ADDITIONALITY OF THE CLEAN DEVELOPMENT MECHANISM: INSIGHTS FROM CENTRAL AMERICAN CASE STUDIES
A thesis
submitted by
Abby Lindsay
In partial fulfillment of the requirements For the degrees of
Master of Arts in Law and Diplomacy in The Fletcher School of Law and Diplomacy
and
Master of Arts in Urban and Environmental Policy and Planning
TUFTS UNIVERSITY
May 2009
© 2009, ABBY LINDSAY
ADVISORS: William Moomaw, The Fletcher School Justin Hollander, Urban and Environmental Policy and Planning
! ABSTRACT
As part of the global response to climate change, the Clean Development
Mechanism (CDM) was developed to involve developing countries in emission reductions by allowing them to sell developed countries carbon credits generated from emission-reducing projects. The CDM theoretically should help developing countries implement renewable energy, thus contributing to sustainable development, so this study focuses on the interaction between renewable energy, the CDM, and small developing countries. It analyzes the barriers to projects and the decision-making factors that determine whether or not projects are pursued in
Honduras and Costa Rica. A host of barriers were found throughout the study, ranging from low electricity production revenues to investment barriers. The major decision-making factors were government policies, financial viability with and without revenue from the credits, and other barriers. Furthermore, since the carbon credits can be traded into cap and trade systems, the emission reductions must be additional. This study uses the barriers and decision-making factors to analyze the additionality of the CDM projects in comparison to the theory. The results found that while the additionality claims of the CDM projects were not false, in most cases the reasons cited would not likely have prevented the projects from being implemented. Implementation is more complex than the theory, and the next round of climate negotiations must take the difficulty ensuring strict environmental additionality into account.
ii ACKNOWLEDGMENTS
Thank you to my two advisors, Bill Moomaw and Justin Hollander, for all of your support and guidance throughout this study.
Thank you to Tufts Institute of the Environment for supporting the costs of this research through the Graduate Research Fellowship.
Additionally I would like to thank all the people who allowed me to interview them or discuss this project with.
iii TABLE OF CONTENTS
Abstract ii Acknowledgments iii Table of Contents iv List of Tables vi List of Figures vii Acronyms viii
1. Introduction 1
2. Clean Development Mechanism Background 3 2.1. Introduction 3 2.2. International Negotiations and Mechanisms to Address Climate Change 4 2.3. The Clean Development Mechanism 7 2.3.1. CDM Overview and Negotiation 7 2.3.2. Current CDM Projects 10 2.3.3. Key Actors 13 2.3.4. Project Cycle 14 2.3.5. CDM Markets 16 2.4. Additionality 17 2.4.1. Additionality Basics 17 2.4.2. Additionality Determination 18 2.4.3. Debate over Additionality 21
3. Methodology 24 3.1. Project Development 24 3.2. Research Overview and Boundaries 25 3.3. Case Study Methodology 28 3.4. Database and Literature Review 30 3.5. Research Trips for Stakeholder Interviews 31 3.6. Analysis 33
iv 4. Honduras 34 4.1. Honduras Energy Sector Overview 34 4.2. Energy and Renewable Energy Legislation 38 4.3. Energy Institutions 40 4.4. The CDM in Honduras 42 4.4.1. Overview 42 4.4.2. Current situation 43 4.4.3. Actors 44 4.5. Barriers to Renewable Energy 46 4.6. Barriers to the CDM 53
5. Costa Rica 54 5.1. Costa Rican Energy Sector Overview 54 5.2. Energy and Renewable Energy Legislation 57 5.3. Energy Institutions 59 5.4. The CDM in Costa Rica 60 5.4.1. Overview 60 5.4.2. Current situation 62 5.4.3. Actors 62 5.5. Barriers to Renewable Energy 64 5.6. Barriers to the CDM 68
6. Additionality 69 6.1. Introduction 69 6.2. Additionality Analysis 70 6.3. Main Decision-Making Factors 77 6.3.1. Introduction 77 6.3.2. Government Policies 78 6.3.3. Financial Viability 79 6.3.4. Financial Viability with CERs 81 6.3.5. Other Barriers 83
7. Conclusions 84
Appendix I. Sample Interview Questions 91 Reference List 92
v LIST OF TABLES
Table 1. Regional distribution of CDM projects 12 Table 2. Country statistics for Honduras and Costa Rica 27 Table 3. Sources used to meet each objective 29 Table 4. Honduran electric capacity 2006-2007 38 Table 5. Registered CDM projects in Honduras 43 Table 6. Registered CDM projects in Costa Rica 62 Table 7. Additionality analysis of large-scale projects 72-74 Table 8. Additionality analysis of small-scale projects 76
vi LIST OF FIGURES
Figure 1. Growth of total expected accumulated 2012 CERs 10 Figure 2. Growth of expected accumulated 2012 CERs by country 11 Figure 3. CDM project cycle 14 Figure 4. Additionality determination 19 Figure 5. Historical electricity generation in Honduras by fuel, 1971 to 2005 36 Figure 6. Historical electricity generation in Costa Rica by fuel 57
vii ACRONYMS
AAU Assigned Amount Units CDM Clean Development Mechanism CER Certified Emission Reduction CO2e Equivalent carbon dioxide COP Conference of the Parties DNA Designated National Authority DSE Energy Sector Direction, Costa Rica (Dirección Sectorial de Energía) EB Executive Board (of the CDM) ENEE National Electric Company, Honduras (Empresa Nacional de Energía Electrica) ERPA Emissions Reduction Purchase Agreement ERU Emission Reduction Unit GEF Global Environment Facility GHG Greenhouse gas ICE Costa Rican Institute of Electricity, Costa Rica (Instituto Costarricense de Electricidad) IMN National Meteorological Institute, Costa Rica (Instituto Meteorológico Nacional) IPCC Intergovernmental Panel on Climate Change IRB Internal Review Board LoA Letter of Approval MINAET Ministry of the Environment, Energy and Telecommunications, Costa Rica (Ministerio de ambiente, energía y telecomunicaciones) MoP Meeting of the Parties NGO Non-governmental organization OCIC Costa Rican Office of Joint Implementation (Oficina Costarricense de Implementación Conjunta) PDD Project Design Document UN United Nations UNFCCC United Nations Framework Convention on Climate Change
viii ! 1. Introduction
The links between the environment and development are increasingly exposed: climate change is causing visible changes and threatening people’s livelihoods; biomass used for energy is contributing to deforestation and emissions; and poverty is closely tied with economic growth and resource use.
When Honduras was hit by Hurricane Mitch many regions of the country were devastated. Poverty increased drastically, and health and water outbreaks ravaged the region. Energy use has historically been correlated with quality of life (Najam and Cleveland 2003; WRI 2002),1 but we are now calling into question the development progression that is generally based on increasing fossil fuel use for industrialization. There is widespread agreement that the “warming of the climate system is unequivocal” and “most of the observed increase in global average temperatures since the mid-20th century is very likely due to the observed increase in anthropogenic [greenhouse gas] concentrations” (IPCC 2007).
Energy presents an interesting paradox when viewed in the light of sustainable development: increased energy access can reduce vulnerability and increase social and economic welfare, but at the same time, the majority of the energy supply has significant negative environmental effects from the emission of greenhouse gases (GHG). To abate climate change, actions will need to be taken to reduce GHG emissions from energy sources in all countries around the world, even though developed countries are responsible for the majority of historical emissions.
1 As measured by the relationship between energy use in 1000 million tonnes of oil equivalent and GDP in million US dollars in 1998.
1 The international community agreed to reduce global greenhouse gas emissions by signing the Kyoto Protocol in 1997, where developed countries committed to target emission reductions. With the Kyoto Protocol, the Clean
Development Mechanism (CDM) was developed as a market mechanism to reduce emissions and encourage sustainable development by helping finance emission-reducing projects in developing countries through carbon credits that could be put towards developed country commitments. Since its formal start in
2005, the CDM has grown rapidly; there are currently 4,252 projects either registered or in the process, which will amount to 7,125,124 Mt CO2e reduced by
2020 (UNEP Risoe Centre 2008). CDM projects have been touted as having great potential to aid in the economic development of countries on a national scale and help reduce poverty when coupled with energy access (Olsen 2007; Schneider
2007; Borges da Cunha, et al. 2007), but the implementation is often more difficult than the theory. One of the core principles is additionality, which states that in order for the credits to be used towards developed country commitments, the projects must not have occurred in the absence of the CDM. While additionality helps the Mechanism function on the global scale, the decision- making factors that determine whether or not a project is pursued do not always follow the theory.
Much of the attention of the CDM has been on the large developing countries that provide the largest potential for emissions reductions, such as India,
China, and Brazil, but it is often argued that less developed countries have a greater need for CDM projects because they are less affluent, lack universal
2 energy access, and will be hit hard by climate change impacts (Roberts 2007).
This study focuses on the interaction between renewable energy, the CDM, and small developing countries in Central America—specifically Honduras and Costa
Rica. Why were CDM projects pursued there? What were the barriers? Did the
CDM provide sufficient incentive to tip the balance to decide to implement renewable energy over a fossil fuel source?
The decision-making factors and challenges to implementing renewable energy CDM projects are analyzed through a series of stakeholder interviews in
Honduras and Costa Rica. By examining the decision-making factors involved in renewable energy project development and CDM registration in Central America, the study compares the additionality of these projects to the theory behind additionality. Within international climate negotiations, there are contentious debates about how developing countries will grow in the future, especially regarding their right to develop and the emissions associated with that growth
(Roberts and Parks 2007). As the climate negotiations in Copenhagen draw near in December 2009, it is important to understand how the CDM has been implemented on the ground and what lessons can be drawn for a future mechanism, especially with regards to additionality.
2. Clean Development Mechanism Background
2.1. Introduction
In order to analyze the present situation with renewable energy and the
CDM in Central America, it is important to understand several pieces of
3 background information. The CDM was one of the outcomes of the Kyoto
Protocol, and its purpose, design, and implementation are couched in the political dynamics surrounding the international climate negotiations. To provide the foundation for these case studies, this section will review the current CDM projects, key actors involved, project cycle, and CDM market characteristics.
Finally, this section will examine the theory behind one of the CDM’s core principles, additionality, which will be compared to Honduran and Costa Rican case studies in Chapter 6. Specific country and energy sector characteristics are also essential background, however, these elements will be presented in each country case study alongside the results of the stakeholder interviews.
2.2. International Negotiations to Address Climate Change
International cooperation on climate change dates back to 1988, when the
Intergovernmental Panel on Climate Change (IPCC) was formed, and global cooperation has continued to build since then. Based on the premise that more research on the causes and effects of climate change were needed in order to better address it, the IPCC pursues joint investigation on the scientific understanding of climate change. The small group of scientists that first made up the IPCC has since grown into a body of hundreds of rotating scientists, each reviewing data and reports for three years at a time. Compiling and summarizing reports from scientists around the world, the IPCC has been one of the major influences in the progression of climate change negotiations as it has shown the far-reaching effects of climate change and the urgency of global action.
4 The next landmark event was the establishment of the UN Framework
Convention on Climate Change (UNFCCC) at the 1992 UN Conference on the
Environment and Development at Rio de Janeiro. Realizing the complexity of the problem and the young scientific research, the UNFCCC was formed to guide future negotiations on international cooperation to address climate change. With the primary goal of stabilizing GHG concentrations, the body was tasked with sharing national GHG emission data and gathering national strategies for mitigation and adaptation. Developing countries grew concerned that developed countries may try to use this to restrict their economic growth despite the fact that most historic emissions originated from developed countries. As a result, the principle of ‘common but differentiated responsibilities’ was born under the
UNFCCC. This important phrase generally means that while countries are headed in the same direction (which means combating climate change in this context), they will not all be held to the same requirements (such as emission reductions).
The phrase recognizes the differing levels of responsibility, as well as dissimilar levels of development; however the ambiguous wording left it exposed to different interpretations over the years.
Difficulties in climate change governance arise from the lack of correlation between the emitters and those who will be most affected by climate change. Sagar, Lane, and Schneider (2005) estimate that 80% of historic emissions have come from developed countries, yet the poorest countries that have emitted the least will receive the worst impacts. Sea level rise will encroach on several highly-populated areas, retreating glaciers will lead to water shortages
5 and droughts will increase in frequency, devastating crops. On top of these effects, the poorest countries are also the most vulnerable, and the least capable of adapting. With few financial resources, they not only have the little ability to adapt, but also to mitigate further emissions. These three factors – responsibility for emissions, vulnerability to impacts, and capability to mitigate – come together to create tension in international climate negotiations as they lead to different conceptions of what constitutes “fair.”
Parties to the UNFCCC negotiated throughout the 1990s, and with more conclusive climate change science and greater awareness by 1997 the Kyoto
Protocol was signed. Eventually bringing together 182 countries, the Protocol entered into force when Russia joined in 2005, completing the requirement that over 55% of global emissions are governed under the agreement (UNFCCC). To appease ‘common but differentiated responsibilities,’ the Kyoto Protocol separates countries into two groups: the developing non-Annex I countries that are not bound to emission reductions and developed Annex I countries that are bound to emission reductions. Each of the 38 Annex I countries has as emission reduction target compared to a 1990 baseline, resulting in an average 5% reduction by the end of the first commitment period in 2012 (Carpoor and
Ambrosi 2007). The Kyoto Protocol also stipulates that in order to give countries time to prepare for its implementation a post-2012 regime must be agreed upon by the end of 2009, so negotiations are continuing to discuss the future regime throughout the period of this study.
6 The Kyoto Protocol emission reduction targets were intended to be implemented primarily through national measures, but three flexibility mechanisms were designed to help countries meet targets in a cost-efficient manner. First, Annex I countries can trade emission credits, so a country that reduces its emissions beyond its target can sell emission credits to a country that emits more than its allotted amount. Second, Joint Implementation allows Annex
I countries to earn credits for carbon-reducing projects in other Annex I countries, as long as the reductions are not counted twice. Finally, there is a measure involving developing countries, since developed countries agreed to help developing countries mitigate future emissions through the UNFCCC. This mechanism, the Clean Development Mechanism (CDM), allows Annex I countries to obtain carbon credits generated from emission-reducing projects implemented in Non-Annex I countries.
2.3. The Clean Development Mechanism
2.3.1. CDM Overview and Negotiation
The CDM, or the ‘Mechanism’ as it is also called throughout this paper, has been both widely acclaimed and criticized in international negotiations over the years. It has two overarching goals, reducing GHG emissions and sustainable development, as is laid out in Article 12 of the Kyoto Protocol. One of the original reasons for the CDM was to offer a more cost-effective method of reducing emissions for Annex I countries, while helping non-Annex I countries implement carbon-reducing project that normally are not cost-effective. Even
7 though the topics is often skirted within the discussions, there is a core obstacle resulting from the differences in opinion over what is ‘fair’ or ‘equitable’ in respect to responsibility for climate change and who should pay for mitigation.
Although not originally formed for this purpose, the CDM took on the position of attempting to address some of these inequities. However, when the concept was initially proposed by the U.S. and Brazil, several developing countries were skeptical, viewing it as a way for developed countries to buy their way out of emission mitigation within their own borders. Over time, the CDM gained favor as it was seen as an additional form of development aid and a vehicle for technology transfer. Some people even revere it as a grand bargain between developed and developing countries in respect to climate change. Regardless of where one falls in the spectrum of opinions, the CDM led to the participation of developing countries in climate change mitigation.
The text of the Kyoto Protocol outlines three global criteria for the
Mechanism (UN 1998: Article 12, Paragraph 5):
• Participation is voluntary and must be approved by each Party; • Mitigation by projects must have “real, measurable, and long-term benefits;” • Emission reductions must be additional to those that would occur without the CDM.
The Marrakesh Accord in 2001 established the modalities and procedures of the
CDM, and since then the CDM Executive Board has taken on the responsibility for refining the procedures as needed. To offer a variety of options, 15 sectoral scopes are included in the Mechanism. These include:
• Energy industries (renewable/non-renewable sources) • Energy distribution
8 • Energy demand • Manufacturing industries • Manufacturing industries • Chemical industries • Construction • Transport • Mining/mineral production • Metal production • Fugitive emissions from fuels (solid, oil and gas) • Fugitive emissions from production and consumption of halocarbons and sulphur hexafluoride • Solvent use • Waste handling and disposal • Afforestation and reforestation • Agriculture
Although the CDM has never lost sight of its purpose to reduce GHG emissions, it morphed into a much more complex program than was initially intended in order to achieve it dual goals of sustainable development and emission reductions. To meet the sustainable development goal, each project has to meet host country requirements. The result thus far is that the sustainable development benefits vary widely project to project, partially because host country requirements are often lax. In terms of emission reductions, complex rules were developed to ensure that this goal is met. First, projects must prove that they are additional, meaning that they would not have occurred without the CDM, a concept and process that will be fleshed out later in this study. The emission reductions are traded in the form of Certified Emission Reductions (CERs), which
2 are worth one tonne CO2e and traded for a price that is determined by the
2 CO2e is the abbreviation for equivalent carbon dioxide, a measure used to compare the emissions of different types of gases based on their Global Warming Potential. It takes a set amount of a gas (usually measured in tonnes) and converts it to the amount of carbon dioxide that would have the same impact on global warming. For example, with a Global Warming Potential of 21, one metric tonne
9 international market. Each project must show that emission reductions are real, measurable, and quantifiable against a baseline scenario. Then, the CERs can be used towards Annex I emission reduction commitments.
Figure 1. Growth of total expected accumulated 2012 CERs Source: Adapted from UNEP Risoe Centre 2008.
2.3.2. Current CDM Projects
Since the CDM began, the number of projects has increased rapidly and currently there are 1,243 projects registered (UNEP Risoe Centre 2008). The design and registration process can take a few years to complete, so including projects that are at the validation stage or beyond, there were 4,252 projects ‘in the pipeline’ by December 2008 (not including those rejected or withdrawn).
Incorporating the number of years and annual reductions of each project, these will generate 2,865,143 kCERs by 2012 and 7,125,124 kCERs by 2020 (UNEP
Risoe Centre 2008). While there is no limit on the number of projects that can be
of methane is equivalent to the emission of 21 metric tonnes of carbon dioxide, or 21 CO2e.
10 pursued overall, the overwhelming influx of projects and the capacity of the CDM
Executive Board caused the international process of validation and registration to slow down. Nevertheless, the 4,252 projects in the pipeline will produce
2,865,143 MtCO2e by 2012.
Of the projects in the pipeline, 19.1% are renewable energy projects
(UNEP Risoe Centre 2008). The worldwide annual investment in renewable energy over-quadrupled from 2004 to 2007 as global concern for climate change is rising, renewable energy has emerged as a key strategy for both developed and developing countries to pursue to reduce emissions in the electricity sector
(Cosbey 2008). Coal power plants and other fossil fuel-based generators last for
40-50 years, and without a measure to retire plants, they will continue to generate electricity with GHG emissions for the plants’ lifetime. Renewable energy, on the contrary, requires substantial up-front investment before it can begin generating
CERs. In this sense, CERs leverage investment for renewable energy (Capoor and Ambrosi 2007).
Figure 2. Growth of expected accumulated 2012 CERs by country Source: Adapted from UNEP Risoe Centre 2008.
11 As the projects proliferate, it is important to note the geographic distribution. China has 37% of the projects in the pipeline, which represents 54% of the CERs that will be generated by 2012, largely due to a handful of gas capture and destruction projects (or so-called HFC projects, UNEP Risoe Centre
2008).3 HFC projects generate large emission reductions at a low cost; however, they have been criticized for providing few sustainable development benefits
(Schneider 2007; Sutter and Parreno 2007). While China leads in the number of projects, India, Brazil, and other large developing countries also have a large proportion of total projects, as Figure 2 shows. These countries, however, also have large populations. The regional breakdown in Table 1 shows that Africa is the only region that has the least number of projects for its population. Latin
America has roughly 20% of projects in the pipeline, which is impressive given their population (UNEP Risoe Centre 2008).
Table 1. Regional distribution of CDM projects
Popul- 2012 ation CERs Total in the (millio per CDM Pipeline Number kCERs 2012 kCERs ns) capita Latin America 814 19.1% 79430 427930 14.9% 449 0.95 Asia and Pacific 3255 76.6% 476382 2281589 79.6% 3418 0.67 Europe and Central Asia 42 1.0% 4064 18953 0.7% 149 0.13 Africa 87 2.0% 18642 98577 3.4% 891 0.11 Middle-East 54 1.3% 8376 38093 1.3% 186 0.20 Less Developed World 4252 100% 586894 2865143 100% 5093 0.56 Source: UNEP Risoe Centre 2008.
3 China has issued 1,534,306 2012-CERs out of a total of 2,865,124 2012-CERs of projects in the pipeline, and 1,568 out of 4,252 projects in the pipeline.
12
2.3.3. Key Actors
A variety of actors contribute to the CDM throughout the various stages.
Part of this is due to the effort to mollify myriad concerns about the CDM, which resulted in a more complex mechanism than originally intended. The organizational structure is more dispersed than in most programs, splitting the responsibilities up between various actors. At the center is the CDM Executive
Board (EB), a UN body that oversees and regulates the Mechanism and is responsible for registering projects and keeping track of them in the CDM
Registry. The EB consists of eight non-Annex I members and two Annex I members and is assisted by experts and working groups to carry out day-to-day operations (Capoor and Ambrosi 2007). Within each host country, the government must set up or designate an office to be the Designated National
Authority (DNA), which approves projects and determines the sustainable development criteria. To ensure the principle of additionality is being met and verify that emission reductions are indeed occurring, Designated Operational
Entities (DOEs) check each project. These companies are certified by the CDM
EB to carry out this third party verification.
There are also actors that each of the individual projects involve. For each project, there is a project developer that initiates and constructs the project in the host country and sells the CERs. There is also a CER buyer, which is either an
Annex I country government or a non-state party within an Annex I country.
Finally, there are companies that serve as CER brokers, such as Ecoinvest or
13 Ecosecurities, which provide services that relate to the completion of the paperwork involved with registration with the CDM EB as well as connect the
CER buyers to the sellers. Finally, NGOs play various roles assisting with implementation, community benefits, standard-setting, and monitoring. For example, the Gold Standard is a well-known NGO that sets standards higher than the EB to ensure that projects contribute to sustainable development. This distributed model allows public, private, and NGO groups to be involved with the
CDM, as can be seen with the project cycle diagram in Figure 3.
2.3.4. Project Cycle
Figure 3. CDM project cycle
The CDM project cycle brings together the actors in a progression of steps that move projects from conception to completion through the same general process. After the idea is conceived and initial plans completed, the project
14 developer often proposes it to the host country government with a Project Idea
Note to get initial endorsement to continue the project, although this varies by country. The first formal step is the development of a Project Design Document, which intermediaries often assist with. This has calculations and plans, including the baseline calculation, estimation of GHG reductions, and additionality analysis.
The project developer presents this to the DNA to obtain formal support from the host country government in the form of a Letter of Approval (LoA). Next, a third party DOE validates the project by checking all of the calculations the PDD contains and holding a stakeholder comment period. At this point the project developer can apply for approval and registration with the CDM EB. The timing of project construction and CDM registration varies, and often the project is well under way by the time it gets formally registered. After the project has been in operation for at least a year the GHG emission reductions are calculated based on data collected during monitoring based on the monitoring methodology chosen and approved (rather than estimated reductions). Then another DOE verifies the reductions in order for the EB to issue the CERs.
Usually the contractual agreement between the buyer and seller takes the form of an Emission Reducing Purchase Agreement (ERPA). Most of these are
“forward contracts,” where the ERPA is formed well before CERs are ready to be delivered. Sometimes the buyer just buys the credits, and other times they contribute to the initial financing of the project or help prepare some of the CDM documents. The numerous transaction costs associated with the CDM are placed on the project developer, including personnel time spent preparing the documents,
15 DOE fees, and the registration fee. There are often financing options from many brokers and multilateral development institutions to off-set costs until the CER revenue is received (Ecosecurities and UNEP 2007).
2.3.5. CDM Markets
The growth in CDM markets has increased since the Marrakesh Accords defined the modalities and procedures in 2001 (UNFCCC 2001). In 2006 alone, there was almost $5 billion transacted through the project-based market, showing a 32% increase from 2005 (Capoor and Ambrosi 2007). The World Bank also helped stimulate production of mitigation projects by creating the Prototype
Carbon Fund in 2000. By offering up-front financing that was often needed for construction, this helped get many projects off the ground, allowing them to wait until credits were delivered to make payments (Carr and Rosembuj 2007).
The CDM links into several emission trading schemes. Under the Kyoto
Protocol, developed countries have emission caps and they can use cap and trade schemes to meet those caps. To add flexibility to the system, the Kyoto flexibility mechanisms allow credits to help with domestic reductions. These can be
Assigned Amount Units traded through emission trading, Emission Reduction
Units issued through Joint Implementation, or CERs created through the CDM.
All represent the same amount of CO2e. As CERs enter the system after completing all steps to be registered, developed countries can then use CERs to meet their Kyoto commitments. Furthermore, most national or regional emission trading schemes accept CERs, such as the EU Emission Trading Scheme.
16 Most CER buyers are from either Europe or Japan, although the proportion of the volume transacted depends on the year: in 2005 Japan bought
46% of the CERs and in 2006 Europe bought 86%. Either state entities or private companies can purchase CERs, with companies often using them towards their restrictions in a cap and trade system. In 2006, 92% of European purchases came from the private sector (Capoor and Ambrosi 2007). In order to ensure that the public or private entities that purchase CERs do not rely solely on these off-sets coming from developing countries but also reduce their emissions domestically, some regimes place ceilings on the amount of reductions that can be derived from
CERs. The price of CERs fluctuates according to the market. After starting around US$2-3 per tonne CO2e, by 2008 they rose to an average contracted price of US$13.60 for primary transactions (Capoor and Ambrosi 2008). The price on the secondary market was slightly higher given the decrease in risk associated with the credits.
2.4. Additionality
2.4.1. Additionality Basics
One of the most important principles of the CDM is additionality, and more specifically environmental additionality. Emission reductions from CDM projects are supposed to be beyond reductions that would have occurred without the CDM. The importance of this concept relates to how the CERs are used, counting as reductions within cap and trade schemes. The potential problem arises that if a project was business as usual, it would increase the overall
17 emission cap when traded in. Thus, in the process design of this Mechanism, all projects must prove that they would not have been implemented if it were not for this Mechanism, and guidelines were developed to assure strict environmental additionality.
Given the contentious debates around the role and definition of additionality (Schneider 2007), it has been clearly defined by the CDM Executive
Board. It concluded that:
A [programme of activities] is additional if it can be demonstrated that in the absence of the CDM (i) the proposed voluntary measure would not be implemented or (ii) the mandatory policy/regulation would be systematically not enforced and that noncompliance with those requirements is widespread in the country/region, or (iii) that the [programme of activities] will lead to a greater level of enforcement of the existing mandatory policy/regulation (CDM Executive Board 2008).
A project must prove its additionality in the PDD by describing how it meets certain criteria in one of the approved methodologies. Then, when the DOE reviews the PDD, it must support the additionality claim to allow the project to pass. Given the complexity of the analysis, the EB defined a simplified procedure for small-scale projects.
2.4.2. Additionality Determination
To guide the CDM Executive Board created a “tool for the demonstration and assessment of additionality” to (CDM Executive Board n.d.). As Figure 4 shows, this process consists of a preliminary screening (Step 0) and five steps.
For the preliminary screening, evidence is required to show that the CDM was seriously considered in the decision to pursue the project. Step 1 must identify alternatives to the project activity that are consistent with current laws and then
18 show that the project went beyond compliance with the laws. If there are no alternatives that are consistent with current laws, it would not be additional because that project activity was the only option. Step 2 is an investment analysis that shows that the project was economically or financially less attractive without
CERs. As an alternative to Step 2, projects can complete Step 3, a barrier analysis, which proves that the project faced barriers that prevented wide-spread implementation of the technology. Step 4, the common practice analysis shows that the project type was not diffused in the relevant sector and region. Finally,
Step 5 assesses the impact of CDM registration, which consists of an explanation of how CDM registration will enable the project to be undertaken. In total, a project must pass either Step 2 or 3, in addition to passing the rest of the steps
(CDM Executive Board n.d.).
Figure 4. Additionality determination
19 For small-scale CDM project activities, the rules were simplified, and so was the process of determining additionality. Of the three types of small-scale
CDM project activities, the most common in Central America is Type I, renewable energy projects of up to 15 MWs, and Type III, other project activities limited to those that result in emission reductions of less than or equal to 60 kt
CO2e annually (CDM Executive Board 2008). For these projects, the additionality determination is simplified to consist of a description of the barriers to the implementation. A project must provide evidence that it faces at least one of the four types of barriers (Mizuno 2005):
• Investment barrier: there is a more financially viable alternative to the project exists that would result in higher emissions. • Technological barrier: there is a less technologically advanced option that would result in higher emissions, especially projects with lower risk. • Barrier due to prevailing practice (common practice): there is a prevailing practice or existing regulatory requirement that would have led to an alternative activity with higher emissions. • Other barriers: institutional barriers, limited information, managerial resources, organizational capacity, financial resources, or capability to use new technologies.
Despite the simplification for small-scale projects, this process still complicates the process of CDM registration.
Most barriers CDM project face are straightforward to explain; however,
Step 2, the Investment Analysis, requires greater explanation of how it is determined. Detailed calculations are needed to produce a true reflection of the investment decision the project developers face, or as close as is possible. The
CDM Executive Board has accepted three methodologies that can be used to determine investment additionality, and each project developer can choose which
20 method best suits the project. Option I is a simple cost analysis that shows that of the alternatives listed in the additionality analysis Step 1, there is at least one alternative that is less costly than the project. Option II consists of an investment comparison analysis using a financial indicator (Internal Rate of Return, Net
Present Value, cost benefit ratio, or unit cost of service) that is calculated for the proposed project and its alternatives. Option III is a benchmark analysis using an appropriate financial/economic indicator (Internal Rate of Return), and comparing the project without CDM revenue to that benchmark. Both Option II and III should be calculated using the EB guidance for the assumptions, and finishing the analysis with a sensitivity analysis to test critical assumptions (such as the price of fuel). If the project is not the “most economically or financially attractive” alternative (as calculated with Option II) or is not “economically or financially feasible, without the revenue from the sale of certified emission reductions” (as calculated with Option III), then it passes the investment analysis (CDM
Executive Board n.d.).
2.4.3. Debate over Additionality
While the additionality principle is one of the core principles of the CDM, it was also one of the most contentious to negotiate (Freestone and Streck 2007).
When the modalities and procedures of the CDM were fleshed out at the
Marrakesh Accords in 2001, the additionality principle took on the understanding held today. There were several projects that had been pilot projects in the 1990s, but under the 2001 rules, they were unable to qualify as CDM projects due to their
21 lack of additionality (Figueres 2004). To better understand additionality, it is necessary to look at both the arguments supporting additionality and the arguments against additionality.
There are three main arguments that support strong additionality clauses for the CDM: ensuring strong environmental additionality, economic efficiency, and developing country benefits (Sugiyama and Michaelowa 2001). First, as explained earlier, there must be true environmental additionality to be traded into a cap and trade system so as not to enlarge to size of the cap. Furthermore, to be additional, they must be real, measurable, and verifiable, which requires a system in place to ensure that this is true. However, it is difficult to prove the counterfactual and there is great debate over whether additionality can be proven with absolute certainty (Schneider 2007). Along with this argument, additionality is usually supported because it is deemed economically efficient. From an economic perspective, it is cheaper to implement some of these emission reduction projects in non-Annex I countries rather than in Annex I countries. The
CDM is one of three mechanisms in the Kyoto Protocol that provide flexibility to
Parties with emission reduction commitments by allowing the reductions to occur from multiple types of reductions and in multiple locations (Sugiyama and
Michaelowa 2001). A final argument for the CDM is that it allows developing country gains, not only in a greater number of projects, but in technology transfer and sustainable development. Utilizing the additionality concept in a different manner, developing countries negotiated to make the CDM additional, meaning that it must be beyond exiting assistance.
22 There are also several arguments against additionality. Contrary to the third argument above, it is also argued that additionality does not benefit host countries by additional projects because in general a CDM project is useful to the host country regardless of whether it is additional or not, and by limiting the projects that can earn CERs to those that are additional, the host country may lose out on greater funding. Furthermore, the calculations for the proof of additionality add to the complexity of the Mechanism for the project developers.
On the national scale, in fact, the additionality principle could offer a perverse incentive by giving countries a reason not to implement laws that reduce emissions, such as stricter regulations or renewable energy laws. In other words, if a country thinks that the implementation of a law will lead more projects to not pass the additionality test, and therefore be less likely to be registered as a CDM project, then it might reconsider passing that law. There are also arguments against the additionality principle from an economic point of view. The most economically viable projects are the most likely to occur with or without the
CDM, but this also means that they are the least likely to qualify as additional.
Stated in another way, “ ’…The difficulty of ensuring that crediting reflects real and additional emission reductions is compounded by the paradoxes that the most
‘cost-effective’ projects may be the least ‘additional’ and that strict project additionality would give perverse incentives’” (Sugiyama and Michaelowa 2001).
This could also be an incentive for investors to raise the cost (Sugiyama and
Michaelowa 2001), or for governments to give incentives to invest in the least cost-effective sites (Bode and Michaelowa 2003).
23
3. Methodology
3.1. Project Development
The specific topic and focus of this study was developed from a combination of informational interviews and a literature review. The general direction was derived over the past few years from the author’s familiarization of climate change policy and Latin America through the literature, work experiences, and courses. While fitting within the author’s area of interest, the focus of this study was formulated with the goal of heightening the relevance to practitioners and policy formation. The scope and thesis questions were developed from a series of informational interviews with non-profits, private entities, and government officials chosen based on their work in the field, recommendations, and availability (interviews included Gold Standard, World Wildlife Fund,
EcoInvest Brazil, Climate Change Biodiversity Alliance, C3 – The Carbon Credit
Company, and government officials in Panama and Costa Rica). Several people interviewed noted that various analyses have been produced about the CDM; however, the focus remains concentrated on the large developing countries, particularly China, India, and Brazil. Less attention has been directed to the smaller developing countries and their experiences with the CDM and yet the
CDM must function for both. Hence the need for research focusing on regions such as Central America.
The topic, research approach, and methodology were further refined with feedback from researchers and professors, as well as additional casual
24 conversations with practitioners. A case study methodology was chosen to evaluate two Central American countries, narrowing the focus down to the barriers involved in renewable energy CDM projects within those countries and the determination of additionality. Given that each country has very different experiences and there is not a large enough sample size to pursue quantitative analysis, utilizing a case study methodology allowed the author to use a variety of sources to qualitatively understand the antecedent conditions in these two countries. As will be discussed in greater depth in the sections below, the methodology utilized consists of two main types of data; the review of the literature and databases was combined with primary research from stakeholder interviews. Research trips were required to pursue this methodology, which was made possible with a Tufts Institute for the Environment (TIE) Graduate Research
Fellowship that covered the costs of research trips to Honduras and Costa Rica.
3.2. Research Overview and Boundaries
Within the author’s regional focus on Latin America, the practitioners interviewed for the project development spoke of their knowledge of Brazil and
Mexico, but few were familiar with renewable energy or CDM projects in Central
America. Interviewees noted that many Latin American governments, particularly in Central America, are interested in the CDM as a development tool and a source of additional funding, and both NGOs and the private sector are constantly looking for new regions to expand their operations into. Through the initial informational interviews practitioners indicated interest in learning more
25 about how the CDM functions on the ground in smaller developing countries, what the challenges were, and if they should get involved. There was also enthusiasm for evaluating the potential for helping developing countries get on a clean development path.
Honduras and Costa Rica were chosen as the two case study countries based on rationale derived from a preliminary literature review and informational interviews completed during the project development stage. Table 2 outlines basic characteristics of each country, showing the differences between them.
Costa Rica is the wealthiest Central American country, renowned for its environmental laws and its ability to work with international governments to attract funding for the environment. However even though the country has the institutional capacity and political will to pursue CDM projects, it has surprisingly few projects registered. Honduras, on the other hand, is a stark contrast to Costa
Rica: it has high poverty rates, lax environmental regulations, and a government that is often characterized by inefficiency. These characteristics are usually correlated with a low number of CDM projects, but Honduras in fact has many projects relative to its population.
26
Table 2. Country statistics for Honduras and Costa Rica
Central American Honduras Costa Rica Average d Electric power consumption (kWh per capita) a 626 1,719 789 Energy use (kg of oil equivalent per capita) a 566 883 40 GDP (current US$) 10,774,022,144 22,229,172,224 19,365,345,178 GDP growth (annual %) 6 8 6 GDP per capita b 1546 5,053 2,770 High-technology exports (% of manufactured exports) 1 45 11 Internet users (per 100 people) 5 28 . Population, total 6,968,687 4,398,770 7,471,927 Poverty headcount ratio at national poverty line (% of population) c 51 24 . CDM projects 14 6 7 Source: Data from World Bank 2009. Note: There is no average for characteristics that did not have data for many Central American countries. a 2005 data b Author’s calculation based on data in table c 2004 data d Includes Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua
The study is composed of five main objectives, each which provides a main component of the overall analysis. The main objectives are:
• Objective 1: To understand the theory behind the additionality principal of the CDM; • Objective 2: To examine case studies of renewable energy CDM projects in Honduras and Costa Rica; • Objective 3: To disaggregate the barriers associated with renewable energy versus the CDM; • Objective 4: To analyze how the additionality of CDM projects in Honduras and Costa Rica compares to the theory of additionality.
27
3.3. Case Study Methodology
In a comparison to available methodologies, the case study methodology provided the best fit for this study. It allows the researcher to deal with technically difficult situations where there are many more variables of interest than there are data points (Yin 1994). Utilizing multiple sources of data, the case study methodology can use triangulation as well as compare the results to theories
(Yin 1994). Moreover, the objectives of the study that focus around decision- making factors were reflected by this methodology. In other words, “the essence of a case study, the central tendency among all types of case study, is that it tries to illuminate a decision or a set of decisions: why they were taken, how they were implemented, and with what result” (Yin 1994: 12).
The research methodology applied consists of triangulation between a variety of sources in order to combine existing data with first-hand experiences.
This study uses an extensive, broad literature review, including reports, databases, and government documents, and it combines them with stakeholder interviews.
While many studies of the CDM that exist are derived primarily from literature reviews, there is an emerging understanding that experiences with the CDM vary place to place. Therefore some studies utilize interviews as well (Burian 2006;
Figures 2004; Lokey 2007; Capoor and Ambrosi 2007). Similarly, this research seeks to take the existing literature and information from databases and combine it with primary research within the case study countries.
28 Since the research deals with human subjects, approval from the Internal
Review Board (IRB) was necessary and obtained. Initially a survey was developed and approved by the IRB in combination with the stakeholder interview overview. The survey part of the methodology, however, was eliminated because the expected response rate was too low. Nonetheless, the IRB classified the stakeholder interviews as “exempt” because the study will not harm human subjects and preserves the anonymity of the interviewees.
The research methodology for this study was created in order to merge facts with first-hand experiences and perspectives. Case studies are often used to explain causal links or to describe an intervention and the context in which it occurred (Yin 1994), both of which are needed for this study. The four main objectives of the research were matched with the appropriate tools to give the best triangulation. Each method will be elaborated on in the following section, but
Table 3 shows which sources were employed for each objective.
Table 3. Sources used to meet each objective
Objective Types of Sources Used Examples of Sources Objective 1: To understand • Literature review • Analysis of the the theory behind he Additionality Tool additionality principal of the (Ringius 2004) CDM • Database review • Science Direct database Objective 2: To examine • Literature review • REEEP Renewable case studies of renewable Energy Regional Policy energy CDM projects in Analysis Report Honduras and Costa Rica • Semi-structured • Employee in the Energy stakeholder Sector Direction, Ministry interviews of the Environment, Energy and Telecommunications, Costa Rica • Site visits • Inversiones Hondureno cogeneration plant
29 Objective 3: To disaggregate • Semi-structured • Ecosecurities employee the barriers associated with stakeholder renewable energy versus the interviews CDM • Database review • UNFCCC Database Objective 4: To analyze how • Literature review • Additionality of the CDM the additionality of CDM (Mizuno 2005) projects in Honduras and • Semi-structured • Hydropower project Costa Rica compares to the stakeholder developer theory of additionality interviews
There were two main difficulties encountered during the research. First, the Costa Rican research trip was close to the holiday vacation, which extends longer than is typical in the U.S. This limited the interviews because interviewees were leaving town or rushing to complete tasks before vacation. Second, the rapid pace at which projects develop and policies evolve meant that information was, and still is, constantly changing. The research took place over the span of one year, from March 2008 to March 2009.
3.4. Database and Literature Review
Since this study takes an interdisciplinary approach, it was important to establish a solid understanding of myriad topics, both from a methodological perspective as well as an understanding the context and issues. Among the strengths, documents and literature provide a stable source of data that can be reviewed repeatedly. Exact names, specific details, and a longitudinal account can be extracted. On the other hand, retrievability can be low at times, especially working with government documents, and there can be reporting bias within the documents (Yin 1994). A review of other studies working with similar topics
30 showed that they addressed similar concerns about the barriers or the implementation of CDM projects were most often carried out on an international scope, drawing from literature reviews and available online documents. For this study, an understanding of climate change and the geopolitical tensions of international climate negotiations were important to form the context of the
Mechanism, as well as formulate interview questions that were attuned to the variety of perspectives. Country-specific context from the literature review about the governments, society, and particularly the energy sector became the starting point for the analysis and enabled the interviews to proceed with greater depth.
An extensive literature review was necessary to cover the many topics that relate directly and indirectly. Databases used included the UN Framework Convention on Climate Change database of Project Design Documents, Science Direct, Wiley
InterScience, JSTOR, and Project Muse. The Project Design Document of a project provided the starting point for each interview with a project developer.
3.5. Research Trips for Stakeholder Interviews
The literature and document review was complemented by data collection through stakeholder interviews. Many site-specific elements and challenges remain distinct to the host countries and they are often not evident on paper assessments, so two research trips were carried out in order to interview key stakeholders. From August 12, 2009 to August 25, 2009, the author traveled to
Honduras, completing 15 interviews. The Costa Rica research trip was completed on December 11, 2009 through December 21, 2009, and enabled the author to
31 interview 12 people. A few of the interviews took place on-site, providing the opportunity to see the operation, surroundings, and talk to engineers or people that worked on the project in addition to the project developer. These enabled the author to analyze the reality of the specific CDM projects and the situation in each country. Direct observation allows contextual factors to be gleaned from the projects; however, drawbacks include the selectivity, time, and cost (Yin 1994).
The TIE Graduate Research Fellowship helped with the latter factors; however, these inhibited the inclusion of more countries.
The research covered a range of project types and geographic locations, although focused on renewable energy projects (which is the dominant type of
CDM project in Central America). The first trip was to Honduras, carried out from August 12, 2008, to August 25, 2008. It consisted of one week in
Tegucigalpa, the capital, and one week meeting with project developers in San
Pedro Sula, where several companies have their offices, and traveling to project sites. Over the course of this research trip, the author interviewed 15 people: 7 project developers, 3 people associated with project developers, 1 Honduran government employee, 1 non-governmental organization (NGO), 2 intermediaries, and 1 U.S. government employee. Additionally, there were site visits to 4 of the project sites. The second trip was to Costa Rica from December
11, 2008, to December 22, 2008. The 12 people interviewed included 3 project developers, 1 employee of a project developer, 4 Costa Rican government employees, 1 NGO, 1 intermediary, and 2 U.S. government employees. It is important to note that in Costa Rica, the government not only is responsible for
32 energy sector oversight and planning, but also owns the majority of the projects, as Chapter 5 will discuss at greater length. Due to the short timeframe and proximity to Christmas, the time was spent primarily in San Jose, where interviewees’ offices were located.
The interview questions covered a variety of topics related to the CDM, and they varied slightly depending on whether the interviewee was a project developer, government employee, or other position related to either renewable energy or the CDM. Most questions focused on the interviewees’ experiences with renewable energy and the CDM, and for people who work with multiple projects the questions addressed their knowledge of the projects. The questions were centered on the barriers to the projects, and since these were open-ended questions most of the answers revealed decision-making factors as well. As can be seen in Appendix I, the questions included experiences with project risk, initial investment, technological capacity, the interaction between private project developers and government institutions, energy laws, and the CDM process.
Furthermore, the interviews addressed which factors were the most influential in the decision to pursue renewable energy and to apply for CDM registration, as well as which factors were the greatest challenges during implementation.
Overall, the questions were intended to glean an understanding of the implementation of the projects and their additionality.
33 3.6. Analysis
The analysis phase of the case studies used explanation-building, a specific type of pattern-matching analysis. This type seeks “to ‘explain’ a phenomenon,” meaning ‘to stipulate a set of causal links about it” (Yin 1994:
110). Case studies are complex and explanation-building proceeds through an iterative process. Each piece of evidence is used to continually refine the case, testing the initial case (Yin 1994). In this study, the initial case was formulated from the literature review. Then each interview added new pieces of information that were compared to the previous data, which incorporated greater detail.
Moreover, because this study deals with opinions and gray areas of decision- making, the outcomes of each interview were compared in light of each project.
4. Honduras
4.1. Honduran Energy Sector Overview
Nestled between Guatemala, El Salvador, and Nicaragua, Honduras is an interesting case when looking at its electricity sector. It is the poorest country in the region as measured by GDP, characterized by a high poverty rate and poor investment environment. Even with its poor electricity coverage, projections for the state-run National Electric Company (ENEE) show that the energy sector is headed towards another crisis. Over the past three decades, trends show increased private participation and increased reliance on fossil fuels for electricity generation. To set the stage for the Honduran case study, this section will elaborate on the energy sector characteristics before the following sections
34 examine the energy legislation, institutions, CDM projects, and challenges for renewable energy. This section will present the case study of Honduras, providing the data to analyze the additionality of CDM projects in Chapter 6.
Since many decision-making factors and challenges of CDM projects are due to the factors related to renewable energy, as opposed to being attributable to the
CDM, throughout the chapter those are disaggregated.
In the 1980s, the government commissioned a 300 MW hydroelectric power plant called El Cajon, adding more electricity than was demanded on the grid at the time (World Bank 2007). The government incurred substantial debt from this project, but never adjusted the tariffs to compensate. This caused a financial crisis, and when compounded by a lack of investment in generation reserve capacity and a severe drought, an energy crisis erupted in 1993 (World
Bank 2007).
In 1994, the government was forced to deal with the crises and it wrote a new electricity law, called the Framework Law of the Electrical Energy
Subsector. Designed in an era of liberalization and privatization throughout Latin
America, under the advise of international institutions, the new law was designed to create a competitive market and separate the regulation, policymaking, and service provision roles of government (World Bank 2007). This followed the standard model that was promoted worldwide at the time to address development concerns. Unfortunately, the reform was not carried out completely (Dussan
2005) and the National Electric Company (ENEE) remained the dominant institution and the only electricity buyer, albeit with private sector participation.
35 Since 1994, when hydroelectricity dominated the grid with roughly 90% of generation, thermal production has risen (including both power plants burning diesel, gas, and oil). Thermal production gained favor during the years of cheap oil in the 1990s, and by 2007 the private sector had invested US$600 million in medium speed diesel and gas turbines (World Bank 2007). For private investors, the lower risk, lower construction costs, and the ability to build plants quickly made thermal plants attractive. Currently the system is composed of about 67% thermal generation, which makes it extremely vulnerable to world oil prices, and largely due to the cost of energy purchases, fuel expenses doubled from 2001 to
2006 (World Bank 2007).
Figure 5. Historical electricity generation in Honduras by fuel, 1971 to 2005 Source: Adapted from IEA 2008.
Renewable generation did not come to a stand still, but droughts and larger initial investment costs contributed to the reduction of the investment in
36 renewables, which dropped to less than 12% of that of thermal generation over the same period. Of the 62.4% of Honduran electricity supply that is privately produced, only 3.5% is renewable while 58.9% is thermal (Empresa Nacional de
Energía Eléctrica), as Figure 5 shows. As of 2005, ENEE had signed contracts for 20 small renewable energy projects for a total of 83 MWs, of which 46 MWs were operation at this point (Dussan 2005). The renewable energy portfolio consists of a large amount of hydropower – 33% of total renewable energy generated, which is mostly done by the government. There are also a few cogeneration plants using sugarcane bagasse and methane capture. Additionally, in remote regions there are a few small solar development projects. The largest renewable energy project since the 1990s and the first wind power plant will be a
100 MW wind farm located south of Tegucigalpa. Up until the new wind farm is built, the renewable energy projects done by the private sector have been small or medium scale.
Recently there has been insufficient investment in new sources of generation, even though electricity coverage is the second lowest in the region
(World Bank 2007). Urban areas receive 94% coverage, but only 45% of rural areas are connected to the grid (World Bank 2007). “Social electrification” is part of the government’s poverty-reduction strategy, and while progress has been made thanks to the Social Fund for Electricity Development, the government is far from its 80% coverage goal for 2015 (World Bank 2007). As one interviewee pointed out, part of the difficulty is the high expense of running transmission lines to remote areas, such as the eastern lowlands of the country. Also the
37 transmission lines are extremely inefficient, with losses of approximately 25% in
2006 (World Bank 2007). On top of insufficient coverage with current capacity, there is not enough investment in new generation to meet rising demand (World
Bank 2007).
Table 4. Honduran electric capacity 2006-2007
Type of Plant 2006 2006 2007 2007 Potential (kW) % Potential (kW) % State total 588,600 38.0 589,000 37.6 State hydro 464,000 30.0 464,400 29.6 State thermal 124,600 8.0 124,600 7.9 Private plants total 959,009 62.0 979,317 62.4 Private hydro 38,471 2.5 55,266 3.5 Private thermal 920,538 59.5 924,051 58.9 TOTAL 1548,009 1,568,317 Source: Empresa Nacional de Energía Eléctrica.
4.2. Energy and Renewable Energy Legislation
As touched upon above, the primary energy law in Honduras is the
Framework Law of the Electrical Energy Subsector, Decree No. 158-94 (World
Bank 2007), which still prevails over the energy sector today. This has four main pillars: the separation of the roles of government, the introduction of private sector participation, competition, and economic regulation of monopolies. In respect to the separation of government roles into three institutions, the three institutions that were separated from ENEE lack the capacity ENEE has and continually have to rely on it. Weak institutions and continued political clientalism also contributed to the lack of implementation. Distribution remained bundled under ENEE; however the law succeeded in increasing private sector
38 participation. There are now three main ways in which the private sector can enter the market. First, the government can put out a call for a specific size project and project developers compete on a cost-competitive basis, regardless of whether it is renewable or non-renewable, and the winner signs a Power Purchase
Agreement (PPA) with ENEE. Second, a developer can propose a project, but then by law the price and terms are set by ENEE’s calculations. Finally, it is possible to sell directly to a third party, but wheeling charges must be paid to
ENEE for using the grid transmission lines. The most common form completed is the competitive bidding process.
To complement the Framework Law, the Incentive Law, Decree 85-98, and addition to it, Decree 267-98, were designed to promote renewable energy. It requires ENEE to purchase power from hydro, solar, and similar sources at the marginal cost of the system plus 10% according to ENEE’s calculation (Fehr
2003). Furthermore, they allow renewable energy technologies to be exempt from income taxes for the first five years of operation. Finally, a recent remaining law attempts to stimulate private sector and renewable energy production, but it has yet to be fully implemented. Decree 70 of 2007 was put in place to encourage public and private renewable energy projects (GLIN 2007). It did several things
(Lokey 2008): it provided that ENEE has to buy renewable energy from producers if they have not fulfilled the national energy plan and extended the contracts to 30 years; exempted systems of under 3 MW from requiring a generating license or doing a full EIS; allowed renewable energy generators to sell directly to the
Central American grid or large consumers; and stipulated that permits will be
39 issued in a maximum of three months (La Gacetta 2007). These are substantial improvements from; however, some project developers did not know of these changes, and others said they have yet to see the changes. Despite these efforts to promote renewable sources, renewable energy still often fails to out-compete fossil fuel power generation.
4.3. Energy Institutions
In 1957, ENEE was created as a state-owned, vertically integrated company responsible for promoting electrification throughout the country (Fehr
2003; Dussan 2005). During its first few decades, it built a national transmission grid, taking the place of the independent, isolated power systems that were in place, and today it controls the grid throughout the entire country, except for a few remote places that are beyond the grid or have been granted permission to operate privately. Despite the attempt to unbundle generation, transmission, and distribution with the 1994 Framework Law, ENEE remained responsible for all three functions, and even though generation was privatized, ENEE is responsible for putting out the bids, signing the PPAs, and ensuring sufficient generation
(World Bank 2007; Fehr 2003). Regardless of the broad reach of its functions,
ENEE is reliant on Congress to allocate project funding (Dussan 2005).
Furthermore, reports show that ENEE is losing an estimated US$200,000 per year, and without capacity additions, it is not expected to meet rising demand in 2009, 2010, or beyond (U.S. Department of State 2007). The World Bank estimates that even with the 150 MWs of new generation planned for 2007-2010,
40 there will still be 275 MWs of a ‘capacity shortfall’ by 2010, which does not bode well for the institution given the impending financial crisis in ENEE (World Bank
2007).
The 1994 Framework Law conferred the responsibility of policy-making to the Energy Cabinet and the Secretariat of Energy, Natural Resources, and
Environment (SERNA). The Energy Cabinet was to focus on larger policy- making, while SERNA was responsible for day-to-day sectoral planning and making sure that there is enough energy being added to the grid to meet rising demand (Fehr 2003). The institutions lack political support and financial resources, however, so they are reliant on ENEE to a great extent. Additionally,
SERNA is also responsible for approving environmental permits, such as the many permits associated with all hydropower projects.
The National Electricity Commission, CNE, was the final institution created in 1994. As part of the efforts to unbundle, CNE was created to be the regulator and it continues to fulfill the function through the present. Although originally created as an autonomous institution, SERNA controls its budget.
Furthermore, it is technically weak, so it too must rely on ENEE for information and technical analyses (Fehr 2003).
Ever since 1994, the private sector has played a large role in Honduras given the privatized generation market. By 2007, 62.4% of Honduras’ energy was privately produced, and only 3.5% of that was renewable energy (Empresa
Nacional de Energía Eléctrica). In order to help small renewable energy companies negotiate more effectively with ENEE, the Honduran Association of
41 Small Producers of Renewable Energy (AHPPER) was founded. Currently 41 hydroelectricity, 4 biomass, 4 solar energy, 1 geothermal, and 3 wind producers, as well as 3 associated companies make up AHPPER (AHPPER 2008).
4.4. The CDM in Honduras
4.4.1. Overview
Honduran interest in the CDM started early, albeit not as early as in Costa
Rica. The country claims some of the first small-scale projects, such as La
Esperanza. The early stages of involvement were aided by a few players. The
Finnish Industrial Development Fund worked with four projects in Honduras as part of the Finish CDM/Joint Implementation pilot programme (Finnish
Environment Institute). Then, they helped set up the Fundación Mecanismo de
Dessarrollo (MDL is CDM in Spanish). The Fundación MDL is a NGO that aids
CDM project development and continues today as an independent entity.
The government also became involved in the CDM and set up their DNA office. They established sustainable development criteria and according to one project developer, they have improved their application process over time. The government also actively supported awareness for certain sectors by hosting workshops. As of December 2008, the country now was home to 14 registered
CDM projects. Over half are small-scale hydropower projects, but there are also a few cogeneration and methane collection projects as can be seen in Table 5.
There have yet to be any solar projects, and the first wind project is in the planning stages (as of December 2008). Both the prevalence of small-scale
42 projects and the lack of large-scale projects make Honduras unique within the region.
4.4.2. Current situation
Table 5. Registered CDM projects in Honduras
Project name Project type Registrat- Installed Energy: Metric (Developer, if ion date power average tonnes (MW) annual different) CO2e generation reduced (GWh) per annum RIO BLANCO Small 1/11/05 Hydroelectric Project Hydroelectric 5 32 17,800 Cuyamapa 4/23/05 Hydroelectric Project Hydroelectric 12.2 48.2 35,660 Cortecito and San 6/03/05 Carlos Hydroelectric Project Hydroelectric 8.6 50.6 37,466 La Esperanza 8/19/05 Hydroelectric Project Hydroelectric 12.8 . 37,032 Cuyamel 11/26/05 Hydroelectric Project Hydroelectric 7.8 33.7 25,353 LA GLORIA 1/09/06 Hydroelectric Project Hydroelectric 4.7 27.2 20,464 Zacapa Mini Hydro 3/02/06 Station Project Hydroelectric 0.5 . 915 Yojoa Small 3/02/06 Hydropower Project Hydroelectric 0.6 3 1,069 CECECAPA Small 3/02/06 Hydroelectric Project Hydroelectric 2.9 . 1,877 Eecopalsa – biogas 9/02/06 recovery and electricity generation from Palm Oil Mill Effluent ponds Biogas . . 27,615 Tres Valles 6/28/07 Cogeneration Project Cogeneration 12.3 43.5 a 16,479 Cervecería Methane 9/28/07 Hondureña Methane Capture Capture Project . . 7,302
43 Inversiones 12/12/07 Hondurenas Cogeneration Cogeneration Project 14 15.0 a 19,937 Energeticos Jaremar – 3/08/08 Biogas recovery from Palm Oil Mill Effluent (POME) ponds, and heat & electricity generation Biogas . . 30,646 Source: Data from UNFCCC 2008. Note: Data was omitted when it was not in the same form, such as for biogas recovery projects. a per crop (not per year)
4.4.3. Actors
In Honduras there are three main government agencies that interact with the CDM. First, ENEE and SERNA interact with the CDM because the projects are renewable energy projects. Additionally, the Climate Change Unit that is responsible for leading National Communications on Climate Change is located within SERNA. However, despite the connection between energy planning and climate change policy, there is little cooperation between ENEE and the Climate
Change Unit. Then, as is standard with the CDM, the Designated National
Authority issues the country approval of each project, writing the Letter of
Approval and stipulating sustainable development criteria, although no project developers interviewed were asked to pursue further actions to satisfy this. Over the years the office has changed, which resulted in a variety of experiences among the project developers depending on when they interacted with the agency. With time the office has grown in its size and capability, and it has increased the stringency and length of its requirements. Most comments about the current DNA were positive, mainly because they satisfied key criterion: they were quick to
44 process the requests, and they were good at communicating with the project developers. There was concern, however, that some employees were politically appointed, so they were not as knowledgeable as they could be without high turnover.
All of the CDM projects in Honduras were developed privately, as opposed to by the government, so the private sector played a large role with the
CDM. AHPPER works closely with many of these developers and helped with capacity-building and assisted small producers with negotiations for their contracts with ENEE. Most interviewees thought the organization gave them more clout and recognition in Congress; however, one interviewee thought
AHPPER could gain more bargaining power if it were more experienced and advocated for reforms that would help them in the long-run, rather than focusing on the short-term.
Finally, there are NGOs and intermediaries that assist at different points in the CDM process. Fundación MDL assists project developers on their documents and with their process working with communities. They are also a supporting NGO of the Gold Standard, a Swiss-based non-profit that certifies high quality carbon credits that contribute to sustainable development so they can earn a higher CER price. The Fundación MDL’s role is to help project developers more effectively work with their surrounding communities so that they can meet the Gold Standard requirements. Ecosecurities and Ecoinvest are two widely used intermediaries in Honduras. They both perform a variety of functions depending on individual project needs, from completing the CDM registration paperwork to
45 finding buyers for the credits. Sometimes they will not charge the project developers for their services up front, and instead take a percentage of the CER profits, which helps reduce the initial costs for project developers.
4.5. Barriers to Renewable Energy
Throughout the interviews, several barriers to renewable energy surfaced that factored into the decisions to pursue renewable energy and apply for CDM registration. The renewable energy project developers interviewed in Honduras all had pursued CDM registration or were planning to; however, they did not feel that their experiences were different from producers that did not apply for CDM status. Four barriers dominated the discussions: electricity price, financing, government bureaucracy and policy, and the length of time obtaining environmental permits took. It is important to note, however, that these were not necessarily cited as inhibitors to project implementation, but rather as challenges that factored into the decision-making process. As mentioned earlier, CDM projects face a range of challenges, some of which are common for any renewable energy projects, thus not associated directly with the CDM, and others that are attributable to the CDM. To clarify the root of each of the challenges, the barriers are separated into two sections.
The primary barrier to renewable energy identified by project developers was the price ENEE pays for electricity. Of the interviewees that revealed theirs, prices centered around 6-7 cents per kWh, which is not far from the results of a
2005 study that found renewable energy generators to be paid an average of 5-6
46 cents per kWh in Honduras (Dussan 2005). The only exception encountered during this study was an upcoming project that was negotiating around 10.5 cents per kWh at the time of the interview, according to the project developer, which had to do with the large size.
In Honduras, the law mandates that renewable energy should get a 10% premium price over the short-term marginal cost. In theory this is an incentive to encourage greater production of renewable energy and to cover higher costs of production. In reality, however, many project developers felt that the law backfired because renewable energy still has to compete with conventional generation since there is a competitive process for PPAs. In addition, renewable energy recover the large initial investment over a long period, but project developers did not feel that the PPA was long enough to make many projects profitable. Project developers also spoke of the lack of transparency of the calculations for short-term marginal cost, which is done by ENEE. They complained that ENEE often use an outdated price of oil, causing it to appear much less costly than it actually is. It is important to note that the interviews were conducted in August 2008, when fuel prices were high globally. Regardless of the type of generation, all renewable energy project developers all mentioned that the price paid for renewable energy is too low.
Aside from the price paid for electricity, renewable energy projects must compete with conventional generation when a competitive bid is released by
ENEE. Within discussions about the choice to produce renewable energy versus fossil fuel-generated electricity, several interviewees pointed out that the
47 government subsidizes fossil fuel, thus absorbing the impact of higher fuel prices rather than the project developers. Renewable energy is also at a competitive disadvantage because it carries higher risk than conventional generation. There are greater uncertainties in equipment failure, natural disasters, and depending on the type of renewable energy, the variability of the resource.
A second challenge voiced by many renewable energy producers was the difficulty obtaining credit. Most renewable energy projects need a significant amount of up-front financing, both in design and construction of the project, which require project developers to obtain large loans. It is important to note that obtaining credit was more of a challenge for some producers, notably the producers that were not part of a larger company already established in Honduras
(such as a sugarcane plantation). In Central America there are a few multilateral banks that routinely lend to small renewable energy projects, such as the Central
American Bank for Economic Integration (CABEI), and there are local Honduran banks as well, such as Banco Atlantico, that lent to at least one of the projects studied. Local banks will charge interest rates up to 32% for Lempira-based loans
(CDM Executive Board 2004a).
Project developers had mixed experiences with CABEI. It has the
ARECA Initiative, Accelerating Investments in Renewable Energy in Central
America, which aims at financing renewable energy projects of less than 10 MWs
(CABEI 2008). By including CERs based on a signed ERPA, they are able to lend at a higher percentage rate (CDM Executive Board 2004a). However, not all
48 project developers were able to do this, and some found the $20,000 fee to review the project feasibility inhibitive (CDM Executive Board 2005a).
Overall, project developers noted multiple challenges associated with financing. First, it was difficult for some to know where to look for credit, especially when this was their first project. Most banks require some sort of collateral or equity, as one project developer spoke about in the interview, and this could be land, equipment, or another loan. This is part of why many projects obtain their funding from multiple sources, or why they may have a foreign funder for part. While it is possible to get a loan without guarantees, one interviewee said the terms would be much worse. Other project developers encountered difficulties because the bank required a completed PPA in order to get the loan or would not accept CERs as part of their calculation of their revenue because it was not a sure source of funding. The latter meant that the project had to be profitable enough to repay the loan even without the CERs. Finally, one person who works with several CDM projects said that the multilateral banks are difficult because their process is slow, bureaucratic, and non-transparent.
Although government policies and processes can provide opportunities at times, most project developers cited them as challenges to renewable energy in
Honduras. Beyond the low price for electricity as discussed in the prior section, project developers considered the contract too short considering the high initial costs that have to be repaid over time. On the positive side, there are a few measures, such as exoneration from taxes for the importation of parts or exemption from taxes for a set number of years, that project developers
49 appreciated. Along with policies, the government bureaucracy, and more specifically the interaction with ENEE, was cited as a challenge. Interviewees found that ENEE is inefficient, bureaucratic to deal with, and slow to finalize
PPAs. Several interviewees commented that ENEE employees are set in the mindset that thermal energy is the best way forward. Several found ENEE employees to lack knowledge of renewable energy and even to be opposed to it without a factual reason. The lack of interest or acceptance is likely partially due to the dearth of training or exposure to new technologies said one interviewee who used to work for ENEE. Furthermore, corruption and connection between
ENEE employees and thermal power producers was also a concern of many interviewees. ENEE has many political appointees and decisions are often also political.
The PPA with ENEE is not the only part of the process that consumes a great deal of time. Environmental permits must be issued for projects to move forward, and these caused project developers long delays. Renewable energy projects require more permits than thermal power plants. For example, hydropower plants need an environmental license, an operation contract, and a water rights contract, and the latter two need congressional approval (World Bank
2007). Other types of renewable energy do not require the water contract, but the environmental license still posed a barrier. The environmental permits go through
SERNA, and developers said they had to wait a few years to get the necessary permits, which in turn increased costs due to the delay. While those who commented on this agreed with the government that there should be permits, they
50 did not think it was fair that conventional generation had fewer environmental permits and thus weren’t subject to the same delays.
In addition to the four primary barriers, three smaller barriers were also discussed in the interviews. As REEEP found throughout Latin America, technical capacity is also a problem for Honduras. Technical knowledge can include workers and engineers that know how to construct, operate, and maintain the technology. Wind power, for example, is a rather simple technology, but the logistics of constructing towers in remote mountainous areas as well as dealing with problems that arise can be extremely complex. The country’s experience with hydropower is extensive; however, there are fewer trained engineers and technicians that are knowledgeable about other types of renewable energy technologies. Multiple projects were “turnkey projects,” meaning that they were designed and often constructed by a separate company and then turned over to the project developer. For example, Cerveceria Hondurena put out a call internationally for a methane capture project and companies bid on the project.
Local Hondurans were then trained to operate and maintain the project. While some project developers said they turn to Costa Ricans or workers from countries with expertise in a technology, they also said the lack of technical capacity also extends to government agencies. They need employees that are knowledgeable with renewable energy technologies in order to evaluate projects and grant permits.
Poorly maintained transmission lines are also a frequent problem since many renewable energy projects are located in rural areas. ENEE’s network only
51 supplies electricity to 45% of the rural population (World Bank 2007), and the high-voltage transmission lines are centered around cities, not rural areas. If they could, most project developers were careful to locate their projects by high- voltage transmission lines that could handle additional voltage. The sugarcane fields of Inversiones Hondurenos are not located by transmission lines that can carry enough voltage, so the cogeneration plant is not supplying the grid with the full amount it can produce. To feed into a larger substation, they will need to lay and pay for new lines even though ENEE is responsible for electricity transmission. Furthermore, many electricity lines are old and poorly maintained.
La Esperanza has spent roughly US$50,000 in line maintenance and tree trimming around the lines because it affects their turbines when there are outages.
They said they already have had to replace between three and eight turbines due mostly to problems associated with the transmission lines.
A less common problem is NGO opposition, which only affected the hydropower plants of the cases studied. Hydropower is especially contentious among environmental groups, both internationally and domestically due to the environmental and social impact from damming rivers. Several projects are run of the river hydropower plants, which flood less land than conventional hydropower dams; however, there are still some environmental and social impacts that gather negative sentiment. An interviewee wondered whether there was a connection between thermal power producers and anti-hydropower NGOs; however, he admitted that he could not tell positively. Participatory procedures are required for all renewable energy projects in Honduras. While project
52 developers esteemed the reasons for reaching out to the local communities and indicated they would likely do it regardless of whether it was required or not, the procedures still cost the project developer time during the planning stages of the project. Furthermore, some projects are prevented from development due to opposition. The lower Patuca River basin is a potential site for a hydropower project but because it is in a protected area as part of the Mesoamerican
Biological Corridor, the project met opposition from international environmental groups and local communities (World Bank 2007).
4.6. Barriers to the CDM
Most of the challenges project developers encountered during the development of their projects were difficulties of renewable energy and not due to the CDM; however, a few factors are directly associated with the CDM. These pertain to the project developers interviewed, and additionally extend to the larger situation in Honduras.
The first reason for pursuing CDM registration, as well as conversely not pursuing it, is that of awareness of the CDM. At the moment there is a wide awareness of the CDM in Honduras, but looking back five years, there were few people who were aware of it in Honduras. In Honduras a geographic dimension could also exist with less awareness in more remote regions of the country.
Currently, all of the projects producing electricity are connected to the grid, yet the grid only reaches 45% of rural regions (World Bank 2007). Interviewees this was discussed with were split – half thought that rural eastern regions of
53 Honduras were not aware of the potential of receiving CERs from off-grid projects and half thought they were aware, but just did not pursue the option. The government played a large role in promoting certain types of projects. For example, there are six sugarcane cogeneration plants, several of which they also promoted the use of the CDM (CDM Executive Board 2007b). Other sectors, such as wind power, have not been promoted in this manner.
The second challenge to the CDM projects cited by interviewees is the complexity of the CDM. There is a significant amount of paperwork involved in the CDM and many project developers thought that it was unnecessarily complex.
Intermediaries helped a great deal in Honduras completing the paperwork if the company provides the data; however many project developers interviewed still thought just gathering the data was an overly complex task. Additionally, domestic NGOs, such as Fundación MDL, international organizations, and foreign governments also assisted with some projects.
5. Costa Rica
5.1. Costa Rican Energy Sector Overview
Despite its proximity, Costa Rica is an interesting contrast to Honduras for several country-specific characteristics and energy sector differences. Costa Rica has the highest GDP and lowest poverty rate in Central America. The country has a well-maintained national park system with high biodiversity, which draws eco- tourists from around the world. Its ‘green’ image is also strengthened by its high percentage of renewable energy use. In recent years, the government has
54 increased reliance on fossil fuel power plants, albeit close to the extent Honduras has. Nonetheless, there are difficulties applying for CDM registration given its low current emissions. Furthermore, unlike Honduras, Costa Rica only privatized
30% of it electricity generation, all of which must come from renewable sources.
This section will mirror the Honduran case study, looking at an energy sector overview, legislation, institutions, CDM projects, and barriers to renewable energy and the CDM.
Unlike most countries where renewable energy laws are a subset of the energy laws, in Costa Rica they are better viewed as one and the same. Costa
Rica is rich in many types of renewable energy resources, but the country’s reliance on renewable energy began with and is still dominated by hydropower.
The government started down that path in the 1940s because the substantial amount of rainfall and mountainous topography make the country a prime location for hydropower. In the beginning, the decision was determined due to the abundance of resources rather than for environmental ambitions, although it strengthens the country’s green image today.
The strong government involvement in the electricity sector stems from
Costa Rica’s belief in government provision of social services. It is widely recognized as one of Latin America’s socialist-leaning states (Franko 2007), and energy followed this trend over the years with ICE carrying out electricity generation, transmission, and distribution. While 15% of the electricity market was opened up to private sector participation in 1992 and 30% in 1995, generation still remains primarily in ICE’s control.
55 Over the second half of the 20th century, electricity generation grew primarily with hydroelectricity. Although the development of hydroelectric dams led to a high percentage of renewable energy in the energy mix, recently the government has been increasing the use of thermal power plants. Because
Congress has not invested enough in new renewable energy plants, and because they generally take several years to construct, when the country ran into an energy shortage in early 2007, the quick, easy, and cheap method to increase power was through thermal plants (Hamilton, Jon. “Rainfall Shortages Threaten Costa Rica
Power.” NPR, February 11, 2008, Morning Edition; Nelder, Chris. “High Oil
Prices Bring Energy Shortages.” Energy and Capital, Aug 10, 2007). Another reason for adding thermal production is to increase the base load of steady power, because hydropower generates more electricity during the rainy season. Wind power could be a complement because it peak production is in the opposite part of the year; however, it’s still not base load.
On July 6, 2007, with Decree No. 33487-MP President Arias announced the ‘Peace with Nature’ initiative included a declaration that Costa Rica would become carbon neutral by 2021. Among a variety of program areas, this new plan calls for a National Climate Change Policy to address emissions both within the electricity sector and beyond (Paz con la Naturaleza). Since the 1990s, Costa
Rica has diversified its every portfolio to include wind, geothermal, and biomass energy sources. Despite the diversification thus far, the many years of hydropower experience, gave the country much greater technical capacity and know-how about hydropower than the other sectors they are expanding into.
56
Figure 6. Historical electricity generation in Costa Rica by fuel, 1971 to 2005 Source: Adapted from IEA 2008.
5.2. Energy and Renewable Energy Legislation
Costa Rica has several energy laws that drive the use of hydropower and to some extent the generation of other renewable energies. The laws affecting renewable energy production began with the water law, which allows the state to use the country’s water for hydropower. In 1949, the Costa Rican Institute of
Electricity (ICE) was created as an autonomous state institution to be the vertically integrated utility charged with generation, transmission, and distribution of electricity (Instituto Costarricense de Electricidad). For the first few decades of its existence, ICE concentrated on developing the abundant hydropower resources.
In 1990, the Law on Rational Energy Use, Law 7200, provided new direction for the electricity sector. As its name implies, the law promotes the
57 efficient use of energy. More importantly for this study, however, is that it was the first law to privatize part of the electricity generation market. Law 7200 allowed up to 15% of the country’s electricity generation to come from private producers (IADB 1999; WRI 2009), limiting the size of those plants to 20 MWs.
In 1995 that was raised to 30% of private participation, and the size limit was increased to 50 MWs with Law 7508. Furthermore, private participation is limited to renewable energy and 35% of the ‘share capacity’ must be locally owned. Finally, Law 7508 introduces a new process called Built, Operate and
Transfer (IADB 1999). This enables an internationally competitive process where a private company can bid to build a plant, operate it for an agreed upon period, and then transfer it to ICE’s ownership (IADB 1999). They also have a similar program called Build, Lease, and Transfer, which operates in accordance with its name.
Two other laws lightly intersect with the electricity market. In 1993, Law
7329, the General Law for Concessions of Public Services, provided for private participation in all areas of public service concessions; however this “has yet to make a significant difference in the electricity sector” (IADB 1999; WRI 2009).
Established in 1995, the Organic Law of the Environment is an influential law throughout Costa Rica because it grants the state authority to protect the environment to prevent and control pollution and guides the sustainable use of natural resources (WRI 2009). For the energy sector, the main relevance is the public participation process that projects must follow.
58 5.3. Energy Institutions
In Costa Rica, government responsibilities for the energy sector are distributed throughout several agencies. The Costa Rican Institute of Electricity
(ICE) is the largest and most prominent institution. It implements policies in the electricity sector and oversees the electricity market. Responsible for generation, transmission, and distribution, ICE also owns and operates most government- owned power plants. Since there is a cap on private sector participation, this is the majority of electricity generated. For distribution, there is an exception to
ICE’s monopoly: the National Company of Force and Light (CNFL), a subsidiary of ICE, was given the mandate by Congress to distribute power in the San Jose region, which composes approximately three-quarters of the market (IADB 1999).
The Energy Sector Direction (DSE) in the Ministry of the Environment,
Energy, and Telecommunications does planning for the energy sector. Established in 1974 by Law 5525, it is in charge of the policy functions, including setting the strategic orientation, defining the policies, and coordinating activities throughout the sector (IADB 1999; Dirección Sectorial de Energía). It takes the National
Development Plan and elaborates on it to form the National Energy Plan
(Dirección Sectorial de Energía), promoting development of alternative energy sources and appropriate technology. The National Development Plan is created by the Ministry of Planning (MIDEPLAN), which coordinates between all the
Ministries for long-term planning (IADB 1999).
In order to distribute the functions of government agencies in the energy sector, in 1996 the Regulatory Authority of Public Services (ARESEP) was
59 created. ARESEP is a multisector agency that was created from the National
Service of Electricity, and is charged with regulation and setting tariffs (IADB
1999).
5.4. The CDM in Costa Rica
5.4.1. Overview
Costa Rica´s history with the CDM dates back to before the CDM was created. As international climate negotiations ensued after 1992, Costa Rica was on the forefront of an instrument to help developing countries mitigate climate change. They started an office for such initiatives in 1995 called the Costa Rican
Office of Joint Implementation (OCIC), and they were involved in Actively
Implemented Jointly (AIJ), a pilot program for what would become the CDM
(Figueres 2004). OCIC originally consisted of a mix of government agencies,
NGOs, and private sector participants (Figueres 2004).
The Tejona wind farm was one of the first AIJ projects pursued. Although preliminary plans for it date back to the 1970s, they were not developed in depth until the 1990s. Initially the project was not fully supported, and even in 1994, when the project was endorsed by the World Bank and the Inter-American
Development Bank, the project still did not move forward because at that time the
IMF had imposed restrictions to limit the financing for Costa Rican government bodies, thus preventing the Ministry of Finance from legally permitting ICE to enter into a loan agreement. It was not until the prospects of funding from a climate change mechanism arose that the Tejona Wind Power Plant was pursued
60 as a Build, Lease, and Transfer project. For this, Costa Rica launched an international bid, which was won by Essent, a Dutch company supported by the
Dutch AIJ program. The prospect for a climate change mechanism supporting the project was important from both the Costa Rican side and the Dutch side (CDM
Executive Board 2006d) from the beginning.
After the Kyoto Protocol was signed with Costa Rica as a non-Annex I country, and the Marrakesh Accords defined the modalities and procedures, two notable criteria emerged from this. First, projects had to prove additionality, and second, credits had to be calculated based on a baseline. These are what killed extensive CDM development in Costa Rica. Costa Rica had developed ten AIJ projects by 1998, and out of the five that were energy generation, the Tejona
Wind Power Project was the only one that was able to later receive credits under the CDM (Figueres 2004). Because Costa Rica had strong renewable energy law before the Kyoto Protocol and because its electricity comes from mostly hydropower, it is difficult for projects to generate many CERs if they are connected to the grid because the baseline is very low. The fact that many of the
AIJ pilot projects could not receive CDM CERs was extremely disappointing for
Costa Ricans. They had not only been front-runners in the program, but they had dedicated substantial resources to pursuing these projects and starting OCIC, as several interviewees noted.
A government interviewee commented that although hope seems to be lost for now, any Costa Ricans still remain hopeful throughout discussions of a post-
2012 climate regime. The President has pledged that the country will be carbon-
61 neutral by 2021, and with implementation plans in process, Costa Rica could conceivably step up and take emission reduction commitments. Several interviewees thought this may be a way to increase their ability to benefit from carbon trading schemes or a Joint Implementation-type mechanism.
5.4.2. Current situation
Table 6. Registered CDM projects in Costa Rica
Project name Project type Registration MWs Energy: Metric (Developer, if date produced average tonnes annual different) CO2e generation reduced (GWh) per annum Rio Azul landfill gas and Landfill gas utilization and project utilization 10/13/05 3.7 . 156,084 Cote small-scale hydropower plant Hydroelectric 3/03/06 6.8 13.2 6,431 La Joya Hydroelectric Project Hydroelectric 3/09/07 50.0 252 38,273 Tejona Wind Power Project Wind power 3/23/07 19.8 70 12,600 INOLASA Biomass 11/30/07 . . 38,212 CEMEX Costa Rica Cement 6/05/08 . . 42,040 Source: Data from UNFCCC 2008. Note: Data was omitted when it was not in the same form, such as for biogas recovery projects.
5.4.3. Actors
The CDM stakeholders within Costa Rica are slightly different from those in Honduras given that it is a less privatized market. The OCIC is the main actor
62 directly linked with the Mechanism, and it is located within the National
Meteorological Institute, a part of MINAET. It is the Designated National
Authority for Costa Rica, responsible for creating the sustainable development criteria, reviewing and approving CDM projects, and writing the Letters of
Approvals. Additionally, OCIC has taken on a greater role than most countries by becoming an advocacy organization for the CDM and helping complete the logistical steps associated with CDM registration. An OCIC employee also said that during the negotiations leading up to the Kyoto Protocol, OCIC also took the lead for the country in the negotiations. Over time this responsibility has stayed within MINAET but been elevated to the Minister of the Environment, leaving
OCIC to help with the preparation, data-gathering, and its DNA functions.
ICE also has a role with CDM projects given that they own most of the electricity generation and all of the transmission. It was involved throughout the development of Tejona Wind Power Project, and more recently it dedicated one of its personnel to the potential to earn CERs for its projects and ICE hopes to be able to use the Mechanism in the future.
The private sector is involved to the extent that they are developing projects and applying for registration. Given that legally they can not compose more than 30% of the market, the potential for private producers to become more involved is small. NGOs and intermediaries have little influence in Costa Rica related specifically to the CDM, largely because there are fewer prospects for making use of the Mechanism than other countries. Even intermediaries, such as
Ecosecurities, have little incentive to take on projects in the country because the
63 likely CERs are so low that their financial returns would not compare to countries with higher baselines.
5.5. Barriers to Renewable Energy
The interviews in Costa Rica revealed many barriers to renewable energy, some that resemble those in Honduras and many that do not. The barriers vary depending on whose perspective it is and the specific experiences faced. Within the set of stakeholder interviews done for this study, the widest divergence in opinion occurred over the amount of private participation that should be allowed in the electricity sector. Due to the fact that Costa Rica has a limit of 30% private participation in electricity production, which must be renewable energy production, the experiences with electricity generation varied from Honduras. In particular, the main challenges faced by the government were different for those the private sector encountered during the implementation of renewable energy projects. There were, however, several smaller barriers faced by all developers, both public and private. Thus, this section is split into five main parts: the main public sector barriers, the privatization debate, the main private sector barriers, and smaller challenges pertinent to both.
The Costa Rican government is responsible for generating at least 70% of the electricity supply and signing the PPAs with private companies for the remaining 30%. More specifically, ENEE is responsible for generation and its two main barriers to implementing more renewable energy are the low oil price and lack of government investment, which go hand in hand. ENEE calculates and
64 compares the financial viability of projects and when the price of oil is low, thermal projects are more financially attractive and renewable energy projects less attractive. Interviewees noted that this is a large part of the reason there has been more new thermal power production in recent years. ENEE is responsible for delivering low-cost electricity to their citizens, so if thermal is calculated as cheaper at the time of the decision, it will likely be chosen.
Another major barrier to renewable energy, and another reason ENEE has implemented thermal plants, is because Congress did not allocate sufficient funds for renewable energy, nor has it approved pursuing bank loans for financing.
Several interviewees, both inside and outside of the government, outlined the problem as such: Congress did not allocate enough funding for renewable energy projects with enough lead time so that the plants would be operational when needed (one government employee said hydropower takes roughly five years to complete, whereas thermal only takes a year). As a result, there have been near- capacity shortfalls, and given that wind, hydropower, and geothermal all need more time to construct than thermal plants, ENEE had to quickly build thermal plants. Additionally, they noted that as part of this responsibility to produce enough electricity with the budget allocated by Congress, ICE must balance the funding allocated by Congress with the need to supply enough energy.
Additionally, there must be sufficient base load in the event there is a drought or such. Fortunately, hydropower and wind power are complementary in Costa
Rica, so they could be used to balance each other. However, projects are chosen primarily based on price, not based on how they complement the existing system.
65 The price of oil is commonly cited as another barrier to investment in renewable energy. When the price of oil is high, it makes renewable energy appear more attractive, but with a low price, renewable energy is not competitive.
ICE performs the calculations to determine the competitiveness of a project, and multiple interviewees noted the lack of transparency in these calculations. 2008 revealed the volatility of world oil prices, and since Costa Rica imports all of its fossil fuels, it is vulnerable to oil shocks. The price of oil used for the cost comparison calculations is determined internally to ICE.
Related to the price oil, renewable energy requires a large initial investment and requires several years to construct. There are more environmental permits needed and often land acquisition is needed as well, both of which take substantial time to complete. These and construction together generally take between four to six years to complete, whereas thermal plants can be constructed in a year. The last few years provide a good example: the government did not invest in renewable energies, and then when the country was not projected to have sufficient electricity to meet demand, it had to add thermal power, which could bring additional electricity quickly. ICE and private producers alike must endure longer pay-back periods for renewable energy or at least while the price of oil is relatively low.
The contention over private sector participation was not very blatant throughout the study, both with the public and private sector interviewees, but it arose many times. Currently, only 30% of the electricity can be generated through the private sector, which is much more restrictive than other Central American
66 countries. Interviewees either wanted more private participation than currently allowed or they wanted the current proportion to remain the same (no one wanted less). Interviewees recognized that this largely arose from the strong social service system that the government has prided itself on, which some people also thanked for the very high electricity coverage. Others, however, lamented the fact that there is a limit on private sector involvement in electricity generation, saying it stifles private investment. As of December 2008, at least two interviewees knew of new legislation being developed that would open the electricity sector to greater private participation. After it is drafted, it will be debated in the
Legislative Assembly, so it is unclear whether the proposed changes would still impact ICE’s role as the sole electricity purchaser or whether it would just mean greater proportions of privately-generated electricity. They also said there is a possibility that this may allow private producers to sell to SIEPAC, the regional electricity system, which some speculate would stimulate investment into renewable energy. Several Central American countries face energy deficits, so
Costa Rica is well poised to sell given their resources and experience, one interviewee said.
In concern to barriers the private sector faces, along with frustrations related to the limit on private participation, most interviewees voiced government policies. Both the limited participation and the lack of a competitive market discouraged private generation, project developers noted. Furthermore, they were frustrated with the process dealing with the bureaucracy, particularly when solidifying the terms of the contracts. A few were also concerned over corruption
67 within government institutions and the lack of transparency in ENEE’s calculations, assumptions, and decisions. Private sector actors like predictability and perfect information, and interviewees found it frustrating without these.
Finally, there were some barriers that both public and private entities faced while trying to implement renewable energy. NGO opposition against hydropower is strong in Costa Rica, both from domestic and international groups.
Given the public participation rules, it is difficult to pursue projects when there is strong opposition, interviewees said. Second, they found it took a lot of time to get the environmental permits needed. This is especially true for private hydropower projects that need Congress to grant them a concession for water rights due to the Law of the Water. Finally, interviewees knew of some technical barriers as well. These ranged from difficulties obtaining the technology, such as wind turbines that are in high demand internationally to risks associated with new technologies, like geothermal. They commented that risks were higher with new technologies and could unexpectedly increase the costs, such as encountering geologic challenges with a geothermal project.
5.6. Barriers to the CDM
As in Honduras, while the barriers do not directly relate to the CDM, some are specific to the Mechanism. The main problem, as mentioned earlier, is ironic:
Costa Rica has too much renewable energy on its grid to make the CDM profitable. The baseline has low emissions, which means that new renewable energy projects can’t reduce emission by as much as countries with dirtier
68 baselines. All of the Costa Rican interviewees noted this as a major barrier.
Furthermore, it is also commonly difficult to prove that the projects are additional, a concept that will be discussed further in Chapter 6.
Another main barrier is the transaction costs. While transaction costs are a barrier for projects in many countries, in Costa Rica the issue is especially acute given the low CER revenue projects are likely to receive due to the low baseline.
Project developers said that it was not worth paying the transaction costs (which are roughly the same regardless of the CERs received) and going through the complex paperwork when they would receive such little revenue from the CDM.
6. Additionality
6.1. Introduction
Additionality is one of the core principles of the CDM as well as one of the most contested. It is important to ensure that emission reductions are additional to those that would have occurred in the absence of the CDM so that the credits can be transferred into cap and trade schemes without enlarging the cap, yet there are arguments against the CDM due to the difficulty of ensuring strict additionality. The additionality analysis was designed based on a set of theoretical assumptions and the experience from pilot projects, although much of the focus and analysis thus far has been on large developing countries. This section seeks to compare the theory behind the CDM with the experiences in two small developing countries. Building on the barriers outlined in the Honduran
69 and Costa Rican case studies, this study seeks to add a fresh view to contribute to the overall debate surrounding additionality.
This section is derived from both the PDDs and the stakeholder interviews in Honduras and Costa Rica. There has been substantial speculation as to whether or not CDM projects are truly additional and whether they would have gone forward without CER revenue; however, because all projects must be additional to be accepted as CDM projects, the topic can be sensitive. Therefore, anonymity is preserved again in this section by providing a more in depth analysis of a sampling of projects. After reviewing the reasons additionality was claimed in the PDDs for the CDM projects, the decision-making factors gleaned from the interviews were examined and applied to the additionality concept. It is also important to keep in mind throughout this section that many of these projects are classified as ‘small-scale,’ which requires a barrier analysis rather than a complete additionality test.
6.2. Additionality Analysis
In order to analyze additionality in greater depth, the Project Design
Documents and stakeholder analyses were used in conjunction to rank the true environmental additionality of the projects. A sample of projects are outlined in
Tables 7 and 8, comparing the additionality justification in the PDDs to the results of the stakeholder interviews. It is important to note that the selection of projects to include in the report was made based on the completeness of data and the ability to analyze multiple steps of the additionality process, regardless of whether
70 or not they showed additionality or not. Furthermore, the written parts of this section and the following section take into account all projects, not just those included in the tables. Finally, please note that the conclusions in the tables are often based off of input from multiple interviewees.
CDM projects are split into large and small projects in this section. For large-scale projects, the additionality justifications were broken down into the steps outlined by the CDM Executive Board. Due to the proportion of Honduran to Costa Rican projects, six Honduran projects and two Costa Rican projects were included. For each project included in Table 7, after the additionality justifications were summarized, they were ranked according to the author’s findings of their truthfulness: they were ranked 1 if the author found the justification to be false and a 5 if no indication of falsity was found, giving the benefit of the doubt. The second ranking was a 1 to 5 scale of the true environmental additionality of the projects, with 1 being not additional and 5 being truly additional. There is the possibility that a barrier was present but would not prevent the project from occurring if the CDM were not present, so the two scales are used to distinguish between false claims and author’s findings of environmental additionality. The rankings are followed by comments of the author’s findings, including if the author had insufficient information or other pertinent details. Insufficient information occurred most often with the investment analysis because the author did not have access to financial information besides that given in the interviews.
71 Table 7. Additionality analysis of large-scale projects Additionality analysis justification in PDD Analysis and ranking from meetings with stakeholders PDD Author Comments Additionality found Justification- project is True (5) or truly PROJECT 1 not (1) additional Step 2 – Investment An investment benchmark analysis shows that it is 5 (5) or not (1)2 Author did not have sufficient information to verify analysis not financially viable without CERs due to the financial calculations in the PDD. However, this calculation of an IRR of 5.3% based on interest stakeholder analysis shows that this is a small project for rates of over 11% a larger operation and it will both increase the efficiency and decrease the amount of electricity needed from the grid. Step 3 – Barrier analysis Technical and logistic barrier - cogeneration 5 2 While these barriers are present, they would not likely systems are not produced in Honduras and must prevent the project from going forward. Equipment be imported, equipment needed to deliver importation and acquiring new knowledge are commonly electricity to grid is not typical equipment for done in Honduras. sugar cane production, and new knowledge in electric transmission and sale of electricity in needed; Core business barrier - sale of electricity is only small share of total revenues and sugar mills prefer to invest in equipment related to their core business
Step 4 – Common There are only six sugarcane producers that are 5 5 As this project was starting, it was a new technology; practice analysis pursuing cogeneration and selling the excess however, this raises the question of when a technology is energy to the grid no longer "new" and becomes "common practice"
Step 5 - Impact of CDM Registration will help combat Honduras' reliance 5 3 The PDD does not mention whether it make the project registration on thermal generation; it will also diversify the financially viable, largely because the project is part of a income of Inversiones Hondurenos and hedge larger business and the firm's annual revenue does not against the Lempira depend much on this project. Additionality analysis justification in PDD Analysis and ranking from meetings with stakeholders PDD Author Comments Additionality found Justification project is PROJECT 2 truly additional Step 2 – Investment An investment benchmark analysis shows that it is 5 2 Author did not have sufficient information to verify analysis not financially viable without CERs due to the financial calculations in the PDD. The interest rates used calculation of an IRR of 20.4% based on interest in the comparison were the maximum interest rates rates of over 30% denominated in local currency. The PDD notes that the company has debts in dollars, so it is questionable as to why it only included interest rates denominated in Lempiras. If the foreign-currency based interest rates used in the PDDs of other projects had been used, this would not have passed. Furthermore, generally an IRR of 20% will recover the costs in five years. Step 3 – Barrier analysis Technical and logistic barrier - cogeneration 5 2 While these barriers are present, they would not likely systems are not produced in Honduras and must prevent the project from going forward. Equipment be imported, equipment needed to deliver importation and acquiring new knowledge are commonly electricity to grid is not typical equipment for done in Honduras. sugar cane production, and new knowledge in electric transmission and sale of electricity in needed; Core business barrier - sale of electricity is only small share of total revenues and sugar mills prefer to invest in equipment related to their core business Step 4 – Common There are only six sugarcane producers that are 5 5 As this project was starting, it was a new technology; practice analysis pursuing cogeneration and selling the excess however, this raises the question of when a technology is energy to the grid no longer "new" and becomes "common practice." Step 5 - Impact of CDM Registration will help combat Honduras' reliance 5 2 While CER revenue will help compensate for risk, which registration on thermal generation; it will also increase the is an important factor not always accounted for, the IRR is IRR to make the project a better investment option already over 20% without CERs. The stakeholder and help compensate for risk analysis also revealed that due to the efficiency gains and the ability to protect against changing electricity prices. Additionality analysis justification in PDD Analysis and ranking from meetings with stakeholders PDD Author Comments Additionality found Justification project is PROJECT 3 truly Step 2 – Investment The investment analysis shows that the calculated 5 .additional Author did not have sufficient information to verify analysis IRR of 16.6% is higher than the 'plausible' financial calculations in the PDD. alternative but not as high as the IRR reference value used in Costa Rica to rank the attractiveness of projects, which is 18% to be a feasible project (according to the PDD); therefore the Barrier Analysis must be used. Step 3 – Barrier analysis Investment barrier - barrier due to the absense of 5 1 The majority of stakeholder interviews indicated that capital in undeveloped markets to finance project; financing was not difficult in Costa Rica and that it was common practice of passive venting of gas would not difficult to get loans. However, the PDD lays out have led to higher emissions difficulties encountered, in particular the inability to meet the debt service ratio. W Step 4 – Common This is the first landfill gas project in Costa Rica 5 1 It is true that this is the first project of its type in Costa practice analysis Rica; however, the government has intended to do such a project for many years. Step 5 - Impact of CDM Incorporating the CERs into the financial analysis 5 3 Again, the author did not have sufficient information to registration made it possible to meet the debt service cover verify financial calculations and investment difficulties ratio for the loan outlined in the PDD. It should be noted that the company won the bid for this project competitively based on price.
PROJECT 4 Step 2 – Investment An investment benchmark analysis was used and 5 5 Author did not have sufficient information to verify analysis showed that the 8.8% IRR is below the average financial calculations in the PDD. Furthermore, the interest rate of 12% in Costa Rica stakeholder analysis found that the project had continually been unable to attract investment. Step 3 – Barrier analysis Financing barrier - financing a thermal power 5 4 This has been a significant barrier for wind power. plant poses less risk than a wind power plant. Step 4 – Common When this was being built, there were only 3 other 5 5 As this project was starting, it was a new technology; practice analysis wind farms, all of which were applying for carbon however, this raises the question of when a technology is credits no longer "new" and becomes "common practice" Step 5 - Impact of CDM The grant associated with the Dutch PPP-JI 5 5 The stakeholder analysis verified the PDD. registration programme raised the IRR to a viable level; Both the grant and the financing arrangement were agreed upon in anticipation of future credits As can be seen by Table 7, Step 0, the starting date, and Step 1, alternatives, were excluded from the report; this was done to maintain confidentiality of the interviewees as well as the unimportance of the steps in respect to environmental additionality. The author had no information to verify these steps. The two most important steps are Step 2, investment analysis, and
Step 3, barrier analysis, of which a project must pass one. Although the author did not have the financial data to verify the calculations, in most cases the stakeholder interviews provided insight into whether this was a barrier that would have prevented the project or not from the decision-making point of view. One project had been repeatedly delayed due to lack of financial viability and the associated risk; however most interviews found that while the prospect of earning
CERs factored into the project, it was rarely the distinction between a project going forward or not. Similarly, the barriers noted in the barrier analysis were present, but responses in the interviews showed that they were not primary decision-making factors.
Most CDM projects in Honduras fall into the small-scale category, and complete the more simplified method of describing the barriers that make it such that these projects would not have happened without the CDM, although it is still an option to complete the full additionality process of large-scale CDM projects, as one project did. Even though each project only must cite one of the four types of barriers (one of which is ‘other barriers’), most projects cited the three main types - investment, technological, and common practice barriers. Only one project did not cite an investment barrier and only one project did not cite a
75 technological barrier. More specifically, projects commonly explained the barriers to be a lower IRR than bank interest rates, difficulty obtaining credit, and that it was not common practice, which often overlapped with the technological barrier. Finally, several projects cited discouragement from the energy laws and legal framework.
Table 8. Additionality analysis of small-scale projects
Project Investment Technological Common Author barrier barrier practice found barrier project is truly additional (5) or not (1) Comments Project 1 The project was pursued for other reasons and the stakeholder analysis indicated that it would have been pursued X X X 1 regardless of the CDM Project 2 The project receives significant revenue from CERs and would not be financially viable X X X 5 without it Project 3 The CDM was one of the factors involved in the decision-making process, but it likely would have been pursued even without the X X X 2 CDM Project 4 The CDM was one of the factors involved in the decision-making process, but it was not one of the main X X X 1 decisionmaking factors
76 Through the interviews, the author found that most small projects did not demonstrate strict environmental additionality. Small-scale projects did not receive much revenue through CERs due to their size, and thus it was not usually the primary reason for pursuing the project. There was one exception found through the stakeholder interviews, as seen in Table 8; this project generates 30-
40% of its revenue from CERs and interviewees said that it would not be able to proceed without the CDM.
6.3. Main Decision-Making Factors
6.3.1. Introduction
The majority of decisions are the result of how many factors fit together, and the decision to pursue a CDM project is no different. While there is the occasional situation where one factor entirely dominates, such as a law that prevents the alternative or the inability to obtain a loan, in most cases the costs and benefits are weighed against each other. Non-monetary factors are incorporated into the decision-making process as well, which sometimes makes it difficult to discern which factors the decision-maker assigns more weight.
The previous section outlined the justification for additionality that was reported in the PDDs through a project-based analysis. This section builds on that and uses the outcomes of the stakeholder interviews to analyze the broader view of the decision-making factors that went into the CDM projects. Building off of the barriers identified in the case studies and the additionality analysis, this looks at how additionality functions on the ground in a larger decision-making context
77 in order to draw conclusions about the CDM. Through aggregating the experiences of stakeholders, the main decision-making factors fall into four categories that build off of each other: government policies, financial viability without CERs, financial viability with CERs, and other barriers.
6.3.2. Government Policies
Throughout the stakeholder interviews government policies arose time after time as primary decision-making factors. In the privatized market of
Honduras, the price paid for electricity generation was very important to project developers. There was only one project developer interviewed that produced both thermal and renewable energy; most project developers were focused solely on renewable energy, and did not have to make the decision to produce thermal or renewable energy. Nevertheless, the competition for ENEE bids pit thermal and renewable energy against each other. Government subsidy of oil, government lack of familiarity with renewable energy, and faulty non-transparent calculations were reasons interviewees said conventional generation had an advantage despite the 10% incentive for renewable energy. Overall, project developers thought that the price paid for renewable energy was too low and a disincentive for producing electricity.
Along with price, government practices mattered to project developers.
The most stark example is that a project can be inhibited if the government will not sign a PPA with the company. Additionally, the amount of time it takes to compete for the project and sign a PPA can increase project costs.
78 In Costa Rica, private power producers are influenced by similar decision- making factors; however in Costa Rica their participation is capped at 30% of generation. Government policies limiting participation, inhibiting competition, and setting the price untransparently prevent greater private production of renewable energy. On the other hand, the government only allows the private sector to participate with renewable energy, which encourages renewable energy as compared to fossil fuels.
In Costa Rica, a few PDDs mentioned ‘unclear regulatory frameworks’ or the ‘legal framework’ as a barrier, but besides these, the issues related to government policy were largely untouched. For large-scale projects, alternatives to the CDM project that are consistent with laws must be cited in the additionality analysis. In Costa Rica, government projects could cite thermal plants as an alternative, but private projects could not if they sell electricity to the grid. The only large-scale CDM projects from the private sector were CEMEX and Rio
Azul, both of which are not based solely on generating electricity for the grid. In other words, because Costa Rica does not allow private producers to generate electricity for the grid from thermal power, it would be difficult for them to meet
Step 1 of the additionality test, which is needed to pass.
6.3.3. Financial Viability
Building off of government policies, which influence revenues, the overall financial viability of a project was a key decision-making factor. The ability to obtain low-interest loans is a crucial component to this.
79 As noted in the case study, the Honduran projects that are part of an existing initiative have less of a challenge qualifying for loans a new projects because they have land or revenue to use for guarantees. New renewable energy projects, however, often struggle to get loans. Local banks charge high interest rates and regional banks either require guarantees or charge higher rates.
In Costa Rica, interviewees did not have the same trouble obtaining financing as those in Honduras did. For ENEE, the difficulty was getting authorization from Congress, not obtaining the loan. Private developers also noted little difficulty, partly because Costa Rica has a much better, safer investment environment than Honduras. Foreign and local banks are more willing to lend because the risk is lower. Loans and electricity prices are not the only components that factor into financial viability. The typical formulas used to calculate the IRR for a project can also be upset by the time and money spent obtaining the necessary environmental permits. Producers in both countries commented on their project costs rising due to excessive waiting periods for the permits. Further time and money is spent on the public participation processes as well. While interviewees recognized the need for and benefits of these processes, they still increased project costs in both countries.
Finally, the financial success of a project can be greatly impacted by risk; but unfortunately this is difficult to judge. Some element of risk can be included in the financial calculations; however, it is difficult to accurately capture the level of risk, especially with a new project. Many of the CDM projects are new or fairly new to the region and experience unexpected problems: loss of
80 hydroelectric turbines due to shortages in the transmission lines, damages after hurricanes change river flow, and broken wind turbines due to strong Central
American winds. All of these factors impact the financial viability and yet they are often not included in the financial calculations.
6.3.4. Financial Viability with CERs
Adding another layer to the analysis, the financial returns with CER revenue included helps project developer decide to pursue a project or not. This decision-making factor more directly links to the CDM than the previous two, which relate to all renewable energy projects.
Some project developers said that they initially considered the project due to the possibility of receiving carbon credits. The AIJ projects Costa Rica pursued in the 1990s and the sugarcane cogeneration plants fall into this category.
Most projects, however, first seriously considered the CDM during the project development process. Furthermore, a few project developers referred to CER revenue as a “bonus,” but not a reliable source they depended on. Out of the three main determinants of CER revenue – the market price of a CER, the baseline, and the size of the project – the latter is the only one that the project developer has control over. The size of the project, most commonly measured by megawatts generated, could produce different quantities of CERs depending on the baseline.
While Honduras benefits from this methodology given its high-emission baseline,
Costa Rica is severely hurt by it. Interviewees cited the baseline as a main reason there were only six CDM projects in Costa Rica. Since its baseline is very low
81 for electricity added to the grid due to the predominance of hydropower, additional megawatts of renewable energy reduce emissions by a minimal amount.
Project developers must also decide whether a project is financially viable with or without CERs. The investment analysis makes a project prove that it is not financially viable or as profitable as alternative projects, which makes intuitive sense for the calculation of additionality; however, interviewees indicated that the decision is not quite as clear from the project developer point of view. When a project is planned, there is no assurance that it will achieve CDM registration and receive CERs, thus it is a risk to the project developer to rely on it. If it did not receive CERs, the project developer is forced to make the decision of whether it is profitable enough to continue.
Two secondary matters also impact the financial viability with CERs.
Interviewees commonly complained about the complexity of the CDM. It costs time and money to complete the measures required for registration, and on top of that there are transaction costs. Interestingly enough, the transaction costs were cited by interviewees as more of a barrier in Costa Rica than Honduras, albeit not by much. They said this was because they already would receive little CER revenue due to the low baseline, and the transaction costs would reduce the revenue even further.
82 6.3.5. Other Barriers
There are many other barriers CDM projects face. The PDDs allow technical or common practice barriers as justification for small-scale projects or
Step 3 of the additionality analysis. The case studies describe many of the intricacies of these barriers and other challenges. Yet does the existence of these barriers mean that a renewable energy project would not go forward if there was no CDM?
Perhaps it is useful to look at a few examples where questions arise based solely on the PDDs, not stakeholder interviews since the CDM Executive Board only reads the PDDs. First, switching fuel from coal to palm oil mill biomass waste residues at INOLASA has an IRR of 61% (CDM Executive Board 2007c).
While it has a high rate of return and is a new technology to Costa Rica, would a project developer not pursue this without the CDM?
Second, in Costa Rica Grupo SARET won the bid from CNFL to use the methane from landfill gas to produce electricity. The PDD says that there are alternatives and they would have higher IRRs than this project. Plus, there are barriers due to investment, technology, and prevailing practice (CDM Executive
Board 2004b). While none of these are false, if Grupo SARET did not do this project, would not another company receive the CNFL bid and do a similar project?
These two examples are not meant to critique these projects, but instead to illustrate how some barriers may not prove strict additionality. Furthermore, it is
83 recognized that there are many projects where the barriers are indeed strong enough to prevent the project from occurring in the absence of the CDM.
Bringing all the decision-making factors together, it is important to look at the project cycle. By the time a project applies for CDM registration, it has already completed and paid for feasibility studies and project design; it has applied for and hopefully received a loan to finance the project; it has competed for a PPA if done by the private sector, or competed internally with other options if done by the government; and it has applied and likely waited for environmental permits to be approved. Each of these takes time and money. If the project is rejected by the CDM Executive Board, will it really cease to be implemented, especially with these sunk costs? Furthermore, how does a project developer incorporate the risk that a project is not approved?
7. Conclusion
The CDM was designed as a flexibility mechanism for the Kyoto Protocol, and was meant to offer more economic ways for Annex I countries to meet their emission reductions as well as to provide sustainable development benefits for non-Annex I countries. In the broader view of the intersection between climate change, energy, and development, the CDM offers a mechanism to involve developing countries in carbon dioxide reductions and help them develop on a cleaner energy trajectory than they likely would have otherwise. Amid the potential benefits of the CDM, it is a challenge to create an international mechanism that relies greatly on how it is implemented on the local scale.
84 This study analyzed interaction between renewable energy, the CDM, and small developing countries in Central America. First, it focused on the decision- making factors that determined why projects were pursued, the barriers to implementation, and whether the CDM provided an incentive to implementing renewable energy over fossil fuel sources of energy. Second, it used the findings to analyze the additionality of the CDM projects.
A variety of barriers and decision-making factors fed into the decisions to develop the renewable energy projects in Honduras and Costa Rica. Although each project presented a different case, on average project developers focused primarily on four aspects: they considered the government policies (including the price of electricity and the process), the financial viability of the project alone, the financial viability of the project with CERs, and other barriers. Most privately developed projects were owned by Central American companies, only a few were foreign-owned firms with a plant in Central America, and a few used foreign help for turn-key projects. Few companies were involved with both renewable energy and fossil fuel-generated electricity, thus eliminating the trade-off between the two for most project developers. This was partially because many projects were based off of existing resources, such as sugarcane plantations, methane from waste, or biomass. It was also partially due to Costa Rica’s limit on private electricity generation to renewable energy, although both governments had to make decisions on the trade-offs between different sources of energy.
Government policies and their process of choosing projects were critical in the decision to construct the renewable energy projects.
85 While the CDM was one element considered in the planning of the projects in this study, for most projects it did not provide incentive that ‘tipped the balance’ towards renewable energy rather than fossil fuels. This was primarily because most project developers were only involved with renewable energy, as mentioned earlier. Nonetheless, even for the decision of whether a single project should be constructed, the CDM was not a primary reason to follow through with them. The CDM attracted several interviewees to renewable energy projects, but the decisions to follow through with them were more complicated and CER revenue was rarely sufficient incentive to impact the decisions, especially in Costa
Rica.
Renewable energy helps diversify energy supplies and decrease susceptibility to oil price fluctuations. If either country wants to increase renewable energy projects, based on the results of the case studies there are several measures that could be taken. In Honduras, renewable energy legislation should be revised to provide greater renewable energy incentives and not favor fossil fuels. Along with this, there should be improvement in the transparency of project cost calculations, education of ENEE personnel about renewable energy, and promotion of awareness of the legislation. To leverage the use of the CDM, the DNA could assist with the complex paperwork and continue to do awareness workshops.
In Costa Rica, the barriers and decision-making factors are different than in Honduras, especially considering that the private sector can only produce renewable energy. More private participation and competition would likely
86 increase private participation, but that is part of a larger debate already underway.
For now, transparency in ENEE’s calculations, a greater focus on diversification not just lowest-cost sources, and greater government investment in renewable energy would increase renewable energy production. Unfortunately, given Costa
Rica’s clean baseline, there is not much else that the government can do to promote the CDM.
The second part of the study used the barriers and decision-making factors found to analyze the additionality of the CDM projects. Additionality was one of the concepts used to reconcile the global and local scales. Projects implemented in developing countries have potential to contribute to domestic sustainable development, such as the provision of energy, technology transfer, increased knowledge and training, employment, and community projects. At the same time, the credits can be used to meet Annex I Kyoto commitments. The difficulty is that the theory applied in the policy-making process does not always carry through as planned to implementation. The projects included in these case studies are just a tiny sample of the existing CDM projects, and yet they shed light on how the theory of additionality is implemented. As is often the case, implementation on the ground is messier than the theory. Implementation is filled with regional specifics, some of which parallels other places and some of which do not.
It has been established that there is a range of barriers that can prevent a project from occurring. The CDM Executive Board has worked hard to incorporate this into the additionality analysis by allowing projects to choose the
87 investment or barrier analysis and by simplifying small-scale requirements.
While this is a positive step in one sense because it realizes the complexity of the decision-making process; on the other hand, it may allow for additionality justifications that allow a project pass, even if the factors were not strong enough to prevent the project from occurring without the CDM. Although there are many shades of grey that are difficult to discern, if a project would be implemented without the CDM, it does not adhere to the principle of strict environmental additionality.
Furthermore, if there is not strict additionality, there are implications for the inclusion of CERs in cap and trade systems. Revisiting the underlying structure of the Kyoto Protocol, the emission caps placed on Annex I countries are intended to limit each country’s emissions so the world can reduce emissions below the business as usual level. If projects that would have occurred in the absence of the CDM earn credits, and those credits are used to meet the Kyoto targets, then essentially the size of the cap is enlarged. This is not meant to draw specific conclusions as to how many projects are or are not additional, but rather meant to point out the consequences. Often the decision-making factors behind projects are more chaotic than theory predicts, and if projects are not strictly additional, there are negative implications for their impact on Kyoto reductions.
Even though this only includes 20 out of 4,252 CDM projects in the pipeline, there are a few implications for policy worth noting, especially as the climate change negotiations in Copenhagen approach. While this study did not pursue analysis of the CDM’s goal of sustainable development, which is already
88 widely researched, it is nonetheless important and should be included in policy discussions. There are many reasons to continue a mechanism similar to the
CDM in the post-2012 climate regime; however, these case studies signify that the design needs to be carefully examined and learn from CDM experience in a variety of countries. First, now that the CDM has been functioning for several years, there is a need to re-evaluate the role of additionality in a mechanism such as the CDM and how it functions in different parts of the world. The question of how the CDM intersects with cap and trade systems – and if it even should do so
– should be revisited too. Given the questionability of strict environmental additionality, options to deal with the uncertainty should be considered. This could take the form of a double cap on emissions, one for only domestic reductions and one for questionably-additional CERs to be included, or it could take the form of a percentage of the reductions, such as up to 25% of emission reductions can be achieved through CERs. Furthermore, given the importance of energy policy as seen in this study, a new CDM could work with government policy to a greater extent through a sectoral approach. Throughout any revisions, considering the critique that the CDM is too complex, there needs to be care to ensure additionality while limiting complexity.
As part of a global initiative, the CDM must be applicable to a wide range of countries – from the size of Belize to that of China, from the affluence of Haiti to that of South Korea. As it is implemented in this variety of countries, the CDM must overcome the barriers present in each place. The Honduran and Costa Rican
89 case studies reveal two pixels of the overall picture, but two that are often overlooked due to their size and very small contribution to global emissions.
Further research on the implementation of the CDM and the decision- making factors that determine whether renewable energy projects are pursued in other countries would be useful to complement this research. In addition, a policy analysis of options reflecting case study findings and various goals would help make this even more applicable to Copenhagen. The CDM hold potential for local sustainable development benefits, large scale emission reductions, and the conversion of energy infrastructure to a lower-carbon trajectory, and yet the additionality principle illustrates how multiple goals can be difficult to combine.
Finally, it is important to recognize that while the discussions that ensue leading to Copenhagen will incorporate both theoretical and practical arguments, they will also take on political dimensions. The debate over how the world should cooperate to combat climate change will involve larger debates over responsibility for emissions, capability to mitigate, and the right to develop, all of which will impact the future of the CDM. The energy path and future emissions of developing countries will have a profound impact on climate change, and who takes responsibility for the emissions is primarily a political question at this point.
Then, beyond the political negotiations, a post-2012 mechanism must continue to strive to reconcile the global level with the local and to make implementation reflect theory, or at least recognize when it does not.
90 APPENDIX I. Sample Interview Questions
1. What type of organization do you represent?
2. What is your relation to renewable energy and/or the CDM?
3. What are the greatest barriers you encountered during the development of this project?
- Examples include: technological capacity, interaction with the government, laws/regulations, price paid for electricity, environmental permits, initial investment, complexity of the CDM process, lack of transparency, etc.
4. What factors made you (or make project developers) decide to pursue this renewable energy project?
5. What factors made you (or make project developers) decide to apply for CDM registration?
6. What were your experiences with government institutions (Designated National Authority, energy institution, and others)?
7. What was your experience with the CDM process?
8. Did you work with any (non-governmental) organizations or private entities during the development of this project? If so, in what capacity and what were your experiences?
9. How did the laws and regulations present impact the project and your decision to pursue the project?
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