PCF Approaches to Additionality, Baselines,

Validation and Verification

Washington, 27 July 2001

PCF TrainingJuly 2001

What do we want to achieve today?

• Understanding of the PCF’s approaches to – additionality and baselines,– validation and verification.

• Identification and discussion of open issues.

• Feedback

Contents

I. Project Cycle: Overview

II. PCF Baseline Development

III. Special Issues with Baselines

IV. Validation, Verification and Certification

V. Conclusions

Part I

What are the basic concepts?

What is the idea of the CDM?

• Reduce GHG emissions in one countryto permit

• an equivalent quantity of GHG emissions in another country

• without changing the global emission balance

How to know how much has been reduced??

What does the Kyoto Protocol say?

• Nothing! -- But: criteria for CDM projects:– Real, measurable, and long-term benefits related to

the mitigation of climate change. (Art. 12.5b)– Reduction in emissions that are additional to any that

would occur in the absence of the certified project activity. (Art. 12.5c)

• Modalities / guidelines to be elaborated by the Conference of the Parties.

What is the PCF approach to additionality?

• Environmental additionality is the relevant criterion

• Established as positive difference between Baseline Emissions (counterfactual)

– Project Emissions (measurable)___________________= Emission Reductions

(if > 0 , then additional) (to be verified)

Baseline and additionality

CO2

Time

CDM project CO2 emissions (observable)

Real, measurable and long-term

Additional CO2 emissions reduction

Baseline scenario CO2 emissions (would occur)Baseline emissions

Project emissions

How to figure out what baseline emissions are?

• Beliefs about what would happen are a starting point Possible baseline scenarios

• but beliefs are not sufficient: a methodological approach is needed, which can be tested Various baseline methods

_____________________________________

Determine the relevant baseline scenario

What do we mean by …

• Baseline method:– Systematic way to compare alternative baseline scenarios

• Baseline scenarios:– All alternative plausible courses of development

including the proposed project

• Baseline:– Methodologically selected, most likely baseline scenario

• Baseline emissions:– GHG emissions in the baseline scenario

What are baseline scenarios?

• How can a particular product or service be provided?– Principle of service equivalence

• Examples:– Electricity production using coal, natural gas, biomass,

hydro etc. – Heat production using individual boilers, district

heating

• What is the time profile of different technologies

• What is the regulatory and policy framework

How to measure emissions?

• Project emission are directly observable / measurable

• Baseline emissions are hypothetical / counterfactual But often real time indicators can help tell what would

happen

Develop a Monitoring Plan

– Take measurements / monitor emission indicators– Calculate / assess baseline and project emissions

How to be sure that emission reductions are real, measurable and long-term?

• Baseline Study• Monitoring and Verification Plan

Validate (before project construction)

• Monitoring records• Emission reduction calculations

Audit / Verify / Certify (during project operation)

Part II

How does the PCF determine project baselines?

How does the PCF system for baseline establishment work?

• At PIN stage – Baseline discussions with PCF team

• Preparation of PCN – Discussions with project proponent– Possibly reconnaissance missions

• After PCN– Formal Baseline Study– MVP– Validation

What is the purpose of the baseline study?

• The baseline study– Is a systematic and methodological analysis to

determine the most likely development scenario and its evolution in time in absence of the Kyoto Protocol mechanisms.

– Is the basis for the projection of emission reductions.– Credibly demonstrates environmental additionality.– Provides all arguments, facts and evidence in support of

the determined project baseline, so that the baseline can be validated.

PCF baseline process

Information on

project

project context

Kyoto Protocol

etc.

Possible baseline methods

Baseline method selected

Plausiblebaseline scenarios

Baseline scenario selected

Criteria for baseline method selection

Monitoring and Verification Protocol

Project specific tools and instructions on emission related data socio-environmental impacts quality assurance verification

Some criteria of baseline method selection

• Type of problem:– Major one of a kind fixed-asset investment– Demand side intervention: many consumers

• Size of investments– E.g., small project rules?

• Availability / accessibility of information– E.g., can risks be quantified?

• Costs of methods

• Note: Baseline method depends on identified (supply/service) problem, not on proposed project.

Which baseline methods has the PCF applied to date?

• Project-by-project methods– Investment / financial analysis Latvia, Morocco– Scenario analysis Uganda– Control groups (Latvia MVP)– Expert opinion (Uganda bl study)

• Standard-oriented methods– Sectoral baselines, benchmarks (Costa Rica)

– Technology matrix, default baselines, Top-down baseline, ...

– Require political decisions

• Hybrid methods– Political guidance on key parameters– What should happen? (policy decisions, policy baselines)

Investment Analysis

Investment analysis is a rigorous approach ...

• Behavioral assumption: – Rational investor maximizes return on investment under given

constraints: financial analysis

– Public decision maker maximizes public benefit under given constraints: economic / cost-benefit analysis

• Baseline definition: – The baseline is the (time dependent) investment alternative

(scenario) with the highest IRR or the highest NPV or the lowest costs (all risk adjusted).

– not considering GHG emissions or the value of ERs.

What level of analysis?

• Financial analysis:– Cash flow

• Economic analysis: (correct for state activity)– Subtract taxes– Add subsidies

• Benefit-cost analysis: (correct for externalities)– Valuate and subtract social and environmental costs– Valuate and add social and environmental benefits

=> Policy issues!

… and an established methodology …

• Distinguish between private and public sector projects.

• Create a menu of investment alternatives (scenarios)– that deal with the problem on hand / satisfy an identified

demand (service equivalence). – include only plausible scenarios (constraints)– include zero investment scenario (BAU) and proposed

project– Include alternative investment start times

• Determine investment constraints and parameters (regulatory policy, costs, risks, etc. – but not ERs).

… and World Bank practice

• Prepare financial model or cost-benefit model.

• Calculate comparator: risk adjusted IRR or NPV or net benefit or least cost for each alternative.

• Use comparator to rank projects.

• Select highest ranking project as baseline.

=> Use Word Bank good practice.

How has the PCF applied investment / financial analysis?

Example: Latvia• Objective: solve waste management problem in Liepaja• The project was treated as a private sector investment• Plausible investment scenarios were described and

analyzed by Task Manager in a feasibility study• Financial and Economic IRRs were provided• Ranking of alternatives with and without carbon value• Baseline: highest IRR without carbon value• Project: highest IRR with carbon value

Liepaja: Economic Analysis of Alternatives

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IRR without C revenues IRR with C revenues

Baseline

PCF project

How has the PCF applied the least cost method?

Example: Morocco• The wind farm is treated as a public sector power project (by

ONE).• A comparison of investment alternatives on the basis of cost

per kWh is typically used in power projects planning.• The PCF task team / the baseline study examine the:

– Expansion plan for the power system: Additionality of investment• What is the next expansion? • When would the proposed project be implemented?

– Dispatch model for the power pool: Emission reductions• Which power source is displaced at the operating margin?

• MVP will base verifiable ERs on observed dispatch.

Scenario Analysis

Scenario analysis is difficult

• Not very well defined as a methodology.• Use if non-economic constraints are predominant• Employ a multi-dimensional, risk-based scenario analysis,

to identify most likely course of development• Attempt to understand and describe all aspects and

circumstances that contribute to an investment decision, in particular risks and other barriers

• Combine with other methods if available (e.g. costs)• Provide data and/or expert opinions and references that can

be confirmed by a validator. • Note: The project proponent’s or consultant’s beliefs or

simple statements cannot be validated.

How has the PCF used scenario analysis?

Example: Uganda• A typical electric power development project• Non-economic constraints and barriers are predominant

– Investment / financial analysis overshadowed by high non-quantifiable risks, which drive the baseline.

– Suitable control groups not available.

• Simple, not risk-adjusted cost-per-kWh ranking shows that– current situation (small private diesel gensets) is most expansive

– investor needed (West Nile population unable to make investment)

– grid extension to West Nile is cheapest, and

– proposed hydro-project ranks second cheapest

How has the PCF used scenario analysis? Cont’d?

Example: Uganda (cont’d)• Multi-dimensional, risk-based scenario analysis

identifies and describes reasons, why – grid extension is currently not a feasible option– current situation (small gensets) would persist

• Baseline study backs these findings with “confirmable” information (e.g., expert opinion)

• MVP checks if baseline study claims remain valid– Indicators for grid extension and major fixed-asset

investment in West Nile region

Control Groups

How to use control groups?

• Two types of control groups– Different group of consumers or facilities that are not involved

in and/or affected by the CDM project

– Same group of consumers or facilities before implementation of proposed project (historic baseline)

• Control group must be situation-specific– The selected control group is the baseline: Describe the

baseline!

– Must be similar in all aspects but for the CDM project

– Often complicated, but can be combined with other methods

– Useful for projects with large number of units (e.g. households)

How to use control groups? Cont’d

• MVP to measure critical control group indicators– If possible, use observed control group emissions as

baseline emissions– Combine control group data with other relevant data in

project area, such as activity level

• Distinguish two questions:– What is quantity of baseline emissions?

• Decreasing baseline emissions as members of control group switch to new technology?

• Replace new technology in control group with old technology?

– When does the baseline shift? • How many members of control group have to switch?

Has the PCF used control groups?

• Example: Latvia, Uganda• No. – But control group-like methods have been used to

project and measure ERs– Uganda: Survey of private gensets and electricity demand to

project growth. (historic control group) (baseline study)

– Latvia: When will landfills be used for power generation? (MVP)

– Uganda: When does a major non-removable investment occur in the region. (MVP)

• We hope to experiment with control groups, for example:– Transport projects

– Demand side energy conservation projects

Standard Baselines

How would standard-oriented baselines work?

• Objective:– simplify baseline determination for project developer– reduce transaction costs and risks for investor– control gaming

• Tool:– public provision of pre-approved baselines for project

categories– not yet available

• Philosophy:– additionality “on average”– political decision (equity, development priorities)– research and pilot application in concrete projects

For instance benchmarks …

• Prepared for fairly homogeneous category of projects / technology / circumstances, a sector, power grid etc.

• Often based on activity level / efficiency– For instance: baseline benchmark in kg coal/kWh

• Methods– historic: average energy efficiency in power sector (last five years)– present: efficiency of latest addition to grid– projection: expected technology– Country/region-specific: local circumstances, energy policies etc.

• Needs proof that – benchmark is applicable, because project falls in project category

Has the PCF used standard baselines?

Example: Costa Rica• No. – Standards for baselines are political and not

yet available.

• But standard-like methods are used in small projects– Carbon intensity factor for Costa Rican power sector– Cost benchmark for micro-power projects– Multi-project baselines (same project class)– ERs from demand side projects (research)

Part III:

Which special baseline problems has the PCF encountered?

• Conservative estimates• Project time horizon / crediting time• Dynamic baselines?• ODA• Power systems• Cross-border reductions• Policy baselines & perverse incentives• Development related emission• Leakage• Small projects

How does PCF deal with the possibility of overestimation of ERs

• Proposed, e.g.:– Investment additionality– Thresholds– Discounting of ERs– Short crediting periods

• PCF– Principle of conservative assumptions and estimates in

baseline study and MVP– Conservative: More likely to underestimate than

overestimate ERs (“be on the safe side”)

Which project time horizon does the PCF use?

• Project lifetime– full economic lifetime of the project, or, if shorter,– until the baseline scenario catches up with the project

• Baseline review and renewal– not planned unless mandated by MVP or verifier– will apply KP review periods (7 years?)

• Crediting time– PCF projects claim ERs throughout their lifetime – PCF purchases a time slice of available ERs

Does the PCF use dynamic baselines?

• No. – But the PCF recognizes that baseline scenarios evolves in time– E.g., the PCF project may go forward anyway in X years– Latvia must comply with EU law in Y years.

• The baseline study – discusses the time dimension of the baseline– identifies possible shifts in activity levels and baseline scenarios

• The MVP– includes indicators for activity levels and baseline shifts – adjusts baseline emissions accordingly

• PCF baselines are– constant regarding baseline methods and technical parameters– variable regarding activity levels and anticipated types of activities

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Additional ERs

PCF ERs

Morocco Wind Farm Project

What does the PCF think about development assistance in projects

• The possibility that projects may be financed with ODA must not make them non-additional.

• The PCF does not consider ODA in determining the baseline.

• ODA should fill the financing gap after the project has obtained revenues from selling ERs.

• At current low carbon prices, many renewable projects must be topped up with ODA.

• It seems that ODA cannot be used to purchase ERs.• => Can we consider projects with ODA automatically

additional?

How do we think about PCF projects in power systems?

System capacity

Base load capacity replacement

Major capacity addition (Morocco)

Micro capacity addition (Costa Rica)

Base load

Dispatchmargin

Coal Coal Wind

Thermal

HydroDispatch

additional?

What happens if project baseline and emissions baseline are distinct

Example: Costa Rica• Emissions baseline: Dispatch pattern

– Weighted system average carbon intensity of dispatched power over project’s lifetime.

– Projected in baseline study. Measured by MVP.

• Project baseline: None– Small projects not included in expansion plan, therefore not

considered as possible baseline alternative.

• Additionality? Cost benchmark– Use weighted average of long run marginal unit cost for system

expansion over next 5 (?) years.

– Problem of manipulations of cost calculation.

How can independent power producers (IPP) claim emission reductions?

• Sequencing problem in power systems, if several IPPs back out several different thermal power sources. – First CDM power in, first baseline power out? etc.– System average for all projects? Costa Rica

• Make power pool responsible for measuring / announcing carbon intensity at operating margin (dispatch model).

• Carbon purchase agreement with power pool?– Incentive to factor carbon value into dispatching behavior– ERs measured against unconstrained dispatch model

How do we deal with GHG reductions that occur in another country?

• Latvia– ER occur in neighboring countries due to lower power imports.– PCF decided not to buy these reductions.

• Costa Rica– Central American power pool becomes operational during

project lifetime. – Project depends or ERs from the entire power pool.– What to do?

• Swaziland– ERs can only be generated by backing out coal-based power

imports from South African.– A political issue?

What is the PCF’s propose on policy baselines?

• Should PCF considers domestic benefits and willingness to pay as part of the baseline scenario?– This excludes concessional finance in determining the baseline– It includes in the baseline scenario any subsidies and policies

aimed at achieving domestic benefits (cost-benefit analysis)

• Perverse incentives: How to deal with the problem of – “punishing” a country for “good” climate policies, if those

policies are driven by domestic benefits?– “rewarding” a country for “bad” policies, … in particular if these

policies are driven by the desire to increase the flow of carbon finance.

• Need for more – experience, discussion, and political decision

Where does the PCF face the policy baseline problem?

• Latvia– Prepares for EU accession– Solved: No legal obligation to collect LFG until accession

• Morocco– Wants wind energy to increase supply security– Proved irrelevant: Morocco unwilling to go ahead with project without

concessional finance

• Uganda– Wants to develop the West Nile region, politically important– Irrelevant: No willingness and ability to subsidies as needed, ODA fills gap.

• Costa Rica– Has priority for expensive hydro power in its expansion plan– Raises cost benchmark for small hydro power projects, makes them non-

additional. – Is this fair? – Solution? – More discussion needed!

How does the PCF treat emissions from project induced sustainable development?

Example: Uganda• Development projects can lead to an increase in GHG

emissions, due to– Increased service / supply where a supply gap existed.– Increased economic activity, income and consumption growth

• Uganda:– Increase of diesel generated power supply from 4 to 24 hours in

West Nile– Increase of consumption and economic growth

• Disregard development related project emissions– Use principle of service equivalence– Define development boundaries– Disregard growth effect in project emissions.

Is leakage a pervasive problem?

• Has not yet been encountered as a problem in PCF projects, but:

• Few projects do not affect the wider market• Appears serious for energy and land use projects• Can be negative (leakage) and positive (spill-overs)

– price and income shifts (affect demand and supply)– techno-economic system (power grid, inputs)– removal of barriers (knowledge, market transformation)

• Determine indirect effects in order to correct direct emissions reductions

• Have been dealt with effectively in DSM programs

How to deal with leakage?

• Define project and system boundaries

• Develop rough models of system-wide effects (energy, forests)

• Select control group to capture leakage

• Design projects which neutralize leakage

• Use sector-wide or regional emission caps

How does the PCF deal with baselines in small projects?

- Bundling of similar small projects in one country- Project intermediation (e.g. through ESCOs)- Standardization of project documents

- Sectoral baseline and MVP, e.g. carbon efficiency in power pool applied to mini-hydro power

- Standard baseline study and MVP for sub-projects- One validation and verification process for the sector

and for all sub-projects- Standard carbon purchase contracts

- Kyoto Protocol small project rules

Part IV:

How does the PCF handle validation, verification

and certification

Which at are the PCF’s key project design documents?

• Project Design Document

• Baseline Study

• Monitoring and Verification Protocol (MVP)

• Emissions Reduction (ER) Projections

• Other background documents

Why is the MVP important?

• creates transparence, reliability, verifiability, and credibility.– Serves as a project-specific performance standard.– Is a performance monitoring and measurement tool.

• provides a consistent and (to be) validated system for the flexible, yet conservative determination of ERs.– performance criteria, observable indicators, measurement

methods, default parameters, technical equations, record keeping systems, ER model and calculation procedures

• determines clear responsibilities for all parties.• can be adapted to a variety of CDM projects.

What does the MVP contain?

1. Instructions for systematic monitoring and recording of emissions related data for baseline and project case.

2. A models and tools for the calculation of ERs.3. Targets and monitoring instructions for social,

environmental, and development indicators as a measure of sustainable development.

4. Instructions for the management and quality control of the monitoring system.

5. Guidance for the verification of ERs.

What do we mean by validation?

• An independent assessment of project design and compliance with a set of criteria.– Baseline/additionality/leakage

– Sustainable development

– Other criteria, e.g., stakeholder participation, environmental impact assessment, host country approval

• Carried out by qualified (accredited) independent private sector (operational) entity (validator).

• Successful validation is pre-requisite for project registration by CDM Executive Board (EB).

What are validation prerequisites?

• Full project preparation– technical, political, financial

• Project design documents– most important: Baseline Study and MVP

• PCF Preliminary Validation Protocol (PVM)– Validation guidelines– Table of requirements– Template for validation opinion

How does the validation process work?

• Selection of independent validator by PCF• Submission of project documents• Review and amendment of Validation Protocol

– Revised rules and modalities?

• Validation procedure– Desk review of documents– Interviews, possibly project visit, other evidence– Input from concerned parties– Draft validation report– Clarification of issues, adjustment of project design and

documents by PCF, resubmission of documents

• Final validation report and opinion

What does project implementation and commissioning involve?

• Project operator implements MVP– Set up of monitoring system– Train monitoring and record keeping staff– Implement quality control system– Ready to monitor baseline and project performance data

• Initial Verification– Qualified (accredited) independent private sector (Operational)

Entity (auditor/verifier), not project validator.– Verifies & confirms readiness of project and quality management

and assurance system to generate and monitor ERs– Adjustments to MVP if needed– Establish relationship with operator

• Project commissioned to produce ERs

How is monitoring done?

• Monitoring during operation is responsibility of project operator

• To be carried out in full compliance with MVP• Read meters, collect and record data, undertake

surveys etc.• Complete self-calculating spreadsheets• Store records (paper trail)• Report to PCF and host country authorities• Follow quality management and assurance system• Prepare for verification

What does verification involve?

• Periodic assessment and confirmation that project has achieved a quantity of ERs in compliance with MVP and relevant project criteria

• Verifier (operational entity)– audits records, reviews interpretations, checks calculations– reviews project performance and confirms (or determines)

achieved quantity of ERs– reviews continued validity of baseline, if required by MVP,– checks compliance with MVP, reviews adequacy of MVP– assesses proper handling of management, operational and

quality assurance system– drafts report, requires or suggests corrections, points out risks

What is certification?

• Verifier issues written assurance (the certificate) that, during the verification period,– the project has achieved stated ERs,– in compliance with all CDM and project performance

criteria.

• Certificate is legally binding statement, verifier is liable for professional work.

• Executive Board (or accreditation body) can undertake spot checks – accreditation can be revoked.

How to receive emission reductions?Who reports?

• Verifier informs CDM executive board and project participants of successful certification and delivers certificate.

• Host country transfers or authorizes transfer of ERs to acquiring party.

• Executive board issues certified emission reductions (CERs) into national registries.

• PCF Participants receive CERs in their accounts in national registries.

• PCF and host country report periodically to UNFCCC Secretariat and/or CDM EB.

Part V:

Conclusion

Finally: What emerges …… is a complex picture:

– No single, but a hybrid mixture of methods

– Complexity depends on project design

– Unsolved political issues

• Baseline study and MVP must be seen together– More or less rigorous, method-driven forecasts in the baseline

study – as a basis for

– selection and application of monitoring tools for baseline and project emissions in the MVP

• More experience and discussion is needed!– PCF contribution to evolutionary concept for baselines etc.