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Bunding Perspectives
: small scale
CDM projects
Udit Mathur
udit@sdalt.ernet.in
With
the ninth annual meeting of the Conference of the Parties (COP) to
the United Nations Convention on Climate Change (UNFCCC) fast
approaching, it becomes extremely pertinent to do an appraisal of
the ‘flexibility mechanisms’ put in place in the Kyoto Protocol.
For developing countries, the Clean Development Mechanism (CDM)
offers the maximum hope for furthering their sustainable development
goals as well as to direct the flow of capital, expertise and
technology into developing countries. To put the CDM into effective
implementation, certain issues were raised in COP 8 regarding the
prohibitively high transaction costs involved in making the projects
go through the project cycle. For small scale projects, the decision
Marrakesh Accords Decision Statement read :
Project activities may be bundled or portfolio bundled at the
following stages in the project cycle: the project design document,
validation, registration, monitoring, verification and
certification. The size of the total bundle should not exceed the
limits stipulated in paragraph 6 (c) of decision 17/CP.7;
The
above decision may have a significant impact on the small scale
projects becoming viable as CDM projects. We study here a bundling
exercise undertaken by the Climate Change Centre at Development
Alternatives:
Case Study: Bundling of Five Mini Hydel Projects
Background of the Projects: The Himalayan Range in India can be
considered a “Large Water Machine” with several perennial rivers
like the Indus, the Ganges and the Brahmaputra emanating from it. A
number of large hydropower projects are already either operating or
are in the construction stage. However, given the several
controversial issues arising out of large projects, India is
changing its strategy towards Small Hydro Power Projects, including
“Mini” and “Micro” hydel projects. The potential for these projects
is estimated to be around 10000 MW. Small hydropower can be
exploited wherever sufficient water flows in small streams, medium
to small rivers, irrigation dams and small drop sites over heads as
low as 2 metres and above.
The
state of Himachal Pradesh (H.P.), being located on the Himalayan
range, has several small streams and tributaries of big rivers
passing through it. This offers a potential of about 1000 MW of Mini
and Micro hydropower generation of which very little has been
harnessed so far. Since the state faces power shortage, the
government is tapping this source of renewable energy to fulfil the
needs of its people in rural as well as urban areas. This can also
catalyse sustainable development that includes social, economic,
environmental and technological development. Thus, several private
investors were invited to participate in hydropower generation at
137 potential sites for capacities varying from 50 KW to 5 MW.
The
bundling exercise undertaken by Development Alternatives was for
five of these projects awarded to the same project developer. The
basic premises on which this study was based were:
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The small projects are in the same geographical area and are
on-grid projects avoiding emissions in the same grid to simplify
building the baseline. |
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The technology used in the projects under bundling is similar. |
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3. |
It
is ideal if all the small CDM projects are being operated by the
same business sector, as in the present study, so that many of
the financial and administrative matters are simplified and are
easy to incorporate in the Project Design Document. |
While conducting the study several observations were made:
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Even though a lot of simplifications have been made in the
modalities and procedures of the CDM process, a lot more
simplifications are still needed to reduce the high transaction
costs. Typically in the case of small projects, these
transaction costs sometimes reach up to 30% of the total project
costs. For these small scale projects, to go through the CDM
cycle alone can result in very little gain through the carbon
money even though they may be generating a substantial number of
Certified Emission Reduction (CER) units. Added to this, is the
fact that the CDM process itself faces so many uncertainties
that the project developers are averse to spending money on even
the first stage of the CDM cycle, i.e. the preparation of PDD.
There are two ways to bring these small scale
projects back into the mainstream CDM process. The first, at the
policy level, is further simplification of the procedures of the
CDM cycle. Some of these could be at the PDD stage itself such
as standardising baselines, standardising monitoring protocols,
introducing a simplified leakage determination factor etc. These
steps would not only eliminate the need for detailed studies
using thorough information on the technology used as well as
on other parameters, but would also eliminate the need for
extensive capacity building of organisations required to do
these particular tasks.
The second way to reduce these transaction costs
is through bundling a number of projects together. The economies
of scale achieved by a large number of projects sharing the same
fixed costs leads to a substantial reduction of transaction
costs even if they are bundled only for certain stages of the
CDM cycle. This was very evident from the present study as,
without bundling, the increase in the Internal Rate of Return
for these projects due to sale of CERs at a conservative price
of $4/tonne of CO2 equivalent was invariably a very small
fraction of one percent. In contrast, when the projects were
bundled together, the increase in the Internal Rate of Return
for these projects was about one percent. These figures are for
bundling only at the PDD stage. If we extrapolate this situation
for bundling at all stages of the CDM cycle, we will see a
substantial increase in the profitability ratios.
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The second observation made in the study was the difficulty in
meeting the stringent criteria of establishing the environmental
and financial additionality of the projects. Though the
Marrakesh Accord had largely dropped the criterion of financial
additionality, the Executive Board’s recent decisions appear to
have resurrected it. In the fast growing Asian countries like
India, that has highly favourable investment climate, proving
that a project would not have occurred without CDM is extremely
difficult. This is evident from the Board’s recent decision to
reject almost all projects on the basis of not meeting the
financial additionality criterion. What exacerbates the problem
is the fact that the CDM process faces a lot of other risks, the
prominent among them being the major policy risk of the
ratification of the Kyoto Protocol itself, the economic risk of
price uncertainty of emission credits and allocation of carbon
property rights and the technological risk of uncertainty of
quantity of emission reductions achieved. In such a scenario,
any project developer would be highly averse to implement a
project that is not viable without the carbon revenues. Thus
arises the situation of only ‘no regret ‘ projects applying for
CDM eligibility and then not meeting the financial additionality
criterion. |
In
the present study, the Internal Rate of Return for the five mini
hydel projects ranged from about 11% to 18% for different
projects. With such high Internal Rates of Return, it is
extremely difficult to meet the financial additionality
criterion. This however, means that a project bundle that meets
all the criteria for promoting sustainable development as well
as leads to avoidance of emissions of 90,000 tonnes of
carbon-dioxide will have difficulty in passing through as a CDM
eligible project.
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The third observation made in the study was that the cap of the
size of the bundle at 15 MW for renewable energy projects is a
major hurdle in the growth of the small scale sector. In a
country like India, where there is an acute shortage of power,
giving incentives for setting up power generation capacities is
extremely necessary for the growth of the economy. Installation
of big power plants being a highly capital intensive exercise,
it is of prime importance that sources requiring low initial
investments and lesser operational cost be promoted. The private
sector participation, it is now being felt, is necessary to
increase the generation capacity in the capital scarce country
like India. Providing this sector with an opportunity to earn
additional revenues through the CDM route could make their
projects more profitable and give them an incentive to make
investments in this sector. Profitable generation of revenues
through CDM would be greatly affected by an increase of the cap
on the size of the bundle as more projects would benefit from
the economies of scale and give rates of return much better than
the current scenario. |
Conclusion
The
true manifestation of sustainable development lies in the
internalization of what economists have historically classified as
“externalities”. In a truly sustainable economy, these externalities
will be internal to the free market economy and part of the
financial equation for all private enterprises and government
operations. To make effective the internalisation of these
externalities through the CDM process, innovative ideas like
bundling have to be promoted so as to enable the developing
countries take full benefit and further their sustainable
development efforts. What this also means is that the concerned
institutions in the developing countries have to be provided with
technical expertise to carry out these tasks successfully so that
the whole process is undergone at the least cost. CoP 9 may like to
deliberate upon these issues.
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