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:

1. 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.
2. The technology used in the projects under bundling is similar.
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:

q 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.

q 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. 
q 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. 


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.   q

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