13% >> A snapshot of ICT in Serbia >> In the starting blocks >> Poland listed as one of Europe's windiest locations >>> AIR POLLUTION Warsaw Entry forbidden >>> Donor funding for environmental investments in Belarus >>> Chinese engage companies from Bosnia Herzegovina for Stanari power plant >>> EIB may lend $1.2 bln for Romanian projects in 2013 >>> EBRD contributes to safety of Ukraine’s nuclear power stations >>> EMS takes on eastern European auto supply busines >>> Taiwan, EBRD ink green investments pact >>> EIB supports modernisation of air traffic management infrastructure in Ukraine >>> EIB and EBRD to support completion of TES-Thermal Power Plant Sostanj project >>> EIB and BCR continue to support SMEs, midcaps and municipalities in Romania >>> EBRD President Chakrabarti visits Taipei >>> EBRD and partners explore next-generation biofuels >>> EBRD strengthens capital base of Siauliu bank >>> Bulgaria’s Biomashin attracts EBRD support 3 New Wind Farms For Romania >>> EBRD invests in Lithuanian port’s future as major hub >>> Biggest ever EIB loan in Slovenia: EUR 500 million for co-financing with EU Funds >>> EBRD adopts new Russia strategy for 2013-2015 >>> EBRD lends to Ukraine’s Coal Energy >>> EBRD boosts support for Belarus banking partner >>> EBRD channels safer drinking water to more of Tajikistan >>> Head of the EU Delegation: Serbia and EU to commence accession talks soon >>> New Joint IFI Action Plan for Growth in Central and South Eastern Europe >>> Poland to get new 53 MW wind farm in Kukinia: EBRD finances a new wind farm and supports the existing one in Tychowo EIB reinforces its support for upgrading Poland’s energy distribution network >>> EIB supports SMEs in Romania with EUR 45 million >>> Hungary: EIB continues to support smaller private companies with EUR 100 million >>> Leasings up in CEE >>> Romania has 750MW of wind farms in testing stage >>> Serbia's Energy Minister announced new incentive tariffs for the production of electricity from renewable energy sources Major new gas plant in Lithuania to replace lost nuclear power >>> EBRD funds Continental’s Russian tyre plant >>> The EU agreement on climate Polish law AAU emission units defended >>> STRABAG to build Europe’s most modern waste treatment plant in Ljubljana >>> EU greenhouse gases in 2011: more countries on track to meet Kyoto targets, emissions fall 2.5 % >>> Protected areas have increased to cover one fifth of Europe’s land >>> EBRD: world’s major waste - flaring gas - could be turned into profit >>> Valcea, Romania, to upgrade water and wastewater services with EBRD loan >>> EBRD directors visit Poland >>> EBRD to finance its first solar power project >>> EBRD unleashes energy efficiency potential of Ukraine’s district heating sector >>> New EBRD financing facility for residential energy efficiency projects in Moldova >>> Giving old tyres a new life >>> Serbia - RWE and EPS (Serbia) sign collaboration agreements >>> Two new hydropower plants in Albania >>> Poland - RAG (Austria) signs deal with GazSystem for gas storage in Poland >>> Poland - Enea signs EPC contract for 1,075 MW supercritical plant (Poland) >>> Ukraine - Ukraine starts construction of 750 kV transmission line >>> Ukraine - Ukraine receives €200m loan for 22 hydropower projects (980 MW) >>> Bosnia - RWE will develop 210 MW of run-of-river capacity in Bosnia >>> ... Slovakia spends 33 mln eur on car-scrapping subsidy ... EBRD helps boost green energy use in Poland >>> ... EBRD reiterates Poland's 2011 GDP growth forecast at 3.8% >>> Geomorphological Secrets Yana River Basin Revealed >>> Imtech: strong further growth in Poland, broad palette of new orders >>> WÄRTSILÄ INTERIM REPORT JANUARY-JUNE 2011 >>> Outotec >>> Hungary 'should focus on CO2 cuts outside ETS' >>> We cannot afford to waste energy and raw materials – the informal meeting of the EU Competitiveness Council with Minister Andrzej Kraszewski. >>> Smart meter producers report huge increase for shipments in CEE region
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Trading in the dark
2009-03-06 00:00:00

By Grzegorz Peszko

Carbon Finance, 6 March 2009

This article also appears on www.carbon-financeonline.com

Negotiations over the sale of surplus Assigned Amount Units are gathering momentum, with a few deals already concluded. Grzegorz Peszko outlines ways to calculate a fair price in this nascent and opaque market

As a market for Assigned Amount Units (AAUs) is just emerging, there is little public information about prices, structures and terms of specific transactions. In the absence of information from a marketplace, the parties to AAU trades have to find a “fair” price that could stand up in parliamentary hearings and that would satisfy taxpayers’ concerns. While it is hard to define what such a price should be, there are alternative methodological approaches for transparent and fair price negotiations that are being applied, before the AAU market matures enough to reveal price information.

Four main approaches to establishing an AAU price are emerging:

  • modelling;
  • cost-plus method;
  • auctioning; and
  • benchmarking.

Modelling
AAU price estimates are sometimes derived from economic modelling of the hypothetical future price of carbon credits. Models can provide comprehensive and objective decision-making support, but are of limited use for today’s pricing decisions, when the AAU market is still immature. Even basic fundamental market analysis suggests that the market equilibrium price should be zero, because potential AAU supply exceeds expected demand.

However, a ‘positive’ AAU price is emerging because different market players have different trading strategies and some sellers will enter the market late, if at all. Many of these strategies are driven by short-term political considerations rather than long-term economic optimisation, hence modelling of this hypothetical market is inherently difficult. However, the possibility of banking them into the next commitment period adds extra value to pre-2012 AAUs. Lastly, the economic models treat all AAUs as homogeneous commodities, which they are not, given how sensitive buyers are to country and transaction-specific risks of AAU delivery and ‘greening’ – where revenues from the sale of AAUs are channelled to emissions-reducing activities in the seller’s country.

Cost-plus method
This method derives an AAU price from the unit costs of reducing greenhouse gas emissions. The idea is simple – the seller would not be willing to accept less, and the buyer would not be willing to pay more for an AAU than they would have paid to reduce the equivalent of one tonne of carbon dioxide in their respective countries. The buyer’s projected cost sets the AAU price ceiling, while the seller’s sets the floor. The seller could choose a specific greening activity, of which the marginal unit cost can be used as an indicative price for domestic emission reductions.

One version of this method derives a present economic value of AAUs from discounting the future compliance cost back to today’s terms1, on the assumption that AAUs can be banked into the post-2012 era. The minimum value of an AAU equals the price at which the seller is indifferent between selling the units now or keeping the surplus for future, when the country may have to either invest in internal abatement or buy credits to comply with caps.

This method is strongly linked to the greening programmes, or Green Investment Scheme (GIS), in the seller’s country. However, it delivers a price range rather than the particular contract price. It requires a lot of information, for example on the marginal – rather than average – mitigation costs in both countries. Unit costs for the GIS project should also be incremental, because AAU revenues will rarely finance the entire project. Furthermore, project costs would need to be known before the AAU Purchase Agreement is closed, which is rarely the case.

A number of conceptual and practical weaknesses limit the application of this approach in negotiations. It is used to determine price boundaries, rather than an actual unit price. This method is more suited to setting a floor price. Buyers will always have a choice between reducing emissions domestically or purchasing emissions credits. Therefore, the price of alternative Kyoto commodities, eg certified emission reductions (CERs), will establish the ceiling price.

Auctioning
AAUs can be offered for international bid and sold to the highest bidder. There are many different auction models, some more beneficial to sellers, others to the buyers2.

Auctioning is a politically acceptable, efficient and transparent method to discover an AAU price. However, auctions are more suited to selling homogeneous goods – AAUs are heterogeneous, as they are supported by different greening measures. Bilateral negotiations (also with several buyers) make it easier to incorporate buyers’ preferences into a transaction and pricing structure. Branding of differentiated AAU products may facilitate auctions in future. Sellers can also choose a quasi-auction approach – issue a request for proposals to several buyers, and then invite those buyers who meet minimum eligibility criteria, including price, for one-to-one negotiations.

Auctions may attract buyers of varying credibility and expose sellers to higher payment risk. On the other hand, new entrants, such as privately-held firms, could increase the number of potential buyers, strengthening the case for auctioning. To reduce payment risk, sellers may have to conduct due diligence of buyers’ credibility, establish eligibility criteria for bidders and hedge or transfer payment risk through contract structures (eg, through a letter of credit or other guarantees used in trade finance).

Some sovereign buyers are unwilling to engage in competitive bidding, particularly now when AAU trading is in the early stages and many uncertainties and risks remain, including reputational risks associated with greening. Officials may find it difficult to obtain a flexible mandate from their authorities, such as finance ministries or parliament, and may find it difficult to explain their choices after the event to taxpayers.

Auctioning is best suited to relatively small transactions with homogeneously greened AAUs. Auctions can provide additional efficiency and transparency to the price-setting process when there are more AAU deals and when benchmarks for greened AAUs are better known. This can be facilitated through improved standardisation of contract terms, in particular those on greening. This is why the European Bank for Reconstruction and Development, in consultations with several sovereign AAU traders (both buyers and sellers), has developed a publicly available template for greened AAU transactions.

Benchmarking
Benchmarking uses a proxy to establish a ‘fair’ unit price by taking an agreed reference price and adjusting it for transaction-specific risks. It can also be applied to price formulas.

A representative benchmark for AAU prices should be derived from the price that other market players have recently paid for the most similar commodity. There are at least four possible candidates for this price: greened AAUs, primary emission reduction units (ERUs), primary CERs and secondary CERs.

Actual AAU transactions will establish a natural benchmark over time, but, for the sake of comparison, all key terms of transactions should be known. This includes details of proposed GIS projects, because the AAU price will depend on the transaction-specific risks, such as greening risk. No such terms have been disclosed in bilateral AAU transactions concluded so far, and AAUs are not publicly traded yet.

From the sellers’ perspective, the most similar transaction would be the sale of ERUs from Joint Implementation projects, but, so far, few ERUs have actually been issued. Before issuance, ERUs have very diverse risk profiles, so a single benchmark is difficult to establish. A similar argument applies to primary CERs.

For buyers, secondary CERs are the best substitutes for AAUs, for compliance purposes. Secondary CERs are virtually free from project and delivery risk, and their reputational risk is low. Representing verified emission reductions and, in principle, sustainable development benefits to developing countries, CERs raise fewer concerns among NGOs about environmental integrity than other carbon credits, in particular AAUs, which are often associated with the negative label of ‘hot air’ despite greening efforts. But this also means that secondary CERs usually carry the highest price tag of all carbon credits available on the global market. Secondary CERs are widely, and publicly, traded on exchanges and thus have the most transparent prices.

Given the very low volume and transparency of AAU and ERU trading, and the absence of a secondary ERU market, the secondary CER price seems the most robust benchmark. The compliance risk of these instruments is the same. Environmental integrity remains the main value gap, but it can be bridged by the quality and integrity of greening of the AAUs.

In the second step, the benchmark is adjusted to account for risk components and how this risk is shared between the seller and the buyer. Price spreads are estimated for risk attributes related to the terms of the transaction and the integrity of underlying greening projects. Risk factors used to calculate spreads for pilot AAU transactions included:

  • Kyoto compliance risks;
  • greening risk (environmental and operational integrity of the greening plan; legal basis; procedures and criteria; GIS operator; implementation and crediting periods);
  • structure of pricing and payments, eg advance payments, payments upon greening; and
  • technology, region, country and any additional benefits (tied procurement, additional social/environmental benefits).

Price adjustments are not always based on measurable factors, so in the infant stage of the AAU market, a degree of discretion and intuitive judgments are inevitable. The price should be perceived as fair by both counterparties. Different methods can be applied jointly: the cost-plus method can establish an acceptable price range, in particular the price floor, while benchmarking can help achieve a single fair contract price within this range through bilateral negotiations or a quasi-auction.

The choice of price mechanism will be determined by the practicalities and political economy of AAU trading. In early transactions, sellers may find it more efficient and less risky to use simple approaches such as bilateral negotiations with sovereign government(s). Even in the case of auctions (or quasiauctions), sellers may want to set a floor price in a rational and transparent way, for example by using a cost-plus calculation or a benchmark.

For AAU trading to gain credibility, the early transactions, in particular between governments, should be fully transparent. There are no reasons for government buyers and sellers to keep the terms of transactions confidential and hide how public funds are used.

Because AAU trading is so vulnerable to abounding concerns about environmental integrity, it is the shared responsibility of buyers and sellers to ensure that the AAU price structure duly reflects the greening risk and to resist the temptation to “race to the bottom” with the quality of the GIS projects in exchange for lower prices and a quick sale.