Abstract

The Clean Development Mechanism (CDM), is one of the three flexibility mechanisms under the Kyoto Protocol (KP), 1997 that enables developing countries to assist developed countries in meeting their green house gas (GHG) emissions reduction targets. Of proposed GHG abatement projects, those involving renewable energy (RE) are the most promising because they generate clean energy and promote sustainable development.

This paper attempts to provide an overview of CDM and the potential of RE projects under CDM, in India.

The Clean Development Mechanism

What is the Clean Development Mechanism ?

The Climate Change Convention

This is a United Nations agreement to stabilize greenhouse gases in the atmosphere, at a level that would prevent dangerous changes to the climate. The Convention on Climate Change was agreed upon at the United Nations Conference on Environment and Development (UNCED) in Rio, 1992. To date, 186 countries have ratified the convention. To put the convention into operation, a protocol was outlined in Kyoto in 1997. The most important aspect of the Kyoto Protocol is its legally binding commitments for 39 developed countries to reduce their greenhouse gas (GHG) emissions by an average of 5.2 % relative to 1990 levels. These emission reductions must be achieved by 2008-2012: the so called 'first commitment period'. Developed1 countries with emission reduction targets are called Annex 1 countries, whereas those without targets are the non-Annex 1 countries. The Kyoto Protocol allows developed countries to achieve their targets in different ways through 'flexibility mechanisms'. These include:

¢ Emissions Trading
(trading of emission allowances between developed nations);
¢ Joint Implementation
(transferring emission allowances between developed nations, linked to specific
emission reduction projects); and
¢ Clean Development Mechanism (CDM).

The CDM is the only flexibility mechanism that involves developing countries. It allows developed nations to achieve part of their reduction obligations through projects in developing countries that reduce emissions or 'fix' or sequester CO2 from the atmosphere.

The CDM has two key goals:

¢ To assist developing countries that host CDM projects to achieve sustainable development;
¢ To provide developed countries with flexibility for achieving their emission reduction targets, by allowing them to take credits from emission reducing projects undertaken in developing countries.

The rationale of the CDM is that GHGs being global in nature, can be reduced anywhere in the world with the same effect, so the CDM allows these emissions reductions to take place where it is cheapest/most cost-effective to do so.

The greenhouse gas benefits of each CDM project will be measured according to internationally agreed methods and will be quantified in standard units, to be known as 'Certified Emission Reductions' (CERs). These are expressed in tonnes of CO2 emission avoided (i.e 1 tonnes or 1000 kgs of CO2 is equivalent to one CER). Other GHGs (like methane) will be converted into CO2 equivalent terms for the purpose of common unit. When the Kyoto Protocol becomes fully operational, it is anticipated that these 'carbon credits' will be bought and sold in a new environmental market; in fact, they are already becoming a commodity.

How does CDM work ?

The main elements of the Bonn Agreement with regard to the CDM are as follows (ENB, - 2001):

(i) Establishment of the CDM executive board. (CDM - EB)
(ii) Sinks to be allowed (but only afforestation and reforestation, subject to a cap of 1% base
year emissions, times five).
(iii) No eligibility for nuclear power.
(iv) Host country prerogative to develop sustainable development criteria.
(v) CDM funding to be additional to Official Development Assistance (ODA).
(vi) Small scale projects to have simplified procedures.

General attributes of the CDM

Any project activity starting after January 1, 2000 will be eligible for registration and earn CERs if it meets the interim criteria for CDM projects agreed to during COP 7 held in Marrakech. Final rules and modalities for the CDM were approved during COP 8 held in October 2002 in New Delhi.

To use the CDM, certain procedures will have to be followed and approvals obtained. There are also several ways that a company can participate in the CDM. It can invest directly in a project and receive a return in the form of CERs. Depending on the financial structure of the deal, it may also receive a financial return. Alternatively, a company can simply agree to purchase CERs as they are produced. This reduces the risk to the buyer of CERs, but will come with a higher price tag.

Special simplified procedures were developed to make approval and implementation of the following types of small-scale CDM projects easier, termed Fast Track projects :

¢ Renewable energy project activities with a maximum output capacity equivalent of up to 15 MW;
¢ Energy efficiency improvement project activities that reduce energy consumption on the supply and/or demand side by up to the equivalent of 15 GWh per year; and,
¢ Other project activities that both reduce the anthropogenic emissions by sources and that directly emit less than 15 kilotonnes of carbon dioxide equivalent annually.

Basic rules and procedures governing CDM projects

Real GHG Emissions Reductions

To qualify for credits, GHG emissions from a project activity must be reduced below those that would have occurred in the absence of the project. Without this "additionality" requirement, there is no guarantee that CDM projects will create incremental environmental benefits, contribute toward sustainable development in the host country, or play a role in the ultimate objective of stabilizing atmospheric GHG concentrations.

Any CDM project therefore requires the estimation of 'baseline' emissions - ("those without the project, less the actual emissions" that will occur after a project has been implemented.

CDM Project Cycle and Responsible Entities

Each CDM project must follow a prescribed process to earn certified emissions reductions. A typical CDM project would have to go through the following process cycle in which EB, Operational Entity , Host country would play their respective roles. This cycle also indicates the role of the CDM project promoter.

CDM Project Cycle

Eligibility to Participate in the CDM

CDM credits will only be granted to national governments and companies in Annex 1 countries, that have ratified the Kyoto Protocol.

There is no legal limit or ceiling on the number of CDM credits that an Annex I country can use to meet its Kyoto reduction target, however, individual countries may place their internal limits or targets. For example, The Netherlands has stated that its goal is to achieve their GHG reduction through domestic action measures by 50 % and Canada has stated that its goal is to achieve a majority of its GHG reduction through domestic measures.

Crediting Period for CDM Projects

Credit for CDM projects will be allowed only after entry into force of the Protocol, which is expected in late 2003 due to the delay in ratification of the protocol by Russia. Project activities initiated after January 1, 2000 may be eligible for validation provided they are registered by December 31, 2005, and they meet all the CDM provisions. Emissions reductions in CDM projects may only be claimed for a maximum of 10 years without reappraisal of the project baseline, or for a period of 7 years with two extensions of 7 years each, provided the project baseline is reviewed at the time of each renewal.

CDM Executive Board (EB)

The CDM Executive Board will supervise the CDM and report directly to the Parties to the protocol. The Executive Board was elected at Conference of Parties (COP) 7 and is comprised of ten members of the Parties of the Protocol representing various economic blocs. Interim procedures for implementing CDM project activities and the role of the Executive Board were also agreed to at COP 7 (the Marrakech Accords) so that CDM project development could begin in 2002.

Since then EB has formulated three panels namely,

¢ SSC Panel (Small Scale CDM Panel for developing standardized baselines and procedures for small scale CDM projects)
¢ Meth panel (Panel for developing guidelines for methodologies for baselines and monitoring plans)
¢ Accreditation panel (Panel for recommendation to the EB regarding the accreditation of Operational Entities)

Each CDM project has to be registered / approved by the CDM Executive Board based on the information provided by the Operational Entity. The Executive Board will maintain a list of accredited/designated Operational Entities who can perform the validation, verification and certification of CDM projects.

Simplified procedures have been developed by SSC panel that will reduce the time and cost of meeting these requirements for small-scale CDM projects.

To help meet the costs of adaptation , the Protocol requires that 2% of CERs from CDM project activities be deposited into a designated CDM registry (account), which is administered by the Executive Board.

To cover the administrative costs of the CDM-EB, an initial administration fee at registration stage (Registration Fee) is charged from the project proponent. The amount of this funding varies between USD 5,000 to 30,000 based on the quantum of CERS (15,000<>2,00,000) generated. However this registration fee will be deducted from the share of proceeds for administration, due at the issuance of CERs.

Designated Operational Entity

Validation, verification and certification activities are essentially have to be carried out by an independent party known as an Operational Entity (OE). These operational entities will typically be current private companies such as auditing, accounting, consulting and law firms that are capable of conducting credible independent assessment of emission reductions.

It is an entity accredited by the EB and subsequently designated by the COP to validate proposed CDM project activities and to verify and certify GHG reductions. The same OE can perform validation and verification & certification with the sole objective of reducing the overall transaction cost .

Host Government & Sustainable development

The specific text adopted for the sustainable development objectives is as follows:

"The COP agrees that it is the host Party's prerogative to confirm whether JI/CDM project activities assist in achieving sustainable development (ENB,2001)."

Developing countries wishing to host CDM projects need to put in place the necessary institutional mechanisms for approving CDM projects and ensuring their compatibility with national sustainable development goals and strategies. All countries wishing to participate in the CDM must develop a National Authority (NA) to evaluate and approve the projects.

Although the international process has given general guidelines on baselines and additionality, each developing country has the responsibility to determine the national criteria for project approval. These criteria should comply with the requirements defined by the COP, but should also define the national requisites and priorities for sustainable development. It is important that the evaluation and approval process be transparent and efficient.

Any CDM national authority would perform regulatory and promotional roles. Evaluation and approval of CDM projects is the centrepiece of the regulatory function of the NA. The evaluation and approval process would assess whether potential projects contribute to sustainable development in the host country in addition to emission reductions. The second type of functions, which an NA may choose to perform are those of a promotional nature, centred around capacity building and marketing, designed to meet the specific needs of the host country. NA may offer capacity building opportunities in the following areas: 1) project identification and formulation 2) baseline definition 3) quantification of emissions reductions and 4) monitoring project performance.

The Ministry of Environment and Forests (MOEF), the nodal ministry of the Indian government for climate change related activities has already announced interim criteria for eligibility of projects under CDM.

The MOEF is in the process of establishing the NA for CDM projects. The host country approval process also includes consultation with local stakeholders, whose comments must be considered before the CDM project is submitted for approval. In addition, a host country, upon review of a preliminary project proposal, may require an environmental impact assessment (EIA), which will also have to be completed before the project can proceed.

Transfer of technology and know-how

The transfer of environmentally safe and sound technology to developing countries via CDM projects is both crucial and required as it furthers the objective of sustainable development. Local knowledge and circumstances should be key factors in determining the chosen technology.

However in certain projects, in the absence of CDM itself, state-of-the-art and indigenous technologies have been already employed. In those projects, emission additionality and financial additionality alone can be evaluated.

Project Promoter

The project promoter normally belongs to the private sector (other sectors include the public sector, NGOs etc.,).CDM projects developed by these promoters would require additional procedures to be completed for earning credits for CERs. These additional procedures lead to additional expenditure (viz., transaction cost). Though these process results in an additional revenue for the project, one would prefer simplified & less bureaucratic procedures and low transaction cost for developing baselines, business proposal; carrying out validation, monitoring, verification and certification.

Trading of CDM Credits

CERs earned from CDM projects are a marketable commodity that may be exchanged with other corporations or national governments. A company that has earned CERs may also choose to bank them in order to be traded in future commitment periods after 2012. This is useful if the company does not require the credits in the current period and anticipates an increase in their market value.

Renewable Energy (RE) under CDM in India

Renewable energy deserves global attention and accelerated promotion due to its dual benefits of augmenting energy security as well as mitigating GHG emissions.

There are various reasons for India to push renewable energy viz., :

¢ The inability of conventional systems to meet growing energy demands in an equitable and sustainable manner.
¢ The large scale and negative impact of conventional energy production and consumption on the physical and human environment.
¢ The need for meeting energy needs of an unserved population in rural and remote areas as well as those residing on islands.
¢ Need for maintaining a properly diversified energy mix. Such a diversified portfolio would also help in minimizing the socio-economic impact if the supply of a particular fuel were to break down.

Over the past decade, several RE technologies have attained technological maturity, leading to commercialization. They are biomass power, solar energy (photo voltaic and thermal), small hydro and wind energy.

The current policy environment has been instrumental in creating one of the largest and most diverse renewable energy programmes in the world. The RE potential and achievements of various RETs are given below.

Renewable energy status in India

as on 31 August 2002, Source: MNES
* as on 31 December 2002
MW, MWp, MWe - Mega Watt, Mega Watt peak, Mega Watt Electrical equivalent sq.metre - sq.metre.

The focus has been on utilizing renewable energy technologies that can help traditional fuels to be used in more efficient manner; meet basic energy needs for cooking and lighting; and provide energy to the rural industry so as to improve the overall quality of life in India. RETs are also aimed at complementing and/or replacing fossil fuels in urban-domestic, commercial, and industrial applications.

Renewable energy projects get a positive push through CDM (over other candidate projects) because CDM projects must assist developing countries in achieving sustainable development. According to 'Energy After Rio-Prospects & Challenges-1997'(UNDP Publication 1997) renewable energy and energy efficiency must both be an integral part of any future energy system that addresses the issues of sustainable development. Furthermore, since rural development too, is an intrinsic part of sustainable development, RET based CDM could be a vital means for many developing countries to meet their rural energy demand.

However, as one of the choices in the investment portfolio, RETs would have to compete with other options, e.g. energy efficiency, clean coal technologies, fuel switching, and carbon sequestration. While the host country would like to ensure that the project is in line with its national priorities, especially from the point of view of sustainable development, the investor would look at the most cost-effective project. Therefore, proper optimization would have to be carried out while designing CDM projects based on RETs.

In India, as far as CDM are concerned, the Government of India has given priority to efficient technologies in power generation, centralized and decentralized renewable energy options, and energy efficiency.

A study carried out by Hagler Bailey (during 1999 and before US withdrawal) shows a range of global CDM investment flows of between $5.2-$17.4 billion per year. It is estimated that India could collect about $1 billion per year in additional foreign investment from CDM (Hagler Bailey, 1999). The total investment potential for renewable energy based CDM projects has been estimated to be about 15% of the total technical potential, equivalent to Rs 163 billion ($3.8 billion). The overall investment potential as estimated by Confederation of Indian Industry (CII) during 2000 in the field of renewable energy is $ 25 billion with 60 million tonnes of carbon reductions annually.

Transaction costs

The major elements contributing to the transaction costs in developing a CDM project includes preparation of the project idea note, baseline document, project design document, development of monitoring emission reductions and verification protocol, verification and certification cost (domestic and or international consultants), CDM-EB project registration charges and CDM-EB proceeds for the adaptation fund.

In order to minimize the above transaction cost for fast track projects, various measures are being suggested viz., bundling of small projects, standardized baselines, simplified monitoring / verification and certification, unilateral CDM, longer crediting periods, a simplified project design document etc.,

Potential RE projects

As per the Indian government, the identified areas in the renewable energy sector are as follows:

It is clear that in India enormous and varied opportunities exist for CDM in the field of renewable energy. However, their active realization largely depends on the Government of India's policies and its expeditious handling of various formalities. This is especially so because these factors could affect the transaction cost of the project.

Contribution to the country's sustainable development is one of the major non-cost benefits that RET based CDM projects have over other options. The environmental benefits would also bring many benefits (reduction in local pollution and conservation of water resources among others) in addition to GHG abatement. In that respect, RET projects have an upper hand compared to other, non-forestry CDM projects.

How are CDM projects developed ?

The CERs market has been based so far on calls for project idea notes / project concept notes, project design documents and tenders issued by the government of the developed country, multilateral institutions and few private firms. They include the Carbon Emission Reduction Unit Procurement Tender (CERUPT) programme by the Dutch government, the Government of Finland, the Swedish Government, the Prototype Carbon Fund (PCF- World bank), IFC Netherlands Carbon Facility (INCaF - IFC & Dutch Government) and BC Hydro-Canada. Based on the buyer's terms, the documents need to be prepared by the project developers in developing countries and most of them mandate a project endorsement letter from the host government to draw host government participation in the initial stages itself.

Though revenue from CDM is not high enough to the make an unviable project viable, they facilitate to leverage additional finance and also address certain known risks in RE projects viz., Internal Rate of Return (IRR), tariff fluctuation etc.,

The impact of revenue from CDM on RE projects, in terms of their IRR is given below.

Source : PCF 2001

What can we expect as CDM evolves ?

There is today, a strong, strategic advantage in the development of renewables for sustainable development. The ongoing momentum of renewable energy development coupled with the geographic benefits of resource availability provides this advantage. Since renewable energy can satisfy energy needs in an environmentally benign and cost effective manner while reducing dependence on the import of fossil fuels, India is aiming at mainstreaming of renewables in energy sector plans and policies.

The government, therefore, envisions a central role for renewables during this century. In fact, it is expected that more than half the energy needs of the rural would be met by a range of decentralized renewable energy options by 2050. Furthermore, it is also anticipated that a fourth of grid electricity would be sourced competitively from renewables by that time. Renewable energy projects would also be required to meet distributed and decentralized loads, whether they are electrical or thermal.

For translating this vision to reality, the government is seriously exploring the possibility of tapping flexibility mechanisms such as the CDM for climate change mitigation and environmental funding opportunities such as GEF, in so far as these are in consonance with national policies.

From a country's perspective, both renewable energy and energy efficiency projects are accorded high priority because they represent supply side and demand side options respectively. However, the advantage with renewable energy projects is two-fold. They not only help mitigate local and global emissions, they also support the resolution of energy security issues at national and local levels. To that extent, renewable energy projects might assume a greater role.

In the context of CDM, determining baselines as well as monitoring and verification could be significant barriers while designing energy efficiency projects, especially in case of small and scattered energy efficiency projects (for example replacing existing electrical motors with energy efficient motors). Compared to other CDM options, RETs may not be the cheapest abatement option but they aid the development process in following a sustainable path and allow a variety of local benefits. These factors could make them cost-effective for the country.

Of all the project design activities, determination and calculation of the baseline is likely to be the most difficult. It will require information that is not readily available. For example, knowledge of national plans for future power development and their probability, and information on energy use and GHG emissions in remote and rural off-grid areas. From a financing and investment perspective, while baselines in general will change over time, for the reliability of financial predictions of project performance, the baselines would be better kept static within the individual project for its CDM lifetime. However, CDM-EB's simplified baselines for fast track projects would benefit the RE projects with less than 15 MW capacity to a greater deal, thereby reducing the transaction cost.

Since all CDM projects are required to meet the sustainable development criteria of host countries, it would be required to design a suitable sustainability screen or filter or indicators that can determine whether the proposed project satisfies prescribed criteria or not. At the same time this should not create any additional burden on the project proponent.

Similarly, identification and designation of those organizations that would carry out validation, monitoring, verification, and certification would have to be accorded priority. The cost of monitoring and verification (M & V) comes down substantially if the exercise is carried out by a domestic agency rather than an international agency. Thus, one way of reducing transaction costs is to develop in-country institutions that can take up such tasks. For example, organizations of international repute that already have sound understanding of CDM and related processes and also possess the technical capability to carry out the monitoring and verification of projects, could be designated M & V Agencies. In such cases, the quantum of capacity building requirements too would be minimal.

The Ministry of Non-conventional Energy Sources has already constituted the Climate Change Advisory Group on Renewable Energy to advise it on different aspects of CDM, especially on setting up baselines. The private sector has also been evincing interest in such projects. The time is therefore right for suitably formulated CDM projects to be initiated in India.

This means that in order to take advantage of fast track projects and the likely flexibility involved, potential investors and hosts must be prepared with at least preliminary groundwork such as the identification of project(s), partner(s) and other relevant matters related to the projects, particularly baselines. The fine-tuning could be carried out for responding to tenders and call for CDM proposals.

Preparedness would help CDM project partners in gaining a lead in the crucial initial period when CDM becomes a formal instrument. Taking into account the Bonn Agreement on fast track CDM projects, grid-connected projects could be the first ones to qualify for immediate private sector partnership, as is clear from the case studies.

In developing countries like India launching of CDM would necessarily have to be preceded by intensive capacity building exercise. This would be needed at various levels - for policy makers and technical staff of concerned government departments and institutions, private sector entities, financial institutions, NGOs, and research/academic institutions. This would help the host country attract CDM projects and then gain the maximum benefit from them.

It is upon the national government and state governments to come out with complete information such as its priority areas (in terms of preferred technologies and applications), procedures and guidelines for proposing CDM projects, and sustainability criteria. This will serve two purposes :- assist the development of a portfolio of CDM projects in the country and allow clear options for potential investors.

Where can I get more information ?

www.teriin.org
http://unfccc.int/cdm
www.carboncredit.nl
http://gsn-trade.com
www.prototypecarbonfund.org
www.ifc.org
www.wri.org
www.pewclimate.org
www.cdmwatch.org
www.cdm-connect.org
www.wbcsd.ch
www.undp.org

Reference

Solving the CDM maze for renewable energy technologies in India, TERI, New Delhi

Amit Kumar and Ajay Mathur, 1999. Renewable Energy in the Context of CDM: Past Experiences and Future Prospects in India.

Workshop on `Flexibility mechanisms and climate change policy in Asian countries: Experience and technology response from EC research'. January 14-15, 1999. Organized by Center for Energy-Environment Research & Development, Asian Institute of Technology, Bangkok.

Amit Kumar. 2001. Promotion and Financing of Clean Energy Options in India: Renewable Energy. 9th Greening Industry Network (GIN) Conference. Bangkok. January 24.

Edward Vine and Jayant Sathaye. The monitoring, evaluation, reporting, and verification of climate change mitigation projects: discussion of issues and methodologies and review of existing protocols and guidelines. Lawrence Berkeley National Laboratory. December 1997.

Matsuo Naoki. Baseline as the critical issue of CDM: possible pathway to standardization. Presentation at Workshop on Baselines for the CDM. The Institute for Global Environmental Strategies (IGES). Tokyo Japan. February 25-26, 1999

Michaelowa A and Dutschke M. 1999. Economic and Political Aspects of Baselines in the CDM Context. published in: José Goldemberg, Walter Reid (eds.): Promoting development while limiting greenhouse gas emissions: trends & baselines, New York 1999, p. 115-134

Prototype Carbon Fund. Learning from the Implementation of the Prototype Carbon Fund. www.PrototypeCarbonFund.org. 2000.

TERI website (http://www.ccasia.teri.res.in/country/india/india.htm#trends)

TERI. 2001. CDM project opportunities in India. http://www.teriin.org/climate/cdm-india.pdf

Websites of UNFCCC; IEA; World Bank, Prototype Carbon Fund; OECD

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