Additionality tests

Project developers can chose between two additionality tests, the barrier test and investment analysis. 46 _{To conduct any of these tests the project developer carries out and documents the}

different steps of additionality determination:

the identification of alternatives to the proposed project47, barrier test, or

investment analysis test, and

for all projects as a credibility check, the common practice analysis.48

The identification of alternatives involves a comprehensive illustration of all realistic and credible alternative projects that provide outputs or services comparable with the proposed CDM project activity. These alternatives should include (UNFCCC, 2008):

I. The proposed project activity not undertaken as a CDM project;

II. Other realistic and credible alternative scenario(s) to the proposed CDM project activity scenario that deliver the same quality of outputs (e.g., cement) or services (e.g. electricity, heat); or

III. The alternative of continuing the current situation (i.e. no project activity).

These alternatives and the proposed CDM project have to be assessed with the barrier or the investment analysis tests.

The barrier test requires that the project developer shows that the proposed project faces barriers, which can be removed if the project receives CDM support. These barriers can be of financial and technological nature. For instance, if the proposed project has difficulties to acquire funding or only receives funding at unfavourable rates, the project developer can show how the CDM revenue helps overcome this financial barrier (UNFCCC, 2008a Annex 3, para. 114). For technology barriers, the project developer can show that the necessary infrastructure

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The procedures to demonstrate additionality are described in the ‘Tool for the demonstration and assessment of additionality’ (henceforth: additionality tool) and the ‘Combined tool to identify the baseline scenario and demonstrate additionality (henceforth combined tool)’ (UNFCCC, 2008). Their use is voluntary, but it has de facto become the standard for project developers (Michaelowa, 2009). The rules discussed in this book relate to the additionality tool. The combined tool requires that project developers conduct both the barrier test and the investment analysis. The combined tool refers to the case where project developers can implement all alternatives themselves. Michaelowa (2009) argues that this is rarely the case, because for instance a wind project developer does not have the financial strength to implement a coal-fired power plant as an alternative. The combined tool is rarely used in practice.

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This includes the alternative of doing anything, i.e. not implementing any action.

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to operationalize the project or that skilled labour to operate and maintain the technology is not available in the relevant country/region. If the project developer can demonstrate that the proposed project overcomes the financial and technological barriers with CDM support, the project is deemed additional according to the barrier test.

As an alternative to the barrier test, the project developer can conduct the investment analysis

test.49

The investment analysis allows project developers to choose between two approaches, a) the investment comparison analysis, and b) the benchmark approach.

a) For the investment comparison analysis, the profitability of the proposed project and any identified alternatives are compared against each other. If one of the identified alternatives is more profitable than the proposed project, the project is deemed additional. The alternative could be a more profitable project including the alternative of not taking any action. For instance, if the project developers can show that another more emission intensive project (e.g. coal-fired power plant) would be more profitable than the proposed CDM project (e.g. renewable energy from wind turbines), the proposed project is additional.

If one of the identified alternatives is “not taking any action”, project developers can show that this alternative is more profitable because reducing emissions under the proposed project only carries costs but no revenues without the CDM.50

b) Project developers which use the benchmark approach demonstrate additionality by showing that the financial returns of the proposed CDM project activity are insufficient to justify the required investment. That means that the proposed project is not financially attractive when compared to a benchmark return on investment (ROI). This benchmark rate of return is usually a national or sectoral profitability rate usually achieved by similar projects.51 The benchmark test does not require that the project reaches the benchmark rate with the extra CDM revenue, the project’s profitability should only be below the benchmark rate without CDM support.

Figure 2.3 illustrates the functioning of the benchmark test. The figure shows several projects A to L and their profitability in terms of return on investment (ROI) without and with the extra revenue (in grey) from CERs. For a firm to conduct a project, the ROI of a project needs to be above a minimum threshold ROImin. ROImin is the benchmark rate. In Figure 2.3, the ROI of

projects A to D is already equal or above ROImin. These projects are financially viable without

CDM support and will not be registered under the CDM. The CDM revenue provided to projects

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Renewable energy projects are allowed since 2008 to apply exclusively the investment analysis (UNFCCC, 2011).

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This variant within the investment analysis is called simple cost analysis and has been mainly applied to industrial gas projects. These will be introduced in the literature review in Chapter 3.

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Until the year 2008, project developers also used company internal profitability rates as benchmark rates (Schneider, 2007). The potential effect of this rule is further examined in Chapter 4.

E to H pushes these projects beyond the ROImin threshold. These projects would not happen

without the CDM because they do not reach the benchmark ROI. These projects are thus additional. Projects I to L are not financially viable even with CDM support. The incremental ROI from the CDM is still not enough to reach the ROImin. While these projects would in theory

not be implemented, in practice the benchmark test does not require that the project reaches the ROImin benchmark threshold. Thus, the benchmark test would render all projects from D to

L additional.52

Figure 2.3 Illustration of the benchmark approach to determine additionality

Source: Rentz(1998)

The common practice analysis is a credibility check after the project has passed the barrier test or the investment analysis. It aims at identifying whether the proposed project (e.g. technology or practice) is already commonly applied in the relevant sector and region of the respective host country. If similar activities to the CDM project are observed essential distinctions between the two must be reasonably explained (UNFCCC, 2011a: Annex 7). If similar activities are widely observed and commonly carried out, it calls into question the claim that the proposed project activity is financially unattractive or faces barriers.

Summarising, each project has to pass through an additionality test. This comprises three steps: the identification of alternatives, the application of the barrier or the investment analysis test to these alternatives, and the common-practice analysis. The barrier test requires that the project developer shows that barriers exist that can be overcome with the proposed activity registered as a CDM project. The investment analysis requires that the proposed CDM project is not the most profitable alternative. The common-practice analysis checks whether the proposed project

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There is thus an incentive for both project developers and host countries to choose a high benchmark rate so as to render more projects additional. Chapter 4 assesses the importance of benchmark parameters applied for registered Chinese and Indian CDM projects that have supported wind parks and hydroelectric power plants.

is already commonly applied. If the project passes all these tests, the project can be registered as described above in the seven project cycle steps.