CDM Methodologies and Project Design: Workshop for CDM Project Developers 12/5/2004. Buenos Aires. Analysis of the Additionality Tool (with project examples) Lasse Ringius. World Bank. ENVCF

The CDM Additionality Tool (as approved by EB16) “… how a project activity using the methodology can demonstrate that it is additional, i.e. different from the baseline scenario…” (9 th meeting of the CDM EB).

Purpose and Role of the Additionality Tool The purpose of the additionality tool is to check the claim of additionality and ensure that baseline activities do not receive CERs. The additionality tool must be used in conjunction with the two consolidated methodologies (ACM0001 – waste, ACM0002 – renewables) The additionality tool is guidance that must be used for new methodologies: Project developers must either include the additionality tool in the new methodology, adapt it to the specific case, or propose alternative tools. Already approved methodologies are not affected by the additionality tool and can be used as approved.

Step 0 – Starting date Eligibility criterion for projects that –started construction between 1 January 2000 and first registration of a CDM project, –submitted for registration before 31 December 2005, –provide evidence that the incentive from the CDM was seriously considered in the decision to proceed with the project activity.  Claim crediting period starting prior to project registration.

Step 1: Identification of Alternatives Define all realistic and credible alternatives to the project activity(s) that can be (part of) the baseline scenario which are available to project participants or similar project developers: –include the proposed project not undertaken as a CDM project, –provide output or services with comparable qualities, properties and application area, –include continuation of the current situation (if applicable), –comply with applicable legal and regulatory requirements that are systematically enforced  If the proposed project is the only alternative, then it is not additional.

Step 2 – Investment Analysis Purpose: Determine whether project is economically or financially less attractive than other alternatives, ignoring carbon revenue.  If the project is unlikely to be (the most) financially attractive, proceed to step 4 (or perform barrier analysis).

Investment Analysis - options Step #1: Determine appropriate analysis method: 1 – Simple cost analysis: Use if project generates no financial or economic benefits other than carbon revenue (i.e. sale of CERs) 2 – Investment comparison analysis: Use financial indicator, such as (project or equity) IRR, NPV, levelized unit costs, including all costs, revenues and incentives/subsidies, and compare with all alternatives 3 – Benchmark analysis: Use financial indicator and compare with benchmark indicator representing standard returns in the market. Step #2: Apply appropriate analysis method:

Step 2 – Investment Analysis Step #3: Calculate and compare financial indicators (only option ii, iii): Include capital costs, O&M, and revenues (excluding CER revenues, but including subsidies/fiscal incentives where applicable). Step #4: Perform financial sensitivity analysis (only option ii, iii):  If the project is unlikely to be (the most) financially attractive, proceed to step 4, or perform barrier analysis.

Step 3 – Barrier Analysis Determine whether project faces barriers that prevent the implementation of this project type or activity, but not implementation of at least one of the alternatives. Steps: 3a: Identify barriers (investment, technological, practice), and provide evidence. 3b: Show that barriers would not prevent one of the alternatives.  If 3a – 3b not satisfied, the project is not additional.

Step 3 – Types of Barriers Barriers Investment barriers: -Debt funding not available for this type of innovative project activities. -No access to international capital markets due to real or perceived risks associated with domestic or foreign direct investment. Technological barriers: -Skilled and/or properly trained labor not available; -Lack of infrastructure for implementation of the technology. Barriers due to prevailing practice: -The project activity is the “first of its kind”

Examples of Actual Barriers: El Gallo Access to financing: The domestic financial market in Mexico has been characterized by high interest rates and short loan terms over the course of the time that the El Gallo project has been under development.

Examples of Actual Barriers: El Gallo Access to financing (continued): Project developers forced to look to international financial markets, which offer more attractive rates and longer terms, but are correspondingly more difficult to access. Prospective financiers look for reliable, creditworthy, sources of revenue for the project. The El Gallo project relies on negotiated power purchase agreements with off-takers, including dozens of small enterprises and municipalities, whose creditworthiness is difficult for prospective international financiers to evaluate.

Examples of Actual Barriers: El Gallo ‘Perceived’ technology risk: The El Gallo project is not based on conventional fossil technology, which immediately raises the level of risk perceived by prospective financers and consumers. The Mexican electric sector does have a large amount of hydro (approximately 25%), but this is predominantly large-scale hydro that has been planned, constructed, owned, and controlled under the authority of the Comisión Federal de Electricidád. There is a very small amount of small hydro advanced by private sector developers, backed by private financing, and reliant on privately negotiated PPAs.

Examples of Actual Barriers: El Gallo Transaction costs: Being a small facility with a maximum output of only 30 MW, El Gallo faces the barrier of project development costs and transaction costs for financing that are disproportionately high, as is often the case for low- capacity renewables opportunities.

Step 4 – Common Practice Analysis Determine whether project type has already diffused in the relevant sector or region. Steps: 4a: Analyze similar activities 4b: Discuss similarities and possible distinctions between project and similar activities  If no essential distinctions can reasonably be explained, the project is not additional.

Examples of Common Practice Analysis (1) The three main mitigating circumstances in the El Gallo case: Mitigating circumstance #1: The comparable operating projects required much less capital investment, thereby reducing or eliminating the financing barrier. The El Gallo project alone requires as much investment capital ($45 million) as the other projects combined ($46 million). Of the entire private sector small hydroelectric portfolio of 15 plants permitted by the CRE, El Gallo has the largest capital investment requirement at $45 million, amounting to one-quarter of the capital requirement of the entire 15 project portfolio.

Examples of Common Practice Analysis (2) Mitigating circumstance # 2: Some of the comparable projects have been undertaken by large industrial firms that have the capital reserves on hand to allow them to make the required investments, eliminating the barrier associated with attracting outside financiers.

Examples of Common Practice Analysis (3) Mitigating circumstance # 3: Five of the seven projects are structured such that the electricity is entirely consumed internally, with no need for negotiation of power purchase agreements. This is relevant to the financing barrier because prospective financers have been reluctant to provide financing to project developers whose future revenue stream depended on sales of electricity to large numbers of small enterprises and municipalities with uncertain creditworthiness.

Step 5 – Impact of CDM Registration Explain how the CDM registration will alleviate the financial or economic hurdles or the identified barriers and thus enable the project to be undertaken. Benefits and incentives: –Anthropogenic greenhouse gas emission reductions; –The financial benefit from selling CERs, –Attracting new players who are not exposed to the same barriers or hurdles, –Attracting new players who bring the capacity to implement a new technology, –Reducing inflation /exchange rate risk affecting expected revenues.  If step 5 is not satisfied, the project is not additional.

Two main advantages of the registration of the El Gallo: 1. The prospect of registering the El Gallo project as a CDM activity with World Bank backing has helped establish the credibility and creditworthiness of the developer in the view of prospective financers, making it possible to secure financing. Example of advantages of CDM registration

2.Registering the El Gallo project as a CDM activity provides a significant amount of revenue, improving the project’s cash flow and hence its bankability. The carbon revenue from the sale of emissions reductions is a small (app. $270,000/yr) but non-negligible contribution to the project’s net revenue. It helps to improve the cash flow standing of the project from the perspective of the funders. The CO 2 emissions sale provides a more secure and reliable revenue stream than the project’s electricity sales, especially given that the creditworthiness of the electricity purchasers is a concern of the financiers. Moreover, the carbon revenue is the only payment to the project that is received in hard currency. This is of considerable interest to the financiers whose loans are denominated in hard currency.

Thank you!