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Kanwal Jit Singh from Surbhi Financial Technologies provides an insight into the concept of CDM additonality: Additionality is a key concept at the very foundation of Clean Development Mechanism (CDM), and new developments happen as we gain experience. EB 41 has taken significant decisions and has also discussed other proposals. An attempt is made here to understand the implications of the decisions taken and the discussions underway for undertaking CDM activities and registering projects with reference to the Investment Analysis to demonstrate additionality. The concept of additionality has been enunciated in decision 3/CMP.1: Para 43 as A CDM project activity is additional if anthropogenic emissions of greenhouse gases by sources are reduced below those that would have occurred in the absence of the registered CDM project activity. Hence demonstration of additionality is a key element to the registration process. EB has issued tools for the demonstration of additionality to add transparency and clarity to the process. The latest version is 05.1. According to this tool, demonstration of additionality is a 4 step process with the option to undertake either step 2 (investment analysis) or Step 3 (Barrier Analysis) along with Steps 1 and 4. Of course, the analysis has to be done in reference to the alternative scenarios to the PA identified in Step 1 of the Additionality Tool. Alternatives that could be considered while undertaking an investment analysis are therefore, related to a. Technology available b. Circumstances; and c. The Investor that provide outputs (products) or services (electricity or heat) with comparable
a. quality b. properties; and c. application areas as the proposed CDM PA. The alternatives have to be referenced with the prevailing practices in the area / projects implemented; and new technologies currently being introduced in the country/region. The alternatives have to be realistic, credible and in compliance with the existing mandatory legal and regulatory requirements. The most attractive scenario is identified as the baseline scenario, and emissions additionality is quantified with reference to this scenario. Step 2 relates to conduct of investment analysis for the alternatives identified. A project is additional if it is not the most attractive project, on economic or financial parameters. Alternatively, it would not be economically or financial feasible without the CDM revenue flows. Since the investment analysis was being done in a variety of ways, EB decided to standardize the process by providing a tool for undertaking the analysis; thus promoting transparency and clarity to the registration process. This tool was first given as Annex 35 to meeting report of EB39. This has now been revised and the revised version is given in Annex 45 to the EB41 meeting report. The revised tool refines the process of undertaking IRR analysis, and comprises of 15 points of guidance focused on adding transparency and clarity to the analysis. This is achieved by : 1. Clearly defining the period over which the computation has to be done, with flexibility to the PP to make choices within the rigid framework. 2. Computation of fair value of residual life of the asset, or fair value of the previous investment for restarting an abandoned project. 3. Introducing concepts from International standards into the analysis – non cash items to be excluded, introducing concepts of Project IRR in preference to Equity IRR. 4. Treatment of benchmarks for evaluation – both public benchmarks and internal benchmarks, and clearly laying down the ground rules for the application of internal benchmarks: only in the case of unique projects. An issue has been engaging the EB, relating to the financially highly attractive projects being exposed only to barrier analysis in the PDDs being filed for registration of projects. This issue is essentially raised by the representatives of the developed nations, and is now open for comments of the public. Based on this call for inputs certain media reports have appeared in the international press that Wind and Hydro projects may not be registered in the future, since the projects are financially attractive. These media reports and the raising of the issue at the EB reflect the perceptions on the issues. Projects that are financially or economically attractive in the Annex 1 world may not be so in the non- Annex 1 world, and even in the non-Annex 1 world there would be significant differences on the national situations. To illustrate the point, we will first look at the Wind and Hydro projects. Both projects have peculiarities that are inimical to them. Wind projects have been implemented in Europe for over a century now, essentially due to the availability of good trade winds in the northern latitudes. The wind patterns in the tropical region and in the equatorial region are significantly different. This is a natural phenomenon and well known. The higher wind speeds in the northern latitudes enable better Plant Load Factors (PLF) for wind power energy. This is reflected in the penetration of energy generated by Wind Power in the grid and better returns on investments. Thus the economic rates of return from the investment are significantly different. Annex 1 countries need to appreciate the perspectives and take positions on such matters considering a developing country perspective, while talking about CDM projects. The Kyoto Protocol is essentially about enabling developing countries and under developed countries attaining developed country standards, while promoting sustainable development in garnering economic growth. There is another issue that is coming on the horizon – that is relating reduced levels of oxygen in the air, due to anthropogenic emissions of other gases. But that is another story.
Similarly for hydro, India has experienced significant shortfall in available energy in the summer months due to lower hydro power availability than normal. This has been due to delayed monsoons. EB has however, focused on other sources of energy than those covered by media – which are essentially waste energies: either in the form of biogas from waste water/ solid waste or waste heat or biomass from agricultural residue. The perception of some EB members is these waste energies are replacing fossil fuels, at zero cost hence being not additional. This is again a western perspective, in my opinion. The growth of use of waste energies is essentially is a recent phenomenon in the developing world with the CDM popularizing them, as an additional source of revenue to attract investment. Maybe EB or some other UN Body can commission a study to evaluate the impact of CDM registration on the growth in the use of waste energies and biomass energies substituting for energies from fossil fuels. The key issue EB has to appreciate that for implementing projects of such nature – there is an issue of raising capital to implement projects, and there are significant issues of capital rationing and risk mitigation due to the CDM Process. Two examples are given from the state of Maharashtra – one of the highly developed regions of India – to illustrate the barriers that investment faces in a developing country. The barriers in a under developed world would be significantly higher. 1. There is significant biomass available in the state of Maharashtra. It is only in 2007 that the biomass allocation for power projects has been completed by the Government body promoting renewable energies in the State. Under 10.50% of the sanctioned Capacity has been commissioned as per information downloaded on August 17, 2008 from http://www.mahaurja.com/PG_Bag_Overview.html. The position of other states is something similar with the Karnataka and Andhra Pradesh states in India taking a significant lead. Others are lagging far behind. 2. A DOE had recently placed one project from the state of Maharashtra has been put up for global comments titled “Methane extraction and energy generation project activity at Shirala, Maharasthra” by Yashwant Energy P Ltd. This is a company promoted by a company which is a co-operative of farmers. The PA is a biomethanation project from the effluents of the adjacent industrial co-operative producing starch from maize managed by the same co-operative of farmers. This project has not achieved financial closure due to risk perception of the banking community. The project is seeking CDM registration with the objective of risk mitigation with CDM registration.
The project would provide generating free fuel to replace fossil fuels. The issue is capturing these risks in a transparent and standardized format in the investment analysis. No beta analysis tools available will capture the true value to arrive at the risk premium that should be factored into the investment analysis. All the beta analysis tools are based on market pricing of equity or debt. The availability of market with depth and liquidity is the fundamentals to arrive at the risk premium. Further the analysis, if feasible gives the risk premium for the company and not the project. If the large Indian companies are grabbing the International M&A space through significant resource raising effort, it does not mean that the other Indian entities do not face barriers to raising capital. Another example, for considering such projects as additional is from a review of the energy profile of the island nations. All island nations have significant energy resources from fossil fuels despite being rich in wind and biomass residue. Mauritius has a developed sugar industry and with significant Bagasse based cogeneration. Fiji has a larger sugar industry, but has lower cogeneration capacity. All developing and under developed countries would have a similar profile. Mauritius produces 17.50% of electricity with Bagasse as a fuel http://www.un.org/esa/sustdev/sdissues/energy/op/parliamentarian_forum/deepchand_bagasse.pdf This is possible due to private sector initiative, government policies, and international developmental financial support. In contrast India (with larger resources) only 7.70% of electricity from renewable sources. 10,855.24 MW capacity for power generation from renewable energy sources of a total of 141,079.80 MW – i.e. 7.70%. [Source: Page 2: Annual Report 2007-08: Ministry of Power, Government of India] CDM is another version of the international developmental financial support but with private initiatives. Kyoto Protocol is based on private initiatives, while Montreal Protocol focuses on governmental initiatives. This perhaps, is one reason that the Montreal Protocol has yet to take up initiatives to phase out HCFCs since the entire action, thus far, has been focused on CFC. Hence CDM support of such technologies is a significant process in their promotion and that to my mind is the basis of CDM in the Kyoto Protocol.
Even in the developed world, there are significant issues in quantifying risk – illustratively, the housing market crisis that has gripped the entire world. The entire world is looking at the recession, and hoping the demand from the developing world – essentially China and India would bail out the world from a recession imposed by the US sub prime issue. This is not the first time that the failure of this tool has been illustrated in quantifying the risk correctly. The first time the shortcomings of quantification in measuring risk was exposed to the world is in the LTCM crisis (LTCM was essentially a private venture, floated by Nobel Laureates who developed the tools). This is not to reject these tools, but to recognize their weaknesses and taken them into consideration. And the consideration is that the actual risk cannot be captured into a mathematical/ spreadsheet based investment analysis at the present time with the available knowledge base in the space of potential CDM Projects, including those that are under the lens by this call for public inputs. This can only be done by a non quantifiable analysis – which is barrier analysis. In the note circulated by the Meth Panel to EB41, http://cdm.unfccc.int/public_inputs/Panels/meth/033/mp_033_an11.pdf such projects have been termed as non additional, without changing the definition of the term additionality. This is not a fair representation of the situation, in my opinion: Item (b). The call of inputs has however, addressed the issue by making the call on a generic basis. EB Members are requested to take note of this and approach the subject with a fresh mind on receipt of the public inputs. Additionality has to be evaluated on the basis of technology available, circumstances and the investor. Interested public is requested to provide their inputs to the EB’s call for public inputs to have a wider perspective on this position.
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