Trading Emissions PLC Third Floor, Exchange House, 54/62 Athol Street, Douglas, Isle of Man, IM1 1JD, British Isles t: +44 (0) 1624 681200 f: +44 (0) 1624 681392 w: www.tradingemissionsplc.com Ref: Response to request for review Hubei Yuquanhe 25.2MW Hydropower Project with the Reference Number 2188 December 30, 2008 UNFCCC Secretariat Martin-Luther-King-Strasse 8 D-53153 Bonn Germany Attention: CDM Executive Board Dear Sir or Madam, We were informed that our project Hubei Yuquanhe 25.2MW Hydropower Project (reference number 2188) was requested for review by CDM Executive Board. As required by the Executive Board and on behalf of the project participants, we would like to answer the questions and clarify the issues raised in the requests for review as follows: Question 1: The DOE should clarify how it has validated the sensitivity analysis, in particular the probability of variations in tariff and electricity generation. Response by PP According to the sensitivity analysis guidance set out in Annex 45, EB41, we clarify how the sensitivity analysis was conducted for the project and how assessment of the probability of variations was made: Only variables that constitute more than 20% of either total project costs or total project revenues should be subjected to reasonable variation. Based on this guidance, we selected four parameters to conduct sensitivity analysis: total investment, electricity tariff and operation hours.
The total investment is the fundanmental cost of the project. The tariff and operation hours together will determine the total project revenues. So the chosen parameters adopted in sensitivity analysis is in accordance with EB guidance and thus appropriate. The range of variations shall be reasonable in the project context and past trends may be guide to determine the reasonable range. The PPs used two different approaches to the sensitivity analysis: The selected parameters were adjusted within the range of positive 10% and negative 10%. The result is provided in the table below: -10% -5% 0% 5% 10% Total Investment 7.27% 6.71% 6.19% 5.72% 5.27% Tariff 5.18% 5.69% 6.19% 6.69% 7.17% Operation Hours 5.18% 5.69% 6.19% 6.69% 7.17% The project IRR remained below the benchmark 8% in each instance. To further confirm the additionality of the project, the PPs also identified the scenarios under which the project IRR will reach the benchmark 8% as follows: When total investment 27.34% below the assumption All the data adopted for project costs in calculation of IRR are from the project FSR completed by Hubei Hydrology and Hydropower Science Institute Hubei Jinlang Survey and Design Institute in December 2005. Four months later the project started construction. Given this short period of time, it has been concluded that material changes on project costs are unlikely and the input estimations in the FSR are still valid at the time of project start date. As the total investment is mostly made during the first two years of construction, and given the high rate of inflation in the past three years in China, it cannot be expected a decrease on estimated assumption by 27.34%. When income from electricity sales 17.49% higher than the assumption This scenario means either increasing the tariff or operation hours of the project by 17.49%, the project IRR can meet the benchmark. Such an increase in operating hours and tariff are not considered reasonable for the following reasons: Probability of tariff variation The tariff adopted in the investment analysis of the PDD was from the Electricity On-grid Commitment Letter issued by Shennongjia Linqu Electric Power Company in January 2006. In the Letter the tariff for Yuquanhe was indicated as RMB 0.213yuan/kwh including VAT. This - 2 -
can be now further confirmed by the signed Power Purchase Agreement between the project owner and Shennongjia Linqu Electric Power Company dated on December 2, 2008. From the project construction in 2006 to date, the tariff remains the same. It shall be noted that at the time of investment decision by the project owner, probability of a large tariff variation in the future was difficult to predict given the Chinese tariff setting process. An increase in tariff is entirely a decision by the Government weighing up various economic and social factors such as Consumer Price Index(CPI), inflation, fuel costs and power needs. 1 After 2006, since the CPI is soaring up in China, the government has decided to strengthen its administrative execution on price. In early 2008, it was confirmed by the government that to control the rapid CPI increase, the current tariff shall be maintained. 2 Although tariff did not increase, CPI will impact O&M and capital costs for the project. In addition, the tariff increase mechanism in China is especially designed for the thermal power plants whose power generation requires fossil fuels and the pre-condition of any increase is the increase on production costs. However, as hydropower plants require natural resources for power generation and there will be small fluctuation on the water resource charge, it is very unlikey to expect big variation on tariff offered to hydropower projects. Probabilty of electricity generation variation The electricity generation of the project is determined by the operation hours. The annual net electricity delivered to the grid adopted in the PDD was calculated on the basis of annual operation hour of 4450 provided in the FSR. This annual operation hour was calculated from hydrographical data covering 25 years from 1973 to 2003. Therefore it is not possible in terms of water resources to have the annual operation hour of the project realize an average annual increase of 17.49%. This increase also cannot be expected in terms of power generation as the estimated power generation was calculated on the basis of 100% reliability operation level throughout the year, which is unlikely to be realized. 1 http://news.sina.com.cn/c/2008-05-12/112915521821.shtml 2 http://www.ycwb.com/xkb/2008-01/26/content_1770786.htm - 3 -
To conclude, PPs have identified the scenarios carefully, under which the project might be financially feasible. However the PPs do not believe in the long term the project IRR can reach the industry benchmark within the reasonable possible variations given the past experience and future trends in China, in particular in tariff and electricity generation. Question 2: The DOE should clarify how it has validated the common practice analysis, in particular the selection of similar activities considering that the total capacity of the project activity is 25.2MW and comparison to hydropower projects in range between 15-35MW (corresponds to approximately +/-50%) would have been more appropriate. Response by PP According to the Additionality Tool, the common practice shall provide an analysis of any other activities that are similar to the project. Projects are considered similar if they are in the same country/region and/or rely on a broadly similar technology, are of a similar scale, and take place in a comparable environment with respect to regulatory framework, investment climate, access to technology, access to financing, etc. Moreover, other CDM project actitivities are not to be included in this analysis. Based on this guidance, we provide further clarification on projects identified in the common practice of the PDD is as follows: Limiting to hydropower projects in Hubei province Limiting projects to the province level is widely adopted when identifying similar projects in terms of location as it is more likely those projects have been taken place in a comparable environment in terms of regulatory framework, investment climate, access to technology, access to financing, etc. Limiting to projects operational or under construction since 2000 To choose projects operational or under construction since 2000 is conservative as usually 2002 is the year that was adopted for common practice in China because of similar regulatory framework, investment climate and access to financing. The power industry in China undertook a significant policy reform in 2002 3, under which the investment environment and tariff setting mechanism were changed. On 10 th February 2002 the State Council issued the Notice on Issuing Electric Power Sector Reform Programme (Guofa [2002] No.5) and the monopoly of the electricity investment was broken down by separating electric power plants from electric power grids and netting by price-bidding. Diversification of investment body was realized, which brought the private enterprises and private funds investment into power industry. For this change in China s power industry, hydropower projects in Hubei province under construction after February 10, 2002 were usually selected as similar projects for common practice in the registered PDDs. The project PDD was 3 Please see Electric Power Reform, 2003 Yearbook of China Electric Power, page 10-14 - 4 -
conducted in a conservative manner to take the year consideration starting from 2000. Limiting to projects with installed capacity under 50MW and not applying for CDM The small hydropower project in China was set at an installed capacity between 50MW and 0.5MW by the Government 4. This standard was further confirmed by Standard for Classification and Flood Control of Water Resources and Hydroelectric Project (SL252-2000) issued by the Ministry of Water Resources of the People s Republic of China and the Classification & Design Safety Standard of Hydropower Projects (DL5180-2003) issued by the State Economic and Trade Commission of People s Republic of China. Therefore projects below 50MW are deemed to be small scale hydropower projects in China. PPs therefore considered projects under 50MW as the similar projects to the project, which is over the range between 15MW and 35MW and therefore conservative. It shall be noted that projects listed in the table of the PDD are all projects other than those applying for CDM we can obtain from the public available hydropower projects information in Hunbei province in China Hydro Statistic Yearbooks. This is in line with EB guidance on common practice in Additionality Tool version 05.2, which states that if necessary data/information of some similar projects are not accessible for PPs to conduct the analysis, such projects can be excluded from this analysis. Question 3: The DOE should clarify how it has validated that real action were taken to secure CDM status for the project in parallel with its implementation in line with EB41, Annex 46, para.5(b). Response by PP The reference of serious CDM consideration and its development has been provided in the PDD. In the below table we have included several events and milestones in terms of CDM development and project implementation to demonstrate that besides early CDM consideration before the start of the project activity, the project entity has continued to take real and concrete actions parallel with the project implementation towards registration as a CDM project. The key milestones in the development of the project are listed below: Date April 2005 Milestone EIA Approval issued by Hubei Province Environmental Protection Bureau 4 Please see Almanac of China s Water Power - 5 -
December 2005 FSR Completion 20 January 2006 FSR Approval by Hubei Development and Reform Commission 25 January 2006 Tariff Letter from Shennongjia Linqu Electric Power Company 10 February 2006 Board Meeting Resolution to apply the project for CDM 17 April 2006 Bank Loan Commitment Letter 26 April 2006 Equipment Supply Agreement Execution Project Start Date 15 May 2006 Project Construction Command June 2006 CDM Consulting Agreement (with individual) June 2006 Start construction of water diversion system September 2006 CDM Exclusive Consultancy Agreement (with company) October 2006 Start construction of dam October 2006 NDA signed between the Buyer and the project owner November 2006 Start construction of power house April 2007 Termsheet Signed with the CER buyer 17 August 2007 Project was approved at NDRC meeting and published at its website 5 20 August 2007 Validation Agreement with DOE October 2007 On-site valiation and PDD for GSP 6 November 2007 Host Nation Approval (paper document) December 2007 Emission Reduction Purchase Agreement Execution 15 July 2008 Draft Validation Report In line with EB41, Annex 46, para.5(b), we provided the following explanation: Continuing and real actions were taken to secure CDM status in parallel with its implementation Since the board meeting resolution to apply the project for CDM, continuing and real actions have been made to secure the CDM status for the project along with its implementation. The CDM Consulting Agreement was signed in June 2006 with an individual, two months after the project start date. In September 2006 the CDM Exclusive Consulting Agreement was reached between this individual s newly established company and the project owner. One month later NDA was signed between the CER Buyer and the project owner. Since the execution of NDA, the project owner and the CER Buyer have been in negotiation with the termsheet for the project, which was finally agreed by parties in April 2007. After the confirmation of the Buyer, the PDD work was started right away. 5 http://cdm.ccchina.gov.cn/website/cdm/upfile/file1426.pdf 6 http://cdm.unfccc.int/projects/validation/db/4xbm17ng5a87zwpsofl7dhkf3npzoc/view.html - 6 -
In August 2007 the project was approved at China NDRC meeting and the validation agreement was signed with the DOE. In October PDD was published at UNFCCC in the following month along with the on-site visit of the project. The following month Host Nation Approval in paper was obtained. In December 2007 the final binding Emission Reduction Purchase Agreement ( ERPA ) was signed between the CER Buyer and the project owner. It can be seen clearly from above that concrete steps were taken for the project development towards registration as CDM, which is in line with EB41, Annex 46, para.5(b). In addition, the PP s believe it is reasonable that commericial negotiation with the CER Buyer delayed the project PDD development work. Market practice in China is typically that the Buyer will pay all the upfront fees such as consultancy, DOE fees etc.and so usually the consultant will not start work until a buyer for the project is secured. That s why PDD development was not started immediately after the signing of consulting agreement. In addition the host nation approval process in China typically requires a buyer to be in place as the letter of approval includes an approval to transfer the CERs to a named Annex 1 participant. Therefore securing an Annex I project participant before application for host nation approval is common practice but sometimes causes delay between project start date and CDM application. From the timeline it can be seen that the project owner worked continuously and steadily towards submission of the project for registration since the start date.. Progress had been sometimes slower than anticipated but at the time the investment decision was made the owner did not foresee the length of time it takes to register a project under the CDM. Despite the difficulties described above, the project participants remained determined in their intention to register the project activity for CDM as this had remained an essential precondition making the project actitivy financially attractive. Yours faithfully, Philip Scales Director and Company Secretary - 7 -