The Concept of Incremental Costs

Typical GEF Projects for Climate Change 1. Energy Efficiency (Operational Prog. 5) Industrial Boilers Agricultural Pump-Sets 2. RETs (Operational Prog. 6) Wind Power, Small Hydro, Biomass Power etc. 3. Low GHG Emitting Technologies (Operational Prog. 7) PV for Grid Power Fuel Cells for Mass Transport Vehicles

Example: Climate Change (Costs/ emissions during the project life cycle) l Baseline: Coal-fired power station with Conventional Boiler (33% efficiency) Cost: Rs Crore, Carbon: 15 million tons l Alternative: Coal Plant with Super Critical Boiler delivering the same electricity Cost: Rs Crore, Carbon: 13.5 million Tons l Incremental Cost: Rs. 100 Crore N.B. There is an incremental cost but no incremental component.

Incremental Cost Matrix IC of mitigation: Rs. 100 Crore / 1.5 MtC = Rs. 667/ tC

Key Elements l Additional net costs (not benefits) l Always relative to some baseline course of action l Costs incurred as a result of redesigning an activity, or selecting an alternative activity l That alternative can be additional to or substitute for the baseline plan

Key Elements..2 When l the baseline plan is designed to achieve only national benefits and l redesigning or selecting an alternative techn is made to meet a global environmental objective, then l the incremental cost is that of achieving the resulting global environmental benefits

Alternate Baselines l Assuming the current trend will continue: current-mix of techn. is projected to continue ex: dependence on kerosene (lighting) or fuelwood l Consider alternatives (fossil fuels) and project Least-cost-mix ex: Diesel system (for electricity) or LPG (for cooking) l Consider no-project scenario situation for the project period l Marginal cost of technology should be considered

Alternative Scenario l Select technology (RET or Energy Efficiency) or Select alternate institutional arrangement or policy initiative l Which provides the same level or scale of benefit as the Baseline Scenario (MWh or GJ) l Leads to reduction in GHG emission or emissions are fully avoided l Alternate technology or alternate institutions will involve addition cost

Example: Climate Change Biomass Gasifier Based Power Generation for an Island l Baseline: A Village is getting electricity from a diesel generator of capacity 1 MW –Capacity: 1 MW –Electricity generation: 5000 MWh / yr l Alternate Scenario: Energy-forest and Biomass Gasifier –Capacity: 1 MW –Electricity generation: 5000 MWh / yr

Incremental Cost-Matrix IC of mitigation: Rs. 5 crore / tC = Rs. 250/ tC

Example: Biological Diversity l Identified Ecosystem –Priority under Convention on Bio Diversity –Threat l Cause of Threat is (say) Industrial Pollution l Solution is Removal of Cause l (Incremental) Cost –Extra cost of same industrial activity with pollution abated

Example Continued l Domestic Benefits –Some fish breeding grounds in the polluted wetland –Some tourism l But, suppose Incremental Cost>>Incremental Domestic Benefit l Grant = IC

Example Continued l Baseline: Development of the industry sector l Alternative: Continued development, same output, but remove the threat l Incremental Cost: The extra cost of achieving the same baseline development IC = [Cost of A] - [Cost of B]

Issues lSlSelection of baseline and its justification lSlSelection of Alternate technology / Scenario stating it will not spread if no project implemented lAlAdoption of technology or Institutional arrangement involves IC; which is not provided by Govt. / Banks - Risk associated with Alternate Scenario lIlIf any additional benefit; it will be deducted from IC estimation lUlUse appropriate discount rate and estimate life cycle cost lSlSourcing of baseline finance domestically

Baseline Course of Action l The baseline course of action is what would normally occur in the project area in the absence of the proposed project.

Incremental Cost Approach for Climate Change Projects l If the project falls under OP#5 or OP#6: – The life-cycle costs of win-win Energy Efficiency and RET alternatives < baseline costs – Incremental costs = barrier removal costs l If the project falls under OP#7: – The barrier is the cost of the technology itself. – Incremental costs = alternative technology costs - baseline costs

Misunderstandings Misunderstandings l Incrementalism: No radical efforts possible l Inseparability of global and domestic benefits l Impossibility of monetizing environmental benefits l Small transfers of resources l Complex

Implementation l Issues –Conflict of interest (country, co-financiers) –Length of communication chain –Unpopularity (strategic flaws, difficult concept) –Sensitivity of estimates

Reaching Agreement on Incremental Cost l Choosing the Eligible Objective l Negotiating a Reasonable Baseline l Estimating the Cost and Ensuring the Equivalence of the Proposed Alternative l Comparing the Cost Streams l Discounting the Future Costs Agree on incremental cost

Incremental Cost Approach for Climate Change Projects l If the project falls under OP#5 or OP#6: – The life-cycle costs of win-win efficiency and renewable alternatives < baseline costs – Incremental costs = barrier-removal costs

Incremental Cost Approach for Climate Change Projects l If the project falls under OP#7: – The barrier is the cost of the technology itself. – Incremental costs = alternative technology costs - baseline costs

The utility of the incremental cost approach Summary of Approach

HISTORY HISTORY l Cost Accounting –Incremental cash flow analysis l Project Economics –Incremental benefits > incremental costs l Global Environment –London Amendments to Montreal Protocol (1990) –FCCC; CBD; GEF Here to stay

MOTIVATIONS MOTIVATIONS l Complementarity –Make a difference –Relieve the added burden on project hosts –Obtain replenishment l Project Selection –Developmental expenditure –Global environment protection