The Concept of Incremental Costs

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The Concept of Incremental Costs
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Typical GEF Projects for Climate Change

• 1. Energy Efficiency (Operational Prog. 5)
• Industrial Boilers
• Agricultural Pump-Sets
• 2. RETs (Operational Prog. 6)
• Wind Power, Small Hydro, Biomass Power etc.
• 3. Low GHG Emitting Technologies (Operational
  Prog. 7)
• PV for Grid Power
• Fuel Cells for Mass Transport Vehicles

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Example Climate Change

• (Costs/ emissions during the project life cycle)
• Baseline Coal-fired power station with
  Conventional Boiler (33 efficiency)
• Cost Rs. 1000 Crore, Carbon 15 million tons
• Alternative Coal Plant with Super Critical
  Boiler delivering the same electricity
• Cost Rs. 1100 Crore, Carbon 13.5 million Tons
• Incremental Cost Rs. 100 Crore
• N.B. There is an incremental cost but no
  incremental component.

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Incremental Cost Matrix
IC of mitigation Rs. 100 Crore / 1.5 MtC Rs.
667/ tC
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Key Elements

• Additional net costs (not benefits)
• Always relative to some baseline course of action
  
• Costs incurred as a result of redesigning an
  activity, or selecting an alternative activity
• That alternative can be additional to or
  substitute for the baseline plan

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Key Elements ..2

• When
• the baseline plan is designed to achieve only
  national benefits and
• redesigning or selecting an alternative techn is
  made to meet a global environmental objective,
• then
• the incremental cost is that of achieving the
  resulting global environmental benefits

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Alternate Baselines

• Assuming the current trend will continue
  current-mix of techn. is projected to continue
• ex dependence on kerosene (lighting) or
  fuelwood
• Consider alternatives (fossil fuels) and project
  Least-cost-mix
• ex Diesel system (for electricity) or LPG (for
  cooking)
• Consider no-project scenario situation for the
  project period
• Marginal cost of technology should be considered

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Alternative Scenario

• Select technology (RET or Energy Efficiency)
• or
• Select alternate institutional arrangement or
  policy initiative
• Which provides the same level or scale of benefit
  as the Baseline Scenario (MWh or GJ)
• Leads to reduction in GHG emission or emissions
  are fully avoided
• Alternate technology or alternate institutions
  will involve addition cost

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Example Climate ChangeBiomass Gasifier Based
Power Generation for an Island

• Baseline A Village is getting electricity from a
  diesel generator of capacity 1 MW
• Capacity 1 MW
• Electricity generation 5000 MWh / yr
• Alternate Scenario Energy-forest and Biomass
  Gasifier
• Capacity 1 MW
• Electricity generation 5000 MWh / yr

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Incremental Cost-Matrix
IC of mitigation Rs. 5 crore / 20000 tC Rs.
250/ tC
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Example Biological Diversity

• Identified Ecosystem
• Priority under Convention on Bio Diversity
• Threat
• Cause of Threat is (say) Industrial Pollution
• Solution is Removal of Cause
• (Incremental) Cost
• Extra cost of same industrial activity with
  pollution abated

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• Example Continued
• Domestic Benefits
• Some fish breeding grounds in the polluted
  wetland
• Some tourism
• But, suppose
• Incremental CostgtgtIncremental Domestic
  Benefit
• Grant IC

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• Example Continued
• Baseline Development of the industry sector
• Alternative Continued development, same output,
  but remove the threat
• Incremental Cost The extra cost of achieving the
  same baseline development
• IC Cost of A - Cost of B

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Issues

• Selection of baseline and its justification
• Selection of Alternate technology / Scenario
  stating it will not spread if no project
  implemented
• Adoption of technology or Institutional
  arrangement involves IC which is not provided by
  Govt. / Banks
• - Risk associated with Alternate Scenario
• If any additional benefit it will be deducted
  from IC estimation
• Use appropriate discount rate and estimate life
  cycle cost
• Sourcing of baseline finance domestically

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Baseline Course of Action

• The baseline course of action is what would
  normally occur in the project area in the absence
  of the proposed project.

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Incremental Cost Approach for Climate Change
Projects

• If the project falls under OP5 or OP6
• The life-cycle costs of win-win Energy
  Efficiency and RET alternatives lt baseline costs
• Incremental costs barrier removal costs
• If the project falls under OP7
• The barrier is the cost of the technology itself.
• Incremental costs alternative technology costs
  - baseline costs

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Misunderstandings

• Incrementalism No radical efforts possible
• Inseparability of global and domestic benefits
• Impossibility of monetizing environmental
  benefits
• Small transfers of resources
• Complex

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Implementation

• Issues
• Conflict of interest (country, co-financiers)
• Length of communication chain
• Unpopularity (strategic flaws, difficult concept)
• Sensitivity of estimates

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Reaching Agreement on Incremental Cost

• Choosing the Eligible Objective
• Negotiating a Reasonable Baseline
• Estimating the Cost and Ensuring the Equivalence
  of the Proposed Alternative
• Comparing the Cost Streams
• Discounting the Future Costs
• Agree on incremental cost

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Incremental Cost Approach for Climate Change
Projects

• If the project falls under OP5 or OP6
• The life-cycle costs of win-win efficiency and
  renewable alternatives lt baseline costs
• Incremental costs barrier-removal costs

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Incremental Cost Approach for Climate Change
Projects

• If the project falls under OP7
• The barrier is the cost of the technology itself.
• Incremental costs alternative technology costs
  - baseline costs

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The utility of the incremental cost approach

• Summary of Approach

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HISTORY

• Cost Accounting
• Incremental cash flow analysis
• Project Economics
• Incremental benefits gt incremental costs
• Global Environment
• London Amendments to Montreal Protocol (1990)
• FCCC CBD GEF
• Here to stay

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MOTIVATIONS

• Complementarity
• Make a difference
• Relieve the added burden on project hosts
• Obtain replenishment
• Project Selection
• Developmental expenditure
• Global environment protection