UNFCCC Workshop March 24-25 1

Assessment of Additionality

New Guidelines Lessons learnedFuture challenges

By Luis de la Torre

UNFCCC Workshop March 24-25 2

Assessment of AdditionalityChallenges for an old topic

Financial benchmarking and its standardization is a common issue in most multinationals and financial institutions to accelerate the decisions and assure a minimum level of quality (risk)

The financial target is not the only value that is commonly treated as default values, all the parameters of capital budgeting are normally treated in this way as policy.

The values can change significantly or stay static for long term according to the context where they are used.

For CDM projects, this is a critical issue that affects the registration process as delays or rejection

UNFCCC Workshop March 24-25 3

Assessment of AdditionalityThe new Guidelines on the assessment of investment analysis

After two years of discussions and global consultations, the Meth Panel could recommend EB a set of default values for cost of equity and rules for computation of WACC (e.g. 0.5/0.5 rule for Greenfield project, use of taxes among others).

This approach is optional and covers all countries signatories of Kyoto Protocol.

International accounting regulations such as IFRS and USGAAP currently covers WACC calculations but the approach for the CDM market is truly pioneer and gives the message of feasibility of more standardization of other parameters to improve the registration process and monitoring (reduction in time and cost of resources).

UNFCCC Workshop March 24-25 4

Assessment of AdditionalityThe whole picture in capital budgeting

Macroeconomic parameters

Microeconomic parameters

Capital budgeting

• Inflation• GDP

growth and demand

• Exchange rates

• Fiscal issues• Capital composition• Books and investee positions• Financial target• Risk acceptance

UNFCCC Workshop March 24-25 5

Assessment of AdditionalityExample of some issues affecting macro/micro indicators standardization

The concern of recent meltdown in 2008 and future return of the market, not very linear

The concept of “strong currency” as benchmark due to the crisis for USD or Euros

The accounting rules seen as very complex and different in many context, specially the discussion on rules for SMEs and large Corporations.

The complexity of validating inflation and currency adjustment in prices in time (e.g. energy delivery contracts as electricity or fuels)

UNFCCC Workshop March 24-25 6

Assessment of AdditionalitySome answers: long term view

Long term analysis of economic parameters have been definitely key to get consensus on default values for cost of equity.

Source: Elroy Dimson, Paul Marsh, and Mike Staunton, LBS 2006

UNFCCC Workshop March 24-25 7

Assessment of AdditionalitySome answers: Accounting

All CDM projects are based on legal entities with accounting Books and following market regulations to avoid discussions on investee positions if the financing is structured from a headquarters, basically using the risk exposure as general rule.

Hosting only CDM ProjectHosting many assets

Assets500 MM

Debt300 MM

Equity200 MMKe=20%

CDMAssets20 MM

CDMDebt10 MM

CDMEquityKe = 14%

UNFCCC Workshop March 24-25 8

Assessment of AdditionalitySome answers: Country risk/risk free rate

There are many companies with reputation and tradition in calculating Country Risk and years of data. All are good but a decision was made to facilitate the construction of default values.

The use of US T-bond indexed to inflation was another decision of a paper with excellent tradition in the largest market, even in times of severe crisis such as 1929, WW1-2 or 2008 Meltdown.

UNFCCC Workshop March 24-25 9

Assessment of AdditionalityFuture challenges (1) : business plan guidelines

Most CDM project financing define sales based on PLF, no ramp up with strong rationale and weak proposals of demand.

Prices are also presented as flat all over the crediting period with no consideration of effect of exchange rate for raw materials or price in final consumers.

The depreciation of assets is another point considered flat in most analysis even there are specific rules according to the type of asset and this affects the tax shield position.

Fiscal rules also changes in most countries and this is difficult to asses by DoEs

UNFCCC Workshop March 24-25 10

Assessment of AdditionalityFuture challenges (2) : business plan guidelines

The answer to this is more standard guidance and now there are conditions to create better rules to give clear and fair values to all countries without exception.

Thinking in a systemic approach, a universal template in a spreadsheet running macros and updated to a official UNFCCC database of parameters is possible and will help to increase the flow of projects and reduce the controversies with DoEs and timing for registration.

Moving forward, it is possible to open a discussion to incorporate risk assessment

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%Assessment of AdditionalityDecisions based only on IRR

UNFCCC Workshop March 24-25

Example: financial return of Power generation Projects

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Assessment of AdditionalityDecisions based on Risk and Value generation

UNFCCC Workshop March 24-25

UNFCCC Workshop March 24-25 13

Assessment of AdditionalityFinal Remarks

Today the level of financial data for most countries and industrial sectors is enough to develop more standard approaches in the analysis of risk and return.

A long run analysis is mandatory to assure the consistency of the values

NAMAs should be developed in parallel with the financial information of the countries related to the carbon market.

No doubt this approach will have a very significant impact in the fairness and transparency of business related to CDM plus the advantage of a higher flow of better projects.