Transcript Introduction to Incremental Cost

The Concept of
Incremental Costs
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
Example: Climate Change
(Costs/ emissions during the project life cycle)
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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.”
Incremental Cost Matrix
Alternative
Global
Benefit
Mt. Carbon
-13.5
Domestic
Benefit
Cost
Rs. Crore
Power
Local AQ
1100
Baseline
-15
Power
1000
Increment
1.5
Local AQ
Improvement
100
IC of mitigation: Rs. 100 Crore / 1.5 MtC = Rs. 667/ tC
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

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
Alternate Baselines
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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
Alternative Scenario
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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
Example: Climate Change
Biomass 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
Incremental Cost-Matrix
Alternative
(1 MW)
Diesel
(1 MW)
Increment
Domestic
benefits
Global
benefit
Cost
(life cycle)
5000 MWh
0
30 crore
5000 MWh
- 20000 tC
25 crore
Local
Benefits
- 20000 tC
5 crore
Local Bemefits
IC of mitigation: Rs. 5 crore / 20000 tC = Rs. 250/ tC
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
Example Continued
 Domestic Benefits
– Some fish breeding grounds in the polluted
wetland
– Some tourism

But, suppose
Incremental Cost>>Incremental Domestic Benefit

Grant = IC
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]
Issues
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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
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.
Incremental Cost Approach for
Climate Change Projects
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If the project falls under OP#5 or OP#6:
–
–
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The life-cycle costs of “win-win” Energy Efficiency
and RET alternatives < baseline costs
Incremental costs = barrier removal costs
If the project falls under OP#7:
–
The barrier is the cost of the technology itself.
–
Incremental costs = alternative technology costs baseline costs
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
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Issues
–
–
–
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Conflict of interest (country, co-financiers)
Length of communication chain
Unpopularity (strategic flaws, difficult concept)
Sensitivity of estimates
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
Incremental Cost Approach for
Climate Change Projects

If the project falls under OP#5 or OP#6:
–
–
The life-cycle costs of “win-win” efficiency
and renewable alternatives < baseline costs
Incremental costs = barrier-removal costs
Incremental Cost Approach for
Climate Change Projects

If the project falls under OP#7:
–
The barrier is the cost of the technology itself.
–
Incremental costs = alternative technology costs
- baseline costs
The utility of the incremental cost
approach
Summary of Approach
Incremental
Local
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HISTORY
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Cost Accounting
– Incremental cash flow analysis
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Project Economics
– Incremental benefits > incremental costs
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Global Environment
– London Amendments to Montreal Protocol
(1990)
– FCCC; CBD; GEF
 Here
to stay
MOTIVATIONS
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Complementarity
– Make a difference
– Relieve the “added burden” on project hosts
– Obtain replenishment
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Project Selection
– Developmental expenditure
– Global environment protection