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<title>May 2003: Renewing Renewables</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" width="375" height="75"><p><b><u><br>
May 2003</u></b></p>
<p align="center"><font size="6">Renewing Renewables</font></p>
<p><strong>by Roger Feldman -- Bingham, Dana L.L.P.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine
Magazine: 2</em>003/06/14)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
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<p ALIGN="JUSTIFY">U.S. energy availability and price issues are back in the
news. The environmental costs of alternative energy policies and alternative
means to deal with them have returned to focus. Innovative approaches to
renewable energy incentives could and should be a by-product.</p>
<p ALIGN="JUSTIFY">As recently reported by the Energy Information Authority
("EIA"), despite increased exports in 2002, the U.S. is still the largest
importer of petroleum products because it is the largest consumer. The U.S.
has the most emissions of carbon dioxide from fossil fuel in the world –
nearly twice that of the second largest emitter. Petroleum consumption is
the primary source of carbon dioxide emissions, followed closely by coal;
the U.S. is the largest producer of carbon dioxide from petroleum
consumption. And what is slated to help pay for Iraqi reconstruction and
possibly U.S. war costs? Increased petroleum production and, presumably,
U.S. as well as global use.</p>
<p ALIGN="JUSTIFY">The U.S. has developed the world’s most effective model
for pollution control methodology through its cap-and-trade program relative
to sulfur dioxide (SO2) and nitrogen oxide (Nox) emissions. It is expected
that by 2010, businesses will meet the Clean Air Act’s reduced emissions
targets. While the Federal government has rejected this approach in the CO2
context, favoring some form of voluntary program to achieve national goals,
the EU is moving ahead in this area.</p>
<p ALIGN="JUSTIFY">The U.S. led the world in geothermal, solar, wind, wood
and waste electric power generation in 2001, while proposed selected tax
credits are up for reauthorization – and there clearly has been a surge in
wind project development – these are certainly not times when increased tax
incentives or other subsidies for renewables are to be expected on an
ongoing basis. A modest return to mandatory standards and limited production
incentives are in the offing.</p>
<p ALIGN="JUSTIFY">Consequently, response to excess oil dependence and
concern with excess CO2 emissions by stimulating renewables development,
using the emerging successful environmental market techniques, would be a
development of historic proportions.</p>
<p ALIGN="JUSTIFY">How realistic is that? Two questions require evaluation.
How well is the U.S. experiment on market trading of conventional pollutants
working? Do any other experiments in the U.S. or overseas point the way to
innovative means of stimulating renewables?</p>
<p ALIGN="JUSTIFY">For these limited purposes, it is sufficient to note that
while great progress has been made in trading programs to date, the Bush
Administration’s efforts to push trading solutions – arguably at the expense
of improved environmental standards – coupled with defects in existing
program implementation, has led to lawsuits crippling several key state
programs. There has been pushback by environmentalists on the entire
concept, as exemplified by the following reported comment:</p>
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<p ALIGN="JUSTIFY">"The Bush Administration is trying to move away
from command and control, but [trading] is fraught with
miscalculations… Banking and trading is a nice long shot, but a
scheme based on market forces takes so much oversight that it is
almost impossible to predict success."</p>
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<p ALIGN="JUSTIFY">This should not be understood as the last word on this
subject from the green community. Nor has it prevented further progress in
improved trading regimes in Texas as well as other states, particularly
where local use of the offsets is anticipated.</p>
<p ALIGN="JUSTIFY">Evaluation of the application of "green commodity"
experiments must begin with a recognition of their relationship to the
project finance characteristics of renewable energy projects. Put briefly,
these are that technological uncertainties, vulnerability to market trends,
variable character of resources, constraints on ability to use conventional
risk mitigation tools arising out of project size represent barriers to
project development. Consequently, returns on equity in special purpose
entities, cash flow firmness to secure project debt, and availability of
credit enhancement to close the project credit gap all are impaired.
Historically, mandatory purchase price offtakes, production incentives,
subsidies and tax credits, and accelerated depreciation have been the
primary responses. They can only be sustained as long as governmental funds
hold out.</p>
<p ALIGN="JUSTIFY">With the technological improvement of renewable energy
sources – wind being a primary example – and the possibility of additional
credit support through payment for the emissions reduction credits resulting
from their use or resource portfolio standard power purchase requirements,
which they help to meet, the opportunities for overcoming these constraints
has become clearer.</p>
<p ALIGN="JUSTIFY">In the conventional SO2 control market, pollution control
firms already have been able to create a basis for equity return by
accepting, as compensation, payment for "overscrubbing" by accepting the
rights to sell reductions in emissions in excess of project requirements
into the existing emissions trading markets.</p>
<p ALIGN="JUSTIFY">In the global environment, there has been an effort to
create markets for certified emission reductions for greenhouse gases (both
in domestic and certified emerging markets arising under the terms of the
Kyoto Protocol. The Prototype Carbon Fund of the World Bank is a closed-end
fund for purchase of "high quality" carbon credits, measured in terms of its
multiple defined baselines and under standardized contract documents. Its
pricing methodology still involves a case-by-case evaluation of the credits
(which may include social and environmental benefits). It is the foundation
for market creation.</p>
<p ALIGN="JUSTIFY">Implementing the impending obligations of the Netherlands
government to acquire Kyoto emissions reductions, the International Finance
Corporation ("IFC") has been engaged to serve as its purchasing agent, to
screen, validate and contractually acquire emissions reduction credits. Like
traditional PPAs, payment for carbon credits is on delivery. Conventional
lenders are still concerned about the efficacy of the marketplace. IFC is
exploring whether, as the market matures, the ERC market may be compatible
with its traditional guarantee mechanisms. As of now, its purchases are a
project revenue enhancement, rather than a "greenstream." This can change as
private financial institution comfort with the market changes.</p>
<p ALIGN="JUSTIFY">In the renewable portfolio standards markets – where
"Renewable Energy Credits" (RECs) for use of green power have become, in
certain European countries and a large number of U.S. states, a
legally-defined commodity – programs to create "greenstreams" are being
initiated by affording green developers markets or floor price guarantees
for their RECs, as well as fostering private competitive auction markets for
RECs.</p>
<p ALIGN="JUSTIFY">These are milestones for referral to facilitate
additional structured finance of renewable energy projects. The principles
are clear. Use of potential financial mechanisms depend on the strength of
markets, trading protocols, and the strengths of counterparties engaged in
markets, because they have confidence in their robustness and transparency.
Government or multilateral programs to facilitate the transition to such
markets is essential.</p>
<p ALIGN="JUSTIFY">Depending on which private mechanisms emerge from the
profile of that market, conventional transactions may come to include:</p>
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<p ALIGN="left">• Tranched debt – some portions of which are backed in
whole or in part by greenstream credit;</p>
<p ALIGN="left">• Greenstream-funded or credit-backed debt reserves;</p>
<p ALIGN="left">• Additional greenstream-backed credit enhancement by
third party guarantors, equity risk assumption or development of
derivatives.</p>
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<p ALIGN="JUSTIFY">Consequently, new market-based programs may represent
more sustainable options for a larger number of projects developed on a
structured finance basis, than do implicit subsidies through a finite number
of dollars of available tax credits.</p>
<p ALIGN="JUSTIFY">The current global energy-environment situation can be
read as a clear indication of the need for enhanced development of renewable
energy. Lessons as to how to do so can be learned from the greenstream"
developments arising from market-based environmental and energy credit-based
trading of the past decade. Public policy and project finance can be linked
through carefully crafted programs leading to the creation of sustainable
markets.</p>
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<p class="MsoBodyText" align="left" style="margin-bottom:0in;margin-bottom:.0001pt;
text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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