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GEF Documentation

The Global Environment Facility (GEF) assists developing countries to protectthe,global environment in four areas: global warming, pollution of international waters,destruction of biodiversity, and depletion of the ozone layer. The GEF is jointly implementedbythe United Nations Development Programme, the United Nations Environment Programme,and the World Bank.

GEF Working Papers - identified by the burgundy band on their covers - providegeneral information on the Facility's work and more specific information on methodologicalapproaches; scientific and technical issues; and policy ahd strategic matters.

G;EF Project Documents - identified by a green band - provide extended project-specific information. The implementing agency responsibie for each project is identified by

its logo on the cover of the document.

Reports by the Chairman - identified by a blue band - are prepared b-y the Office ofthe GE-F Administrator in collaboration with the three GEF implementing agencies for thebiannual Participants' Meetings.

GLOBALENVIRONMENT

FACILITY

The Cost-Effectiveness of GEF Projects

Dennis Anderson

Robert H. Williams

Working PaperNumber 6

UNEP

THE WORLD BANK

(D 1993The Global Environment Facility1818 H Street, NWWashington, DC 20433 USA

All rights reservedManufactured in the United States of AmericaFirst printing December 1993

The views expressed in this paper are not necessarily those ofthe Global Environment Facility or its associated agencies.

ISBN 1-884122-051ISSN 1020-0894

The Cost-Effectiveness of GEF Projects

This paper is the third among a series of GEF Working Papers to deal with the Program for MeasuringIncremental Costs for the Environment (PRINCE). The GEF is a financial mechanism that provides grantsto developing countries for projects aimed at protecting the global environment.

PRINCE was initiated in February 1993 at a workshop held at the Tata Energy Research Institute in NewDelhi. It covers methodological studies, field tests, and dissemination related to the technical issues ofmeasuring incremental cost. This is a concept central to the GEF; the two conventions to which it is linked-the Framework Convention on Climate Change and the Convention on Biological Diversity; and theMontreal Protocol dealing with ozone depletion.

This paper was prepared at the request of the Scientific and Technical Advisory Panel (STAP) of the GEF.It addresses such issues as the costs of carbon emissions (or their reduction) and their implications for projectappraisal; the appropriate discount rate to be used in comparing costs, bearing in mind intergenerationalconcerns as well as cost-effectiveness; cost estimates of the benefits of innovation, particularly thecontribution of investment towards reducing the cost of future investments when cost curves, as a functionof investment, are steep; the role of Type I projects (where national economic benefits outweigh nationalcosts) relative to Type II projects (which are not cost-effective from a national standpoint but provide globalenvironmental benefits); and the possibilities of reducing transaction costs in certain GEF projects witheconomic potential.

Dennis Anderson is Senior Adviser in the Industry and Energy Department of the World Bank. Dr. RobertH. Williams is Senior Research Scientist at the Center for Studies of Energy and the Environment atPrinceton University.

Thanks are due to Professor Amulya Reddy, Chairman of STAP, for initiating this paper and for hiscomments and encouragement; Professor David Pearce for reviewing the paper; and the participants of thePRINCE workshop chaired by Dr. Rajendra Pachauri.

The other Working Papers currently in the PRINCE series are numbers 4, 5, 7 and 8.

iii

Contents

Introduction 1

Investment Criteria 3

2 Costs and Portfolio Choice 11

3 Conclusions 20

References 22

Figures in text1 Carbon accumulations and marginal costs 32 Transitions to the use of renewable energy as the GHG constraint is approached 43 Carbon accumulations' damage function 54 Scenarios for imputed carbon tax under different assumptions about initial estimates of the

accumulations limit 105 Marginal costs of pollution abatement in electric power 116 Overlaps between Type I and Type II projects 15

Tables in text1 Cost of electricity generation 72 Cost of gasoline and zero net CO2-emitting alternative automobile fuels 73 Cost comparison of alternative motor vehicies 84 Pollution abatement through price reforms in electricity demand and supply 125 Emissions control technologies: abatement efficiencies and costs 146 Historical photovoltaics cost data for Japan 177 Estimation of cost-saving benefits of GEF investments in photovoltaics 17

Appendix 25

Tables in appendixA l Cost of electricity generation 26A2 Cost (ex-refinery or fuel processing plant) of gasoline and zero net CO2 -emitting alternative

automobile fuels 28A3 Cost of automotive fuels delivered to consumers 29A4 Comparison of alternative automotive vehicles 30A5 Characteristics of alternative vehicles 32A6 Sensitivity analysis for carbon tax implied by backstop technology 33A7 Cost summary for cruise-design fuel cell electric vehicle by Ira F. Kuhn 34

v

Abbreviations

BPEV Battery-powered electric vehicle

FCEV Fuel cell-powered electric vehicle

GJ Giga Joule

GWh Gigawatt-hour (1 million kilowatt hours)

ICEV (Gasoline-powered) internal combustion engine vehicle

KW Kilowatt or KWe where "e" denotes an energy unit

KWp Kilowatt peak

MW Megawatt or MWe where "e" denotes an energy unit

NPV Net present value

OCC Opportunity cost of capital

ODA Official development assistance

OECD Organization for Economic Cooperation and Development

PM Particulate matter

PV Photovoltaic

STAP Scientific Technical and Advisory Panel (of the Global Environment Facility)

TW Terawatt

Data notes: Dollars ($) are current US dollars unless otherwise indicatedI short ton = 0.9072 tonnesI long ton= 1.0161 tonnes

Introduction

The Global Environment Facility's (GEF) energy- duction and use by 20 percent, and developingrelated investments aim to develop approaches for countries (whose per capita energy consumption isdealing with global warming. While there is still only one-tenth of that of the industrial countries)much scientific disagreement on the extent and were asked to reduce their rate of growth of energylikely consequences of global warming, the GEF consumption from 6 percent per year to 4 percent arepresents a commitment by its member countries year (a major reduction), then this could be achievedto putting precautionary policies in place in the through reforms to energy pricing policies andevent of such climate change. Indeed, as further other measures to improve energy efficiency.evidence on globai warming and its consequences is The global warming problem would be effectivelygathered, the investments of the GEF will leave the "solved" at a negative cost by eliminating unneces-international community better placed to reduce sary economic waste in energy consumption.2 How-carbon accumulations to safe levels over the long ever, even with such improvements in efficiency,term. The GEF supports activities, technologies, global CO2 emissions each year would still be twiceand policies that would be adopted on a large scale their present levels in forty years, and carbon accu-if it became necessary to significantly restrict car- mulations would likewise be twice their presentbon emissions. In the Pilot Phase of the Facility, the levels by the middle of the century; the globalmain emphasis was on testing various approaches warming problem would have been delayed by athat were considered technologically promising; decade or so, but would remain substantiallythese approaches were reviewed by the Scientific unresolved. To fulfill its purpose, GEF funding willand Technical Advisory Panel (STAP) of the GEF need to be based on a scenario in which carbonin May 1992.1 As the Facility moves closer to GEF accumulations in the atmosphere are stabilized atII-its full-scale operational phase-the emphasis some safe level over the long term to avoid furtherhas shifted toward finding cost-effective solutions global warming.to global warming and other issues.

Introducing a carbon accumulations constraint intoIn seeking cost-effective approaches, the terms "ef- the analysis of energy investments amounts to usingfectiveness" and "costs" both require scrutiny. If, the resource depletion rule often used in the past forfor example, the member countries of the Organiza- fossil fuels. The rule has become discredited intion for Economic Cooperation and Development recent years, because each time a limit to reserves(OECD) were required to gradually reduce their net was thought to be approaching, the limit was ex-carbon dioxide (CO2) emissions from energy pro- tended by new discoveries. But if a limit is set to the

I STAP report (GEF 1992).2 World Development Report 1992.

use of fossil fuels, not by their availability, but by supported by the GEF as it is in other areas. Somethe amount of carbon the atmosphere can safely groundrules will have to be setas to whatcomprisesabsorb, the imputed cost (or shadow price) of using a satisfactory portfolio of projects that meet thesuch fuels rises at a rate equal to the discount rate criteria of cost-effectiveness. This issue is discusseduntil the limit is reached. At this point they can be in chapter 2.replaced by altemative energy approaches, knownas backstop technologies, which do not result in net A satisfactory portfolio also cannot be detenninedcarbon emissions. This means that the shadow price without analyzing how relative costs are changing.to be attached to carbon savings is undiscounited in The most promising investments in renewable ener-net present value comparisons of costs, at least up to gy are still small scale, and costs are declining withthe point where the backstop technologies are wide- successive pilot investments and with technically deployed. Chapter 1 develops the argument fur- progress. The transaction costs of demonstratingther, discusses possible complexities, and makes a and developing new approaches are also initiallypreliminary assessment of shadow prices suitable high. Thus, it is important to know the current costfor the appraisal of GEF projects. of such approaches, the prospects for reductions in

costs of the technologies in question, and how theAnotherproblem for setting GEF criteria and ground GEF can help reduce such costs. A related issue isrules relates to the diversity and costs of potential that of the continuity of policies, which many peo-projects. All GEF finance could be consumed many ple have drawn to the attention of the GEF and thetimes over on a single option, such as promoting World Bank. Cost reductions will not be achievedenergy efficiency, or developing aparticularrenew- by one-off investments, but only by a long-termable energy technology. This would preclude many commitment to a program of investments to devel-other investments that meet the criteria of cost- op the more promising technologies. Such a pro-effectiveness discussed below, and thus would un- gram will also help to reduce transaction costs thatdermine the goal of instituting precautionary policies. currently hamper the success of many GEF invest-Risky situations require diverse portfolios, a rule ments. These issues are also discussed in chapter 2.thatis as relevantforthe energy developmentprojects Chapter 3 presents the conclusions.

2

InvestmentCriteria

Global warming as a carbon stant (the assumption is relaxed later). If a limitaccumulations problem were to be set on the safe level of accumulations,From a policy-making standpoint, the problem then there would eventually have to be a switch toposed by global warming (or the threat of it) is best the non-fossil alternatives, and the marginal coststreated as an issue of stabilizing carbon accumula- of meeting demand would rise from f to n.tions in the atmosphere. Several studies have con-centrated on how best to reduce annual emissionrates by a particular period; for instance, it has been |found that most OECD economies could stabilize Figure 1. Carbon accumulations and(and probably reduce) their emissions by the year marginal costs2000 simply by improving energy efficiency.

Magn l n However, even if ambitious emissions reduction Marnrl _

targets were set, CO2 would continue to accumulate fin the atmosphere because net emissions rates in the T tim (t)industrial countries would still be large while thosein developing countries would continue to grow. '18tions

Even if all energy efficiency options were thor-oughly explored, the question would remain of howto control carbon accumulations in the long term. IThis is the question the GEF needs to consider. Thedevelopment and use of non-net carbon-emittingtechnologies--mainly renewable energy-will be The transition to the non-fossil fuel alternativescrucial, with energy efficiency playing a supporting could not be abrupt. The lead times and lags in-role. volved in developing and introducing the technolo-

gies on a large scale would be considerable, perhapsThe way the carbon accumulations constraint af- one-half to three-quarters of a century (all the morefects prices and costs is summarized in figure 1. reasonwhytheyneedtobedevelopedquickly),andThe upper half shows the marginal costs of fossil the actual situation would probably look more likeenergy (f) and of the non-fossil alternatives (n) or that in figure 2 than figure 1. But based on figure 1,backstop technologies, the lower half shows car- each extra unit of fossil fuel that is consumed beforebon accumulations rising over time as fossil fuel is the accumulations constraint is reached brings for-burned. For simplicity, f and n are assumed con- ward thetime whenthebackstoptechnologies would

3

be needed (the shaded area). The present value ofthe extra cost is then Figure 2. Transitions to the use of

renewable energy as the GHGct = (n-f)(1+r)-(T-) constraint is approached

and the actual marginal cost of fossil fuel consump- ERCENTAGE_OF tOTAL PRIMARY ENERGY DEMAND

tion is f, + ct-3 cis the carbon tax that is theoretically 0needed to bring about investment in the non-carbonro0 alternatives; it is also the shadow price or marginal ?O.benefit to be attributed to any activity (such asenergy efficiency, or the use of a low carbon- 0.emitting energy resource) that would delay the time ,0 E

at which the carbon accumulations constraint is 2 - AORO A NUCLEAR

reached-the value of buying time, so to speak.1ti0 201 o 2030 2050

YEAkR

The shadow price rises exponentially at a rate equalto the discount rate until it equals the difference TOTAL PRIMARY ENERGYDEMAND

between the marginal cost of the backstop technol- afO

ogies and fossil fuels. Thus, if it is estimated to be ,00 /$20 per metric tonne of carbon, it would be $52 per 2f0 .SI

tonne in ten years' time (assuming a 10 percent i 200

discount rate) and $130 per tonne in twenty years' 'so: .WAL.time, and so forth, until the upper limit (given by n) 100/

is reached. An alternative would be to leave the net NYORO AND NUCE

carbon benefits undiscounted in the comparison of .- . 0 2

the present worth of costs between one option and .2ARanother. another. CAR80N EMISSIONS

Accumulations constraints andenvironmental damage functionsWhat is the relation between the above approach 20 _

and an approach based on an analysis of the social FOSSIL FUEL C

costs of global warning that some economists haveadvocated?4 The two approaches are consistent in .0principle, and are related as follows. The social cost .ENIWAIE ENERGY SCENARIO

curve (or damage function) associated with carbon e - . . , . 0

accumulations is not known reliably, but may have YEAR2

a trough-like formn, as illustrated in figure 3; too lowa level of carbon accumulations would lead to Source: Anderson and birdglobal cooling, and too high a level to global warm- N equivalenting. Presumably the curve also shifts to the right or eq__va __n_.left according to changes in the earth's orbit, wob-ble, and tilt, which may help to explain past changes If the location, width, and curvatures of the troughin climate.5 were known reliably, it would be possible in theory

I This result is similar to Hfotelling's tomrula for the optimal price of a depletable resource, whereby the optimal price ofthe resource equals the extraction cost plus a "user cost" that rises exponentially over time until the backstop or replacementtechnology becomes economical. In the present case, the resource in question is not the availability of fossil fuels, but the limits ontheir use set by concerns about climate change.

For example, Nordhaus (1991), Barbier and Pearce (1990), and Cline (1991).Goudie, Environm ental Change, 2nd ed. (I1983).

4

The cost of capital and GEF criteriaFigure 3. Carbon accumulations' A general principle of environmental policy-makingdamage function is that policies that tackle an environmental problem

directly are both less costly and more effective thanthose that deal with it indirectly. Thus taxes or

Margirnal regulations on pollution, such as on the sulfur or leadCosts content of vehicle fuels, or on the treatment and

Safety Margin disposal of spent nuclear fuels, are far more effective\i _l ,,lin reducing pollution than, say, a general tax or a

\ ~ - --- (n-f) restriction on energy use. Indirect measures may\ | / 1 penalize clean and dirty fuels alike, and have only

L 1f , small effects on pollution, while raising costs appre-0 Accumulations ciably. By contrast, direct measures may reduce

pollution to low levels at a comparatively low cost.

to choose an accumulations limit appropriate to our A similar principle applies to proposals to lower theenvironmental epoch, at which the marginal costs, test discount rate when deciding on investmentsn - f, of maintaining the accumulations at a given intended to deal with global warming. It works bothlevel equal the present value of the marginal social as a blunt instrument of policy and may also lead tocosts to the world's communities of climate chang- decisions that contradict the aims of the policy;7 ites associated with carbon accumulations, as indi- favors capital intensive solutions over labor inten-cated in figure 3-not an unambitious objective for sive ones, and may sometimes work against invest-decision-makers. The intersection of the damage ments with more immediate promise (such asfunction and marginal costs gives an optimal level renewables) by giving added weight to those withof accumulations under certainty. But since the more distant prospects (such as nuclear fusion). Indamage function is not known, some safe limit may general, lowering the discount rate is no substituteeventually have to be decided upon based on the for direct measures to address a pollution problem,findings of climate research and environmental and will not guarantee the required results. Whilescience. If there is also evidence of instabilities blunt instruments may sometimes serve a usefularising, for example, from the positive feedback purpose, the preferred approach is to reflect environ-between global warming and carbon releases from mental concerns directly in policy and, with duesea and land masses overriding the various negative attention to the welfare of all parties (includingfeedbacks-such that the marginal damage func- future generations), to use a discount rate equal to thetion is thought to rise steeply-then presumably a opportunity cost of capital.safety margin would need to be incorporated in anyagreed limit. This is the approach suggested for the GEF. Hence

the question is, how are the international and inter-The marginal damage function may be a good deal generational concerns about global warming bestflatter over the short term than over the long term, reflected in its policies? Two rules might usefully bedue to the thermal inertia of the sea and land masses. followed.If so, it is possible that we may overshoot theaccumulations constraint, and it would be neces- The first rule is to base the GEF portfolio on the typessary to initiate a process of decumulation.6 In these of investments that would most likely be needed in acircumstances, there would be a premium or rental scenario of global warming. The GEF then supportselement to be added to the carbon tax or shadow a precautionary policy in which the aim is to leave theprice formula noted above. international community well placed to respond to

6 According to some estimates, net carbon fluxes to the atmosphere would be negative if those from fossil fuels were reduced to less thanabout 2 to 3 billion tonnes per year (Bolin in Bolin et al. 1986; Hall and Rosillo-Caille 1990.) Thus decumulations are possible in principle if netemissions from energy related activities were reduced to 0 to 2 billion tonnes per year.7 Markandya and Pearce (1988, 1991).

5

the global warming problem should the need arise. costs of the fossil fuel alternative, and the equaliz-Middle-of-the-road scenarios, such as those on which ing discount (r*) is calculated, a value of r* greaterseveral cost-benefit studies have been based, are not than the opportunity cost of capital (OCC) willrelevant to the GEF. Such scenarios overlook the indicate that the project meets the criterion of cost-asymmetry of risks (noted in figure 2), and also the effectiveness. (A value of r* < OCC would indicatepossibility of a much worse outcome than they that the project is an outlier.) Suppose we have twoproject. The idea of a precautionary policy, like projects with different capital, operating, and main-insurance policies, is to prepare for downside risks. tenance costs, but both reduce total emissions by theFurther, given the ambiguities in the evidence about same amount. Then the shadow value of reducingthe possible extent and consequences of climate the emissions, even if the reductions are achieved atchange, and that some relationships (such as ocean- different points in time, will be the same in bothclimate interactions and ocean currents) have still cases (because the annual values are undiscounted).not been modeled and estimated in a scientifically However, the present values of their capital, operat-satisfactory way, the economist has to pay as much ing, and maintenance costs will differ and they willattention to the variance as to the expected value of be competing on the basis of relative costs-on thethe independent variable. This too argues for con- most cost-effective use of capital and recurrentsidering a downside scenario. Finally, if GEF in- resources-which is what the GEF's sponsors arevestments are based on a seemingly risk-neutral seeking.position or a most-likely outcome, this would workagainst the purpose of the Facility, which is to Lead times, lags and changes in costsprepare for contingencies. To estimate the shadow price (c,), assumptions need

to be made about the time when the switch to theThe second rule is to base GEF decisions on a backstop technologies would need to be begun inresource depletion formula of the form just derived. earnest in a scenario of global warning, and on theSome of the simplifying assumptions that were prospective costs of the backstop technologies rel-made above will be considered in the next two ative to those of fossil fuels.sections, and preliminary estimates of costs (theshadow price to be placed on carbon emissions) will Assumptions about the switch (T)then be derived. The formula gives an appropriate As noted earlier, it would take a long time to switchweight to those options that are consistent with to the backstop technologies in order to complystabilizing (or even reducing) carbon accumula- with the carbon emissions constraints, and the situ-tions over the long tern. In net present value com- ation may be more like that shown in figure 2 thanparisons of costs, the shadow price on carbon in figure 1. World demands for fossil fuels are veryemissions is then undiscounted up to the point large-currently about 7.5 billion tonnes of oilwhere T is reached, since its value rises exponen- equivalent energy a year-while the output of thetially with the discount rate. (This is in accordance renewable energy industry amounts to much lesswith the above equation calculating the shadow than 1 percent of this (excluding hydropower, whichprice.) provides about 2.7 percent of primary energy sup-

plies). The industry would not be geared up forThe shadow price on emissions reductions is undis- substitution on a large scale for several decades,counted because of the accumulations constraint even assuming that the backstop technologies wereand the decision to choose cost-effectiveness as the fully developed.criterion as opposed to the net present value ofbenefits, due to the difficulties in estimating the Thus carbon accumulations could not be stoppedlatter. The net present value of costs, under the abruptly as indicated earlier (by the solid lines in thecriterion just noted, will be the present value of lower quadrant of figure 1), but would likely over-capital, operating, and maintenance costs minus the shoot agreed levels before they could be stabi-shadow value of reducing emissions. When this lized-unless it turns out that T is several decadesexpression is compared with the present value of the away, which would give ample time to plan ahead.

6

In this case it is better to think of T as a point in time applications, renewable energy is already the least-when the transition to the alternatives from fossil cost option-for example, the use of biomass forfuels would need to begin on a large scale. The year cogeneration, wind energy in favorable locations,2010 for the present calculations is chosen for two photovoltaics for rural electrification, and the pro-reasons. First, major cost reductions and technical vision of supplementary power in electricity distri-developments in the manufacture and use of renew- bution networks. But substituting renewable energyable energy technologies (the main option that the for fossil fuels on a large scale would likely raiseGEF can support) should be realized by then. Sec- costs. Table 1 presents one assessment of the long-ond, the evidence on the greenhouse effect will also term costs of using renewables for electric powerbe much clearer and (in a scenario of global warm- generation on a large scale. The details are provideding) will enable governments and industry to make in the Appendix.a firm commitment to the widespread use of non-fossil fuels. Many agree that, for electricity generation, the

backstop technologies may eventually become com-Marginal costs petitive with fossil fuels, at least in regions whereThe costs of the backstop technologies relative to solar radiation is consistently high.8 Technologiesfossil fuels vary greatly for different markets and to provide substitutes for non-electric energy will,applications. They also vary over time. For some however, be very expensive. Non-electric energy

currently comprises 60 percent of the primary ener-gy markets in the industrial countries and over 65percent in developing countries. The main backstop

Table 1. Cost of electricity generation technologies are biomass-derived fuels, primarilyUS centslKWh (1 990 prices) ethanol or methanol; hydrogen derived from nucle-

[ Long-term | ar or solar power; and further electrification of the|Source ofpower Current expectations I energy markets, which will depend crucially on

advances in storage technologies. Table 2 summa-Coal 5.0 May rise j rizes a recent assessment of likely costs of theOil 6.0 gradually with various fuels delivered to the consumer.Gas (combined cycle) 4.5 fuel prices

Nuclear 5.5 Rises with Ethanol and methanol from lignocellulosic (woody-environmental biomass) feedstocks could become competitive withfactors gasoline in the long term if (ex-refinery) gasoline

Photovoltaicsa 30-50 7.0Thermal-solarb 15.0 7.0Biomass 9.0 4.0-6.O

Bio-s I I Table 2. Cost of gasoline and zero netSources: See Appendix table A I for further details. Ref- CO -emitting alternative automobile fuelserence should also be made to Johansson et al. (1992) b ofor renewables in general; Booth and Elliott (1990) for ! ____________________________________

biomass; and the OECD (1989) for nuclear and fossil Prospecrivelfuels. Anderson and Bird (1992) also provide a review Source of power Current long termi of estimates. Gasoline (ex-refinerv) 33 45Note: The estimates shown in this table are averages ofranges which vary with the type of plant or technology, MEthanol from biomass 80-89 55-64the discount rate assumed, and often, the country. The I Methanol from biomass 80-89 55-64tigures are rounded. Hydrogen from

High insolation areas (2,000 to 4,000 KWh/m/year) photovoltaic power 960 144-166b Costs would rise with pressures on land resources Sources and basis of calculations: See Appendix tableat high levels of production. A2.

See Williams ,1990) and Johansson et al. (1992).

7

prices rise to the level indicated.9But if biomass is lished in the market, would be comparable toto meet more than 50 percent of vehicle fuel require- those of gasoline vehiclesments, it will require intensive use of land as an * Their unit fuel costs would be greater, as summa-energy source. A typical net yield would be 300 rized in table 2tonnes of ethanol per square kilometer, but might * Their fuel efficiency would be three times higherrise to around 700 tonnes with technical progress.", than the 20 percent attainable for the internalThe total demand for vehicle fuels (diesel and combustion engine.gasoline) is around 1.7 billion tonnes of oil equiva-lent in developing countries and in OECD nations. Thus net costs of turning to hydrogen may be lowerDemand from developing countries, which accounts than suggested in table 2.for 500 million tonnes, l is likely to triple in the nexttwenty years. Extremely large land areas would be Table 3 presents a reassessment of costs allowingneeded for the cultivation of corn, sugarcane, and for these factors. Several long-term options areother crops if biomass fuels were to be substituted considered and are detailed in the Appendix. In eachfor gasoline and diesel on a scale large enough to case two quantities are calculated. One is the break-meet such demand. At the same time, the area even gasoline price, which is the gasoline pricerequirements of agriculture will rise appreciably (exclusive of taxes) at which the lifecycle cost of awith population growth and increasing per capita gasoline-powered internal combustion engine ve-incomes, depending on technical progress and yields hicle would equal the lifecycle cost of the alterna-in farming. tive vehicle. The other is the net lifecycle cost of

reducing carbon emissions (in dollars per tonne ofWhile biomass fuels are promising in terms of cost, carbon reduction).as the calculations in table 1 show, they wouldprobably need to be complemented by solar-de- The use of two decimal places in the table is notrived hydrogen as a vehicle fuel at high levels of intended to indicate precision, but only to avoid thesubstitution, or by electrification of the vehicles,again with solar electricity being the primary ener-gy source. The advantage of these options are their Table 3. Cost comparison of alternativerelatively low land intensity-the annual yields of motor vehiclessolar schemes are over 30,000 tonnes of oil equiv- Undiscountedalent energy per square kilometer a year (in final net lifecycleenergy units), assuming net conversion efficiencies Break-even cost of reducingof 5 percent, or fifty to one hundred times greater gasoline carbonthan those of biomass. Type of price emissions'

motor vehicle ($Igallon) ($/ton)

It is, however, not sufficient to look at the cost of the Battery-powered 1.81 354fuel alone. If hydrogen (produced, say, from photo- Fuel cell electric:voltaic-generated electricity) or biomass fuels were Methanol-basedto become the premium vehicle fuel in a low- (biomass) 0.72 -175carbon-emissions scenario, it would likely be in H2-based, usingassociation with the use of a fuel cell in an electric [ biomass 0.83 -143vehicle. The engineering economic studies summa- H2-based, usingrized in the Appendix suggest the following: - PV electricity 1.62 117

Sources and basis of calculations: See Appendix.* The capital and maintenance costs of electric Assuming a gasoline price of $1.25 per gallon.

vehicles using fuel cells, once they are estab- -

See also the forthcoming review by Ahmed (1993) on the costs and status of solar and biomass energy, which reviews a large numberof industry and other studies.

Johansson et al (1992).British Petroleum Statistical Review of World Ener gy ( 1992).

8

unnecessary accumulation of rounding errors. In If the above figure of $120 per ton is taken as anfact, there is quite a margin of uncertainty in the initial working estimate of the marginal costs of theestimates. There are engineering-economic rea- (marginal) backstop technologies, and T to be yearsons for thinking that the lifecycle costs of the fuel 2010 for the reasons discussed earlier, the presentcell-powered electric vehicle (FCEV) could even- value of this would be $25 per ton, using a discounttually be lower than that of the gasoline-fueled rate of 10 percent. The appropriate shadow pricesvehicle (as the two calculations in table 3 suggest would then be as follows (figures rounded):for FCEVs using biomass as the fuel source).However, the sensitivity analysis of the cost of fuel Year 1993 1995 2000 2005 2010cells and photovoltaics (Appendix table A6) shows and afterthat the net costs could also be higher, dependingon technological developments. Similarly, if gaso-line prices were lower than the $1.25 per gallon price ($Itonne)used in the analysis, the net costs of reducingemissions would also be higher. Only research, As noted earlier, the shadow price rises exponen-technical developments, and time will tell, and tially at the discount rate until T is reached. Suchestimates are likely to be revised from time to time estimates are not rigid, and there would be goodin the light of new problems and developments. reasons for revising the calculations periodically asFurther suggestions on how best to deal with these new evidence on costs and on the greenhouse effectuncertainties are provided shortly. As a starting comes to light.point, however, a marginal cost of $120 a ton mayprovide a useful basis for analysis; this is roughly Uncertainties and risksthe same as a carbon tax in the equivalent amount The main uncertainty is that the extent, likelihoodof 30 cents per gallon being imputed to the use of and consequences of climate change are not known,vehicle fuels. even within broad limits. This does not, however,

justify arbitrary ground rules for decision-making.Shadow prices Consider the risks at two levels: for climate changeFor the analysis of GEF projects, the shadow price and for the energy industry.to be attached to carbon emissions (ct) needs to bebased on costs of the marginal backstop technolo- Suppose the absorptive capacity of the atmospheregies, not on the costs of the most promising (non- were greater than is implied by the scenarios usedmarginal) options. This means that they are best for the above calculations, which are based on abased on costs in the non-electric markets (shown in fairly rapid development of the renewable energytables 2 and 3), where the substitutes for fossil fuels alternative. If the time at which the greenhouse gasare likely to be more expensive, rather than in the accumulations limit is reached were to be delayedelectricity markets, where the renewable energy by a decade, the shadow price (or imputed carbonoptions have good prospects of becoming compet- tax) would decline by 60 percent relative to theitive with fossil (and nuclear) fuels in the long termn. initial value (of $25 per ton) calculated above;The logic of this is that the more promising of the conversely, it would rise by a fraction of 2.5 if thebackstop technologies, whose costs would be less limit were advanced by a decade. The situationthan f,+c,, would then be given added weight when would thus be as summarized in figure 4.the net present value of costs are compared. At thesame time, some marginal technologies with costs Decisions as to whether to raise or lower the shadowclose to f,+ct would not be excluded-only the price ultimately depend on the findings of currentoutliers would be omitted, pending further develop- and future research on climate change. Such find-ments. Furthermore, those applications of the back- ings will also drive developments in the backstopstop technologies that have costs lower than f, (in technologies, which may justify the initial esti-the so-called niche markets) would have the highest mates of costs being raised or lowered. Thus anyreturns. policy response should keep options open, so that

9

Figure 4. Scenarios for imputed carbon tax important element of policy. But it is onl) anFigure 4. Scenarios for Imputed carbon taxunder differen an aeconomically desirable element, and by itself will

Eunder different assumptions about initial estimates ofthe accumulations limit notpreventcarbonemissions fromaccumulating in

the atmosphere. Global warming could only beprevented by widespread recourse to the non-netcarbon-emitting orbackstop technologies, the most

Carb~on (a)promising of which are renewables.Tax or X * Hence the development and use of renewable ener-

gy technologies merits the highest priority in theGEF portfolio, and their marginal costs set upperbounds to the shadow price (or imputed tax) to be

a 2 '1990S placed on carbon emissions. Further, it is the costs(The growth rate in (a) - the discount rate) of the marginal technologies likely to be brought

Initial estimates of the accumulations limit (a) correct into use-not the most promising ones with the(b) too high (c) too low. lowest costs-that set the upper bounds of the

shadow price. Technologies at the margin, and ofthe shadow price can be raised or lowered relative course those below it, automatically qual.y forto the path initially agreed upon, based on the GEF finance-only outliers do not. Further, L xtrafindings of climate research, energy studies and weight is given under this criterion to those appli-development. cations (such as in the use of photovoltaics for rura:

electrification in favorable locations) that reduceThe risks to the industries supported by the GEF any added costs of turning to renewables.should not be large. It is likely to be more than a * The shadow price needs to be based on accumu-decade before the findings of climate research es- lations constraint rather than on a yearly emis-tablish what the greenhouse gas accumulations lim- sions constraint. This means that it rises with theit is likely to be, and thus before the ground rules discount rate until the long-term cost of using thecould justifiably be changed because of shifts in the marginal technologies is reached. The prelimi-perceived limit. There would thus be some continu- nary estimates made above suggest a figure ofity in policy. If the global warning problem proves about $25 per ton of CO2 rising at the discountto be somewhat of a false alarm, or less serious than, rate of 10 percent per year, up to $120 per ton.say, the projections of the Intergovernmental Panel * Shadow price estimates would be raised or low-on Climate Change (IPCC), technological develop- ered periodically as further evidence on costs isments that already have useful market outlets would gathered. They would also eventually be raisedhave been stimulated, albeit on a larger scale than or lowered according to the emerging evidencewould ideally have been required. on global warming.

By basing its portfolio on the types of invest-A stock taking ments that would ultimately be needed in a sce-The GEF is part of a precautionary policy to address nario of global warming, and by working with anthe problems posed by global warming. The Facil- accumulations constraint, the GEF would be ex-ity supports those activities and investments that plicitly reflecting intergenerational concerns andwould leave its developing country members and risks in its portfolio. The Facility can then con-the international community better placed to reduce centrate on cost-effectiveness in its choice ofcarbon emissions and accumulations on a large investments-an aim that can best be served byscale, should the need arise. Several conclusions using the opportunity cost of capital as the testfollow: discount rate. Technologies and practices with

significant long-term potential for reducing car-In a global warming scenario, the achievement of bon emissions and accumulations would not beenergy efficiency-perhaps the most discussed excluded by using the opportunity cost of capitaloption for reducing carbon emissions-will be an as the criterion.

10

Costs and2 Portfolio Choice

Energy efficiency and the backstop have a marginal economic benefit of approximatelytechnologies 13 - 4 = 9 cents per KWh. CO2 and other pollutantsIn many developing countries, excess demands for would be reduced correspondingly. If prices wereenergy are being encouraged by large subsidies. For raised further, the marginal benefits (savings inelectricity consumption, a recent survey of sixty- costs) would be less, but would still be positive sothree utilities revealed that retail prices average long as the marginal costs of supply exceeded thelittle more than 4 cents per KWh while marginal marginal value of consumption (the price consum-costs, if the power systems were operating efficient- ers pay); pollution would decline correspondingly.ly, would average about 10 cents per KWh; the total The net benefits of raising prices (excluding thesubsidies are thought to amount to over $100 billion economic benefits of reducing CO2 emissions) woulda year, and are a source of both budgetary distress be zero at the point where prices reflected costs.and economic inefficiency.12 Moreover, this under- Beyond this point, further increases in prices wouldstates the costs of poor pricing policies, since low tax consumers and, depending on the budgetarycash flows also lead the utilities to compromise on situation, sharply increase costs. Table 4 shows therequired maintenance and the reinforcement of dis- calculation for various levels of abatement, andtribution networks; resulting electrical losses may figure 5 summarizes the results graphically.range from 20 percent to 40 percent of generation(compared to 10 percent attainable with good prac-tices). The thermal efficiencies of power stationsare several percentage points below nameplate rat- Figure 5. Marginal costs of pollutionings, and, owing to poor maintenance, plant avail- abatement in electric powerability averages only about 60 percent (as compared (wh mf to *vel )

with 80 to 90 percent with good practices). Allow- 35 All

ing for the managerial shortcomings induced by Energy EfficienCy N*O

price inefficiencies, marginal costs are closer to 13 g 25 * PM

cents than to 10 cents per KWh; thus the costs of Q 20 A 002

implied subsidies are much larger than the $100 M 15 Low Polluting

billion just quoted. 10 ecnoge

According to the above estimates, and taking present 10 2 40 50 60 70 80 90 100

day prices as a starting point, a 1 KWh reduction in .10 Pollution Abatement (A%)

demand brought about by an increase in price would

12 World Bank Electric Power Policy Paper (1992).

11

Table 4. Pollution abatement through price reforms in electricity demand and supply(with special reference to developing countries)

Price required Marginal cost Marginal costP = P (I -A)" P, - pi including gains

Abatement A % US centslKWh US centslKWh managerial efficiency

0 4.0 -6.0 -9.210 4.9 -5.1 -7.320 6.3 -3.7 -4.730 8.2 -1.8 -2.040 11.1 - 1.050 16.0 6.0 6.060 25.0 15.0 15.070 44.4 34.4 34.4

Basis: When prices are increased by a certain amount, the decrease in demand can be estimated from a standard priceelasticity fornula. With unchanged technologies, the decrease in pollution is proportional to the decrease in demand.Alternatively, one can postulate a percentage level of abatement, relative to the case of unchanged prices, and estimate theprice that would be needed to achieve it. This is the approach followed here, the results being shown in the first twocolumns. The demand function assumed is (Q/Qo) = (P/P)-', where Q, is the demand at price P,, Q. is the initial demandat prevailing prices P., and e is (the numerical value of) the price elasticity, which is taken to be 0.5, based on the surveyby Bates and Moore (1992). Per unit abatement, A, is by definition (I-Q/Q.), so A = 1-(P,/P0) from which we get thepnce required to achieve A, shown in the second column. The benefits from reforming prices are calculated in two steps.The first, shown in column three, corresponds to the price efficiency benefits. The actual price consumers pay, P, , is themarginal benefit to them of an extra KWh of consumption; if P, represents the actual (unsubsidized) marginal cost (MC)of supply (sometimes called the efficiency price since P, = MC for efficiency), then the cost of reducing demand by oneKWh is simply Pt - P,, and this is negative when, as occurs in the above case, P, < P,. (This calculation neglects theextemal benefits of reducing pollution, since we are comparing the cost-effectiveness of pollution abatement via energyefficiency and using low polluting technologies.) PO is taken to be 4 cents/KWh (slightly below the present average indeveloping countries) and P, 10 cents/KWh. Allow for what are sometimes called "X" or "managerial inefficiencies,"after Liebenstein (1966). These tend to be correlated with shortages of finance, and can add 50 percent or more to costs.For Pt < P,, we have assumed they are proportional to the per unit distortion in prices, or (P, - P,)/(P,-P ), such that thecloser P, is to P1, the lower the level of managerial inefficiency losses induced by price inefficiencies. Based on theevidence presented earlier, we have used a managerial inefficiency factor of M,=1-M (P,-P,)/(P,-P ), where M. = 0.35, sothat when P,=P., managerial efficiency is only 65 percent of that when Pt=P,. Managerial inefficiency losses relative tobest practice cases are assumed to be zero for P,> P,. (See Anderson and Cavendish (1992) for further discussion.)

Also shown in figure 5 are the marginal costs and ing countries. In addition, there would be substan-

long-term abatement efficiencies of low polluting tial economic gains, averaging about 5 cents per

technologies. For turning to renewables on a large KWh (see figure 4) and totaling around $125

scale, the addition to marginal supply costs would billion a year (the current level of electricity

probably not exceed 2 cents to 4 cents per KWh, but production in developing countries, which is 2,500

the long-term abatement efficiency would be 100 TWh, times $0.05). The benefits would rise over

percent (table 5 gives further details and sources, time with demand growth. The additional effects

and provides information on otherpollutants). Three of non-price-induced gains in efficiency, such as

conclusions follow from such calculations: those arising from energy efficiency services,

may conceivably push the "energy efficiency

Energy efficiency gains through improvements frontier" out further, perhaps to the point where

in price and managerial efficiency would likely pollution could be abated by 40 to 50 percent by

reduce pollution by up to 40 percent in develop- a combination of price and institutional reforms. 13

1 3 At present, the additional contribution of non-price measures to improvements in energy efficiency is not known reliably, and meritsresearch.

12

* Beyond a certain point, however, the cost curve * Afforestation programs on farmlands and water-rises rapidly-even tariffs of the order of 40 or 50 sheds (in which carbon-fixing is a by-product)cents per KWh, or four or five times the real cost * The substitution of commercial energy for tradi-of supplies, would not abate pollution by more tional cooking fuelsthan about 70 percent. Once the win-win options * The use of photovoltaics and micro-hydro forof energy efficiency are achieved, the most cost- electricity supply in remote areas where the costeffective measure by far is investment in renew- of diesel generators is high.able energy technologies which, as noted, arecapable of achieving CO2 abatement levels of Type II projects are those for which the national100 percent at a long-term cost of around 2 cents economic benefits are less than national economicto 4 cents per KWh.14 costs (NB<NC), but the global benefits are such that

* Developing country demands for electricity are the project is justified under GEF criteriadoubling on average every seven to ten years, (NB+GB>NC). Projects falling under this categoryowing to the growth of per capita income, popu- include photovoltaics, solar-thermal, wind power,lation, urbanization, and the substitution of com- biomass gasifiers and gas turbines for power pro-mercial fuels for fuelwood. Without efficiency duction, sustainable biomass production to substi-reforms, demand and emissions would be four tute for fossil fuels, fuel cells, and various projectstimes their present level by 2005-20 10, and more that advance the "energy efficiency frontier." Thisthan twice their present level even if ambitious final category includes alternative technologies inefficiency reforms were in place. Furthermore, lighting and water heating; advanced, high-efficien-given the low levels of per capita KWh consump- cy gas-turbine cycles; irrigation pump sets poweredtion in developing countries, demands would by renewable energy; and methods for reducing thecontinue to grow well beyond this period. overall energy intensity of industrial processes.

Thus in a scenario of global warming in which some The distinction between Type I and II projects isagreements on the safe limits to long-term carbon important because, as the World Development Re-accumulations are reached, recourse to renewable port 1992 concluded, it is essential that new interna-energy technologies would be unavoidable. There- tional financing for global environmental problemsfore the development and use of these technologies not detract from the more urgent needs of economicmust be a high priority in the GEF portfolio. development. The elimination of poverty and the

achievement of economic stability and growth areType I and Type 11 projects the main priorities for developing countries. Fur-In the GEF, Type I projects are defined as those for ther, the most serious environmental problems fac-which the national economic benefits (NB) are ing these countries are local, not global; they includegreater than the national costs, and where there are the provision of water and sanitation (2 billionglobal benefits (GB) in the form of reductions in people are without access to satisfactory services),carbon emissions (NB>NC and GB>0). In other the abatement of local air and water pollution, thewords, they are projects that developing countries protection of watersheds, and the prevention of soilcould be expected to undertake in their own best erosion.economic interests, using official aid as and whenconditions require and merit it, even if global warm- The GEF is supporting the applications of someing were not an issue and the GEF did not exist. renewable technologies that have already estab-Examples include: lished a market niche in energy supply. They meet

Type I criteria (NB > NC), and are likely to become* The economically efficient use of flared gas or an increasingly important source of energy and

coalbed methane for power generation economic growth in the decades ahead; the best* Reducing waste in the production and use of examples are wind power and the use of photovol-

energy through price and institutional reformns taic systems for small-scale applications such as

14 Some studies regard this to be a high estimate of costs. See Williams (1990).

13

Table 5. Emissions control technologies: abatement efficiencies and costs

Emissions with and without policies

Sector and Without Withlpollutant (index) without, % Costs

Use of low polluting technologies

Electric power: coalPM 100 <0.1 0.4 cents/KWhSO, 100 5 1.5 cents/KWhNO 100 5-10 0.5 cents/KWh

Electric power: gasPM -0 -0 0.0 cents/KWhSO2 -0 -0 0.0 cents/KWhNO -0 5-10 0.5 cents/KWh

Motor vehiclesI Lead 100 0 4 cents/gallon

NO 100 20CO 100 5 12 cents/gallonVOCa 100 5

PM (diesels) 100 <10 4 cents/gallonSulfur (diesels) 100 5 8 cents/gallonAll fossil fuelsCO2 (electricity) 100 0 2 to 4 cents/KWhCO2 (non-electricity markets) 100 0 $0.5 to $1.0/gallon

Sources and notes: The abatement technologies and costs for electric power are reviewed in OECD (1989), Ken King(1991), Bates and Moore (1992) and Anderson (1991). For coal, the reference plant is a conventional boiler using 3 percentsulfur coals. With combined cycle plants for gas and coal (using coal gasification) the net costs can be negative, onceefficiency gains are factored in. For motor vehicles, see OECD (1986, 1988) and Walsh (1990). For reducing CO2 ' theestimates are based on the costs of renewable energy; these are reviewed in Anderson (1991) and Anderson and Bird(1992), drawing on a variety of sources, including the U.S. Department of Energy's "The Potential of Renewable Energy:An Interlaboratory White Paper" (1990). The cost estimates shown probably err on the high side.a Volatile organic compound.

water pumping, lighting, and rural electrification. tion is that, by giving more weight to Type II, theThere are several government, industrial, and aca- GEF is helping to keep investment options open bydemic studies of such technologies (several are supporting a more diverse portfolio of energycited in this paper's references), including recent technologies than would otherwise exist. Several ofreports of the World Energy Council (1992). Those the technologies used in Type I projects are well-engaged in research and development in industry suited to the circumstances of developing countriesare looking to the GEF and to government programs (if only because solar insolations are much higherto support further developments and applications. than in the industrial countries), which gives TypeRelative costs and prices have changed appreciably II GEF projects an important innovative function.with technical developments over the past twentyyears and, as discussed below, there is a distinct Without the Type I-Type II distinction, the GEF'spossibility that many applications, presently meet- resources could be rapidly absorbed by develop-ing only Type II criteria, will meet Type I criteria in ment projects currently financed by ODA. Thethe future, and thus become part of official develop- resources that can presently be allocated by the GEFment assistance (ODA) and regular investment. to global warming projects amount to less than oneThus another reason for the Type I-Type II distinc- fiftieth of those provided by ODA for energy devel-

14

opment projects, and are also minute compared only meet Type II criteria to the point where theywith investments in the energy sector, which cur- meet Type I criteria. Such developments should berently exceed $100 billion a year for expanding encouraged. Figure 6 summarizes the situation.electricity supply alone. The GEF's resources arealso small compared with the energy supply subsi- Aside from afforestation and some niche markets fordies in developing countries, which are estimated to the backstop technologies, Type I projects will gen-be $230 billion a year.'5 Put another way, Type I erally be those related to energy efficiency-usingprojects are already provided for by ODA whereas flared gas and coalbed methane for power genera-Type II projects are not, and the main contribution tion, for example, and an array of innovations toof the GEF will be to finance the latter. The danger improve end-use efficiency. Such projects have al-is that, if GEF resources are used regularly for Type most always been argued on the grounds that theyI projects, the Facility's impact on Type II projects have good economic retums to investment, as in thewould be greatly diluted, while its contribution to various demand-side management and integratedType I projects would be small. resource planning approaches now being promoted

in the United States.'6 They are being supported byHence the distinction is sound, and the original idea ODA through structural adjustment and sectoralof the GEF concentrating on Type II projects re- reforms to improve institutional arrangements andmains justified. There will nevertheless be excep- price efficiency, and through the provision of fi-tional cases in which the GEF may advantageously nance for the development of energy efficiencyconsider some Type I projects. Such cases can be services in developing countries. Two recent Worldreadily identified. As illustrated by the examples Bank policy papers have discussed the requirednoted above, the number of backstop technology policies and the role of official finance in developingapplications that meet conventional economic cri- them in some detail.7 Type II projects, by contrast,teria is growing rapidly. Thus, if the GEF is blended will generally be the backstop technologies.with commercial finance and ODA in programs thatcombine Type I and Type II applications, the devel- To sum up, the following procedures and groundopmental and transaction costs faced by GEF users rules are suggested for GEF projects:in developing their projects elsewhere will be great-ly reduced, and the scope and effectiveness of the * First, compare the net present value of the costs ofGEF greatly enhanced. the proposed project with the best fossil-fuel alter-

native; the shadow prices to be placed on the carbon1Technical developments in the backstop technolo- emissions of the latter can be estimated as discussedgies, including those listed earlier, are reducing earlier. This will determine whether the project iscosts and thus graduating projects that presently cost-effective according to GEF criteria.

Figure 6. Overlaps between Type I and Type II projects

Tvpe I Type II

Energy efficiency Backstop technologiesAfforestation (non-commercial applications)

Type Type Backstop technologiesI (commercial applications)

1 5 World Development Repon' 1992 and Shah and Larsen (1992).[A See Hirst and Goldman (1991).: 7 "The Bank's Role in the Electric Power Sector: Policies for Effective Institutional, Regulatory and Financial Reforn" (1992a) and

"Energy Efficiency and Conservation in the Developing World: The World Bank's Role" (1992b).

15

* Second, repeat the calculation with the shadow through innovations induced by the investment,prices equal to zero to estimate a conventional through learning-by-doing, or through a combina-rate of return. If the rate of return is satisfactory, tion of the two. For new industries, such benefits canit is clearly a Type I project, and GEF finance be substantial-as they were in the electricity indus-should be provided only if the leverage effect is try over much of the present century, when costs fellindeed exceptionally high, and if supporting the twenty-fold between 1900 and 1960 and the thermaleffort can help the GEF and its users in develop- efficiencies of power plants rose ten-fold.23 The ben-ing Type II projects in general. efit often does not appear in cost-benefit analyses

because the effect is fairly small and the investmentsInnovations and cost reductions being appraised generally use well-developed tech-A GEF requirement will be to support the develop- nologies for which the scales of production are al-ment of promising emissions reduction technolo- ready large. But the situation is different for Type IIgies and practices that have not yet achieved their GEF projects, where production levels and marketsfull potential, and whose costs may be expected to are still small and cost curves are declining steeply.decline as applications and markets expand."8 Thisis already happening in several areas. In the case of Thus the actual costs of a GEF investment have thephotovoltaics, for instance, unit costs of modules three following elements:have declined fifty-fold since 1970, to around $6,000per kilowatt peak (KWp), and are projected to fall * The incremental capital costsagain to the $1,000 to $1,500/KWp range as mar- * Plus the present value of incremental operatingkets expand, and as improvements in materials, and maintenance costsconversion efficiencies, and manufacturing tech- * Less the present value of reductions in incrementalnologies occur.19 Including balance-of-system capital costs in later years, per unit of investment incosts-such as structures, dc/ac invertors, control- year zero, times the levels of investment in laterlers and installation-total costs are about $10,000/ years.24

KWp at present, but are projected to decline to$1,000/KWp over the long term.20 The scope for While the contribution of a current investment tocost reductions in other renewable energy forms, reductions in the unit costs of later investments mayand in the efficiency of end-use and energy conver- be small, the overall benefits of investing in andsion devices is also considerable.2" More generally, developing a technology can be substantial if thethe possibilities for technical improvements and prospective use of the technology is large. It is thecost reductions in all Type II projects that qualify product of two effects that is important-the contri-for GEF finance are far from being exhausted. bution to cost declines and prospective use.

The contribution of an investment to reductions in The cost of photovoltaicsthe costs of future investments can be regarded as an A study of the Japanese photovoltaic industry by Dr.economic benefit.22 The cost savings may come Hamki Tsuchiya enables us to estimate the benefits

Based on the notes to STAP by Professor Robert Williams.See, for example, the U.S. Department of Energy Interlaboratory White Paper (1990).

20 Ibid, and Johansson et al. (1992).21 See Johansson et al. (1989).22 See Arrow (1962).23 See U.S. Department of Energy (1983).24 More formally, let C = the present value of the costs of investments over a long time interval, K, (t = 0, I ...) be the unit capital costs

in period t, I, be the investments in period t (in KW units in the case of electricity), and a, be the discount factor, a, = (1 + r) where r = the discountrate. Then CO = present value (PV) of 0 & M costs + _a,K,II

But K, is a function (to) of the cumulative amount of investment, orK, = o(I, I

Hence aC,/aI. = K,, + Ya(&K/aI )I (the summation is now over t > 0), neglecting changes in operating and maintenance costs, and thetotal present value of costs of an investment in period o are approximately

(aCjal,,l,, - K,,I,, + PV of 0 & M costs + Xa,I,(dK,AI)I,where the third term will be negative under the conditions described, i.e., of cost declining with I.

16

bled, unit costs have declined by roughly 20 per-Table 6. Historical photovoltaics cost data cent. In an independent study using world salesfor Japan data, Cody and Tiedje (1992) have obtained an

Module cost Production Accumulated almost identical result.Year (Yen!Wp) (KW/year) production (KW)

1979 7,000 85.8 85.8 Table 7 below shows how the cost-saving benefits1980 4,000 291 376.8 can be estimated given the relevant cost curves for1981 3,500 1,024 2,424.8 the various renewable energy technologies. It is1982 2,200 2,123 4,547.8 based on Dr. Tsuchiya's data forphotovoltaics with1983 1,800 4,826 9,373.8 the following adjustments and assumptions:1984 1,500 6,918 16,291.81985 1,200 10,800 27,091.8 * A present price of photovoltaics of $10,000/1986 1,100 13,400 40,491.8 KWp, with $1,000/KWp being the minimum

1988 900 13,000 65,941.8 expected volume of costs1988 00 13000 6,98 * A value of b = -0.3

Source: Hamki Tsuchiya (1992). * Annual rates of investment and levels of accu-

mulated production shown in the first two rowsof the table.

that occur when a current investment reduces futurecosts. His cost and production data are noted here A lower limit of $1 ,000/KWp is also assumed in thefor convenience, and are not dissimilar to those outer years. As with the calculation of the shadowreported in U.S. Department of Energy and Europe- price of carbon emissions, the estimated benefitsan studies. shown in the bottom rows of the table are only

applicable in a scenario of global warming, assum-Dr. Tsuchiya estimates the following function: ing the investment levels shown in the first row.

K = aX' On these assumptions, therefore, it would be moreappropriate to appraise current investment in photo-

where K = unit production cost (Yen/Wp), and X is voltaics on a net cost of $10,000-$3,800 - $6,000/the accumulated level of production. His estimate KWp, rather than on a unit cost figure that ignoresof the parameter b is -0.3, which means that each the contribution of the investments to future devel-time the accumulated level of production has dou- opment and cost reduction.

Table 7. Estimation of cost-saving benefits of GEF investments in photovoltaics

Year0 10 20 30 40 50

Investment in Year, I, GW 0.075 1.0 5 25 75 250Accumulated production:

X1, GW 0.3 4.9 32 168 640 2,160Production costs,

K1 , $/KWp 10,000 4,300 2,450 1,490 1,000 1,000Contribution to cost

reductions:aB, = bK I/X,, $/KWp 750 260 115 65 35 0

Present value of B, at r = 10% 3,800/KWpNote: Figures are rounded.

The fornula follows from Table 6.

17

Extensions choices. This is especially true if GEF fundingFurther analysis of the costs and scale of production reduces such costs by facilitating market aggre-will enable estimates to be made forother renewable gation and organizational learning. Transactionenergy technologies. Another factor to consider costs, including the difficulties involved in de-is the scale of manufacturing plant rather than veloping new approaches, can be high for a smallaccumulated annual production. If, for example, operation, but relatively small when the scale ofannual production figures are used, the value of b an operation increases.is (numerically) higher, say about -0.4, and the * Pricing policies have worked against new tech-present value of cost savings would be higher than nologies by subsidizing fossil and hydro power.the figure just estimated. Such studies have been Although good pricing policies will be crucialproposed for the GEF and are now being initiated. for the development of new technologies, they

need to be complemented by investments thatDemonstration projects deal with institutional issues andpromote knowl-Significant opportunities for cost reductions also edge about new options.exist through operations that help to demonstrate * Once the alternatives are demonstrated in devel-the economic, technological, and administrative oping countries, it may be possible to reduce costfeasibility of renewable energy and energy efficien- by substituting labor for capital in the manufac-cy services.25 Examples include: ture and use of the alternative-developing coun-

tries may have a comparative advantage in the- The establishment of industries that market ener- manufacture and use of renewable energy tech-

gy services in developing countries nologies.* The development of niche markets for renewable

energy-such as photovoltaics in rural areas For these reasons, the leverage effects of demon-- Some medium- and large-scale demonstration stration projects may be large, which means that

projects for power generation to win confidence Type I projects would again qualify for finance (onin the new technologies and to provide an oppor- an exceptional basis) under this heading.tunity for the electric utilities (in particular) tofamiliarize themselves with the operational char- Continuity, replicability and aggregationacteristics of such options as wind power, and the in GEF projectsuse of photovoltaics for supplementary power on Achieving cost reductions in the manufacture ofgrid-fed distribution networks. renewable energy projects will require a sustained

commitment from GEF and other sources over tenEach of these examples could involve projects with or twenty years.27 Significant cost reductions ingood economic returns, but the traditional alterna- manufacturing will not be achieved by a few invest-tives (hydro and fossil-fired power stations) have ments over a short period, but only through a pro-been preferred for the following reasons: gram of investments in the more promising Type II

projects over several years-particularly in photo-* There is a natural predisposition among the local voltaics, solar-thermal, and biomass projects. The

utilities and the financing agencies to stay with situation is somewhat different for projects thatbetter known approaches-even though these overlap the Type I and Type II categories. Theseapproaches (for example, fossil fuel stations) projects often have high transaction costs and arehave often proved unreliable.26 likely to become commercial sooner than Type II

* Because the transaction costs of developing in- projects. But with respect to (Type II) renewablenovative energy technologies can be high, GEF energy projects, several companies emphasize thesupport can be crucial in making cost-effective importance of continuity in operations, involving

25 This section also draws in part on notes prepared bv Professor Robert Williams for the STAP Committee.26 The recent World Bank Policy Paper on Electric Power found availabilities to be as low as 40 percent in some countries and to average

about 60 percent, as compared with 80 to 90 percent in good practice situations.27 See Professor Robert Williams' note to STAP (September 24, 1992).

18

repeat projects. Any move to larger scale produc- * Bythefollow-upofsuccessfulpilotprojectswithtion manufacturing plants to achieve economies of larger scale operationsscale and to introduce new, higher-volume-lower- * By aggregating or bundling a large number ofcost manufacturing technologies, can only be justi- small-scale projects into larger operationsfied by private companies if there is market growth. * By complementing Type I with Type II projects

where the same technologies can be used in bothThere are several ways in which the GEF can commercial and developmental situationsfacilitate market growth: * By giving priority to countries whose pricing

and institutional policies better promote renew-Through a commitment to continuity in its in- able energy and energy efficiency, for example,vestment operations, focusing on replicable by not subsidizing the use of fossil and hydroprojects that are candidates for additional fi- energy.nance in other countries or in the same countriesin the following years

28 See the World Bank's two policy papers on this subject (1992a, b).

19

3 Conclusions

For GEF projects, the cost (or shadow price) of A review of innovations and costs in the backstopcarbon emissions is the marginal cost of turning to technologies reveals that the costs of solar andthe backstop technologies. The most promising biomass energy have declined remarkably over thetechnologies at present are those using renewable past two decades, to the point where they are com-energy-primarily solar and biomass-the costs of petitive in niche markets. (These markets are alsowhich have declined appreciably over the past two growing.) The GEF can help reduce costs further bydecades. In a scenario of global warming, they expanding applications. The contribution of anywould be turned to increasingly to stabilize carbon single investment to innovation and the reduction ofaccumulations at a safe level (not yet determined). unit costs is small. The potential for reducing totalThe use of backstop technologies is consistent with costs over the long term, however, is significantstabilizing accumulations at any one of several when the declines of unit cost are multiplied by thelevels over the long term, unless a runaway feed- prospective use of the technologies. An example isback occurs. investments in photovoltaics-their current costs

(including balance of systems costs) are approxi-Costs and innovations mately $10,000/KWp. When projected for large-Estimates of marginal cost can be based on the scale use, such investments could help reduceformula for the optimal price of a depletable re- future costs by approximateiy $4,000/KWp. Ansource, in which the price of a resource (in this case allowance for such effects will make a difference infossil fuels) equals the extraction cost plus a user project appraisal.cost that rises over time until the backstop or re-placement technology (in this case renewable ener- Type I and Type 11 projectsgy) becomes economical; in the present case the The GEF will need to give priority to Type IIresource in question is not the availability of fossil projects; such projects can only be readily justifiedfuels, but the limits to their use set by concerns once global concerns are taken into account, forabout climate change. Preliminary estimates of example, by placing a shadow price on carbonmarginal costs made in this paper amounted to $25 emissions of fossil-fuel alternatives when costs areper ton of carbon, rising at a rate equal to the being compared, and by considering the project'sdiscountrateupto$120perton. Theseestimatesare potential for cutting future costs. Type I projects,not exact, but they provide a useful starting point such as those related to energy efficiency, are prof-for analysis, and would need to be revised periodi- itable and generate positive economic rates of re-cally in light of technical developments and new turn, even if global environmental concerns areevidence on the greenhouse effect. ignored, and they are supported by ODA. While

20

some of these projects can help reduce carbon * Giving priority to countries whose institutionalemissions, they cannot solve the global wanning arrangements and energy pricing policies areproblem. well suited to the success of GEF projects

* Emphasizing replicability.Extensive use of GEF finance for Type I projectswill dilute the Facility's effect and risk leaving its Continuity of GEF operations is needed to achievemission unfulfilled. The development of Type II long-term cost reductions in Type II projects, and toprojects will be crucial if the international commu- reduce transaction costs. Numerous companies, to-nity, especially developing countries, are to re- gether with government departments and researchspond effectively to the global warming problem. institutions, have made the point that costs can onlyGEF funding might be used in exceptional cases be expected to decline if there is a long-term com-when the development of Type I projects (for exam- mitment to develop the markets and the applicationsple, applications of renewables) will catalyze the of promising technologies. Future GEF operationsdevelopment of Type II projects; the GEF may then will therefore need to support the principle of rep-help to reduce transaction costs and expand com- licability by financing follow-up projects.mercial uses. When used for such cases, the lever-age effect of resources would be expected to be GEF's mandateexceptionally high. The appraisal methods and criteria proposed above

for GEF projects are based on conditions that wouldTransaction costs occur in a scenario of global warming, even thoughTransaction costs are not an insurmountable obsta- the seriousness of the global warming problem iscle to high-potential demonstration projects. The not known. It has been remarked that "the unequiv-leverage effect of GEF projects is thought to be ocal detection of the enhanced greenhouse effecthigh for many Type II projects. Examples include from observations is not likely for a decade orwind energy, biomass for power generation in more."29 But the approach is consistent with thesome regions, and thermal-solar and photovoltaics mandate of the GEF, which is to help in the imple-for supplementary power or grid-fed distribution mentation of precautionary policies and leave thesystems. Such projects have potential economic international community better placed to deal withviability according to standard profit-and-loss cri- a particular contingency; this means that its invest-teria. The key obstacles to the use of innovative ments, and the ground rules on which they aretechnologies relate in such instances to transaction based, will need to focus on that contingency. As itcosts and to uncertainties encountered in introduc- happens, the costs of the technologies and practicesing them, not to their economic promise. Demon- the GEF is supporting, notably in renewable energy,stration projects are considered to be important in are declining significantly. Global concerns aside,this respect, and would be satisfactorily screened several such technologies have good economic po-by the cost and innovation criteria suggested above. tential. The GEF is extending early support toTransaction costs can be reduced by: developments that may have long-term economic

merit. If so, this will not be the first example of* Aggregating or bundling many small-scale policies initially introduced to address an environ-

projects into a larger program suited for project mental problem holding the seeds of an economicfinance surprise.

* Combining Type I and Type II projects wherethey are complementary

2'1 John Houghton, Chairman of the Scientific Assessment Working Group of the Intergovernmental Panel on Climate Change (1992).

21

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23

Williams, Robert H. "Analytical Framework for Scientific and Technical Advisory Panel Criteria andPriorities on Global Warming." Notes prepared for the Scientific and Technical AdvisoryBoard Ad-Hoc Working Group. Washington, D.C.: Global Environment Facility, September1992.

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24

Appendix

The Cost of Backstop Technologies

The seven tables in this Appendix present the de- Absent a greenhouse gas constraint, the cost of coal-tailed calculations of Professor Robert Williams, based electricity will not rise much in the future.whose explanatory notes are also attached. They Ongoing technological advances (especially inte-were used as the basis for the calculations of the grated gasification/combined cycle technology) willshadow price of carbon emissions provided in the make it possible to provide coal electricity withtext, and give a fuller description of the various extraordinarily low levels of local pollution at coststechnological options and their costs. that are not likely to be higher than at present.

Notes to tables Al and A2 Table A2In these tables "long term" refers to the period 2000- Only a 12 percent discount rate is used in calculat-2010. The crude oil price in the long term is assumed ing the production costs for synthetic fuels, since itto be $25 per barrel. is assumed that regulated utilities would not be

involved-even for the electrolytic production ofFor the renewable options, a range of costs is pre- hydrogen.sented to indicate the uncertainties for the variablesthat seem the most uncertain. Gasoline is the focus because it is the highest quality

petroleum-based liquid fuel, and the synthetic fuelTable Al alternatives are of comparable quality.Electricity generation costs are calculated for both 6percent and 12 percent discount rates, to highlight There are several reasons for adding methanol andthe sensitivity of the costs to the discount rate. Most hydrogen from biomass in addition to ethanol. Therenewable technologies are more capital-intensive production of ethanol via enzymatic hydrolysis fromthan fossil fuel technologies, so that their costs are lignocellulosic feedstock is the focus of biomass-more sensitive to the discount rate used. based liquid fuel research and development at present,

and its cost outlook is promising. However, it will beAlso, while a low discount rate is appropriate for difficult to use ethanol in a fuel cell vehicle-which,utility investments in industrialized countries, a high because of urban air quality concerns, may well provediscount rate is more appropriate for developing to be the technology of choice for road transportationcountries and for investments by independent power in the decades ahead. Both methanol and hydrogenproducers in industrialized countries. can be used in fuel cell vehicles.

25

Table Al. Cost of electricity generationa(US cents per KWh, 1990 prices (2000-2010))

Current Prospectivellong-termDiscount rate 6% 12% 6% 12%

Coalb 4.1 5.6 3.9 4.8Residual fuel oilc 6.0 7.4 6.7 8.2Natural gas

(combined cycle)d 3.2 3.9 4.8 5.6Nucleare 3.8 5.9 4.3 6.2Wind' 3.7-5.8 5.4-8.8 2.3-3.5 3.3-5.2Solar thermalg 11.7-16.6 18.3-25.9 4.5-8.1 7.0-12.7Photovoltaich 33 55

Moderate insolationiThin-filmi - - 4.6-5.5 7.6-9.0

High insolation'Thin-filmi 3.5-4.1 5.7-6.7Concentrating' 3.6-4.5 5.9-7.3

Biomassnm 7.4-8.9 9.1-10.7 3.7-4.6 4.5-5.3

a In all cases, plant life is taken to be 30 years and all corporate income and property taxes are neglected. The annual insurancecharge is assumed to be 0.5% of the installed annual capital cost. Thus the annual capital charge rate is 0.0777 at a 6% discountrate and 0.129 at a 12% discount rate.

b The present price of coal for utilities is taken to be the average 1990 price in the U.S. ($1.4/Giga Joule (GJ)) and the long-term price is assumed to be $2.0/GJ. Coal plants are assumed to be base-load plants operated at 75% capacity factor. Presenttechnology is assumed to be pulverized coal steam-electric plants with flue gas desulfurization at an average efficiency of 33.9%.Future technology is assumed to be second-generation integrated gasification/gas turbine-based technology at an average effi-ciency of 42.1 %. For details see R.H. Williams and E. D. Larson, "Advanced Gasification-based Biomass Power Generation," inRenewable Energy: Sources for Fuels and Electricity, T. Johansson, F. Kelly, A.K. Reddy, and R.H. Williams, eds., Washington,D.C.: Island Press, 1992.

c The present price of residual fuel oil for utilities is taken to be the average 1990 price in the U.S. ($3.1/GJ) and the long-termprice is assumed to be $4.2/GJ, corresponding to a crude oil price of $25/barrel. Residual fuel oil plants are assumed to be load-following plants operated at 50% capacity factor. Both present and future technology are assumed to be steam-electric plants atan average efficiency of 35.4%. For details see Electric Power Research Institute, "Technical Assessment Guide, Volume 1:Electricity Supply-1986," EPRI P-4463-SR, December 1986.

d The present price of natural gas for utilities is taken to be the average 1990 price in the U.S. ($2.2/GJ) and the long-termprice is assumed to be double this ($4.4/GJ), consistent with the long-term crude oil price of $25/barrel. It is assumed that naturalgas is burned in combined cycle plants that are load-following plants operated at 50% capacity factor. Efficiencies are assumed tobe 42.7% at present and 50% for long-term future plants. For details see H. Kelly and C. Weinberg, "Utility Strategies for UsingRenewables," in Renewable Energy: Sources for Fuels and Electricity.

e The present cost of nuclear power is that estimated by the Electric Power Research Institute for a 1,100 MWe light waterreactor. Under the assumptions that the nuclear industry could be revived, the unit capital cost in the U.S. could be cut nearly inhalf, and plants could be built in six years. For details see Electric Power Research Institute, "Technical Assessment Guide,Volume 1: Electricity Supply-1986," EPRI P-4463-SR, December 1986. The future cost is that estimated by the Electric PowerResearch Institute for a 600 MWe passively safe light water reactor, assuming a five-year construction time. For details, seeElectric Power Research Institute, "Technical Assessment Guide, Volume 1: Electricity Supply-1989," EPRI P-6587-L, Sep-tember 1989.

f Present wind power technology is taken to be the recently introduced variable speed turbine having an installed capital costof $1,000 per KWe, with operating and maintenance and land rent costs of 1I.1 and 0.3 cents/KWh respectively. The range of costsreflects alternative wind regimes: the low end of the cost range corresponds to a hub height wind power density of 630 Watts/m2,where the capacity factor (CF) = 0.36, and the high end is for a power density of 350 Watts/m2, with CF = 0.20. For the long term,it is estimated that the installed capital cost could be reduced to $750/KWe and the operating and maintenance cost reduced to 0.6cents/KWh. For the long term, the low end of the cost range corresponds to a hub height wind power density of 630 Watts/M2 ,where CF = 0.49, and the high end is for a power density of 350 Watts/M2, with CF = 0.27. For details, see A. Cavallo, S. Hock,and D. Smith, "Wind-Energy: Technology and Economics," in Renewable Energy: Sources for Fuels and Electricity.

26

Table Al. (continued)

g Present solar thermal electric technology is an 80 MWe Luz parabolic trough system with an installed capital cost in therange of $2,800IKWe (with CF = 0.25 and an operating and maintenance cost of 1.8 cents/KWh) to $3,5001KWe (with CF = 0.22and an operating and maintenance cost of 2.5 cents/KWh); no credit is taken here for use of natural gas as a backup. Futuretechnology is a 200 MWe advanced central receiver system with high temperature thermal storage, with an installed capital costin the range $1,800/KW (with CF = 0.43 and an operating and maintenance cost of 0.8 cents/KWh) to $2,500/KW, (with CF0.32 and an operating and maintenance cost of 1.2 cents/KWh). For details see P. de Laquil, D. Kearney, M. Geyer and R. Diver,"Solar Thermal Electric Technology," in Renewable Energy: Sources for Fuels and Electricity.

h In 1990 the average price of photovoltaic modules was $6.2/Wp, the total installed cost of the best photovoltaic systems wasabout $10/Wp, and the operating and maintenance cost was about $0.005/KWh.

i Moderate insolation is defined as 1,800 KWh/m/year, the average for the U.S.

j It is assumed that in the long term, thin-film modules achieve efficiencies of 15%, module costs are $45 to $50/m2 , area-related balance-of-system costs are $37 to $50/m2, power-conditioning costs are $100/KW, and indirect costs are 25% of directcosts. The operating and maintenance cost is projected to be $0.3/M2 per year. For details, see "Introduction to PhotovoltaicTechnology," in Renewable Energy: Sources for Fuels and Electricity.

k High insolation is defined as 2,400 KWh/m2/year, typical of sunny areas in the U.S. southwest.

I It is assumed that concentrator photovoltaic systems are deployed in areas of good direct normal insolation (2,400 KWh/m2/year). The low end of the projected costs for the long term is for ID tracking systems, for which it is estimated that modules canachieve efficiencies of 20%, module costs are $60/m2, area-related balance-of-system costs are $50/m2 , power-conditioning costsare $ 100/KW, and indirect costs are 25% of direct costs. The high end of the projected costs for the long term is for 2D trackingsystems, for which it is estimated that modules can achieve efficiencies of 35%, module costs are $150/ni2, area-related balance-of-system costs are $ 100/M2 , power-conditioning costs are $100/KW,, and indirect costs are 25% of direct costs. In both cases theoperating and maintenance cost is estimated to be 0.25 cents/KWh. For details, see H. Kelly "Introduction to Photovoltaic Tech-nology," in Renewable Energy: Sources for Fuels and Electricity.

m The price of biomass for utilities is assumed to be in the range of $2.5 to $3.5 per GJ, which is 1.4 to 2.5 times the present utilitycoal price in the U.S. Biomass plants are assumed to be base-load plants operated at 75% capacity factor. Present technology isassumed to be a 23.4% efficient 28 MWe steam-electric plant. Future technology is assumed to be a biomass integrated gasifier/intercooled steam-injected gas turbine with an average efficiency of 42.9%. For details see R. H. Williams and E. D. Larson."Advanced Gasification-based Biomass Power Generation," in Renewable Energy: Sources for Fuels and Electricity.

27

Table A2. Cost (ex-refinery or fuel processing plant) of gasoline and zero netC02 -emitting alternative automobile fuelsa($!barrel of gasoline-equivalent)

Current Prospectivellong-term

Gasoline (ex-refinery) 33b 45cEthanol from

lignocellulosic feedstocksde 90-103 44-52Methanol from

lignocellulosic feedstocksdf' 80-89 55-64Hydrogen from

lignocellulosic feedstocksc,f 63-70 44-51Hydrogen from wind powerg 140-210 90-140Hydrogen from photovoltaic powerh 960 144-166

a The unit energy measure is the energy content (gross or higher heating value basis) of a barrel of gasoline, which is 5.54 GJ.The costs of all alternative fuels were calculated for a 12% discount rate. For all biomass fuels the plant life is assumed to be 25years; for wind and photovoltaic systems it is assumed to be 30 years. In these cost calculations all corporate income and prcpertytaxes are neglected. The annual insurance charge is assumed to be 0.5% of the installed capital cost per year. The "long term" isdefined as the period 2000-2010.

b Ordinary gasoline from crude oil @ $20 per barrel.

c Reformulated gasoline from crude oil @ $25 per barrel.

d Biomass feedstock delivered to the conversion facility is assumed to cost in the range of $2.5 to $3.5 per GJ.

e It is assumed that ethanol is produced from lignocellulosic feedstocks using enzymatic hydrolysis. Present costs and futurecost estimates were made by researchers at the U.S. National Renewable Energy Laboratory. For details see C. Wyman, R. Bain,N. Hinman and D. Stevens, "Ethanol and Methanol from Cellulosic Biomass," in Renewable Energy: Sources for Fuels andElectricity.

f It is assumed that methanol and hydrogen are produced from lignocellulosic feedstocks at present using a Shell oxygen-blown gasifier adapted to biomass; the Shell gasifier is commercially available technology for coal gasification. The futuretechnology is assumed to be an indirectly heated biomass gasifier (specifically, the Battelle Columbus Laboratory gasifier) de-signed to exploit the high reactivity of biomass (compared to coal); with this gasifier, a costly oxygen plant is not needed (butwould be needed to gasify coal for the production of these fuels). For details, see E. Larson and R. Katofsky, "Production ofMethanol and Hydrogen from Biomass," PU/CEES Report No. 271, July 1992.

g It is assumed that hydrogen is produced via electrolysis from wind power (see table Al) costing at present 5.4 to 8.8 cents/KWh (so that the produced hydrogen costs $25.8 to $38.0 per GJ) and in the future 3.3 to 5.2 cents/KWh (so that the producedhydrogen costs $16.2 to $25.0 per GJ). For details see J. Ogden and J. Nitsch, "Solar Hydrogen," in Renewable Energy: Sourcesfor Fuels and Electricity.

h It is assumed that hydrogen is produced via electrolysis from dc electricity (dc/ac power conditioning is not needed). Withpresent technology, dc electricity from photovoltaic systems costs about 51 cents/KWh (see table Al), corresponding to a photovol-taic hydrogen cost of $173 per GJ. For the long term, it is assumed that photovoltaic hydrogen is produced from electricity generatedin thin-film devices in areas of moderate insolation-1,800 KWh/m2 per year. As in the case of ac electricity production (see tableAl), it is assumed that, in the long term, thin-film modules achieve efficiencies of 15%, module costs are $45 to $50/m2, area-relatedbalance-of-system costs are $37 to $50/r 2 , indirect costs are 25% of direct costs, and operating and maintenance costs are 0.15 centsper KWh. Under these conditions the cost of dc electricity (assuming a 12% discount rate) ranges from 6.2 to 7.5 cents/KWh,corresponding to a range of hydrogen costs of $25.7 to $30 per GJ. For details see J. Ogden and J. Nitsch, "Solar Hydrogen," inRenewable Energy: Sourcesfor Fuels and Electricity.

28

Table A3. Cost of automotive fuels delivered to consumersa($IGJ)

NG->MeOH NG->H2 Biomass->MeOH Biomass->H2 Wind->H, PV->H2

Productiona,b

Feedstockc 3.40 2.72 4.65 3.83 - -

Capital 2.40 1.62 4.21 2.57 - -

O&M 0.93 0.49 1.91 2.12 - -

Subtotal 6.7 4.8 10.8 8.5 21.1d 27.8dCompression - - - - 1.4e 1.4'Overseas

transport l.5 - - -- -

Storage - - - 1.1h 1.g

Localdistribution - 0.5 - 0.5 0.5 0.5

Refuelingh 2.8 5.2 2.8 5.2 5.2 5.2

Retail Price 11.0 10.5 13.6 14.2 29.3 36.0

a Details of the production cost estimates for methanol (MeOH) and hydrogen (H ) derived from natural gas (NG) and bio-mass feedstocks are from E. Larson and R. Katofsky, "Production of Methanol and Hydrogen from Biomass," PU/CEES ReportNo. 271, July 1992. Details of the production cost estimates for electrolytic H2 are from J. Ogden and J. Nitsch, "Solar Hydro-gen," in Renewable Energy: Sources for Fuels and Electricity.

b Lifecycle costs for MeOH or H2 production are calculated assuming a 12% discount rate. All corporate income and propertytaxes are neglected. The annual insurance charge is assumed to be 0.5% of the installed capital cost.

c It is assumed that MeOH and H, are produced from NG feedstocks costing $2 per GJ, and from biomass feedstocks costing$3 per GJ (the mid-point of the range of biomass costs considered in table A2).

d It is assumed that electrolytic H2 is produced from ac wind power or dc photovoltaic power at the average of the hydrogenproduction costs for these sources indicated in table A2.

e The cost of compressing electrolytic H2 to 7.5 Mega Pascals (1,098 pounds per square inch area). Compression costs areincluded in the production costs for H2 from NG and biomass.

f It is assumed that MeOH produced from NG (but not from biomass) comes from remote overseas sources. This cost is fortransport from southeast Asia to the U.S. Gulf coast. See C. Wyman, R. Bain, N. Hinman and D. Stevens, "Ethanol and Methanolfrom Cellulosic Biomass," in Renewable Energy: Sources for Fuels and Electricity.

g When H, is produced from intermittent sources, storage is needed near the production site so as to keep the pipelines full.

h The cost for MeOH includes local distribution. The refueling station costs for H2 include the costs of compressing H2 to thehigh pressures needed for H, storage canisters on board the cars.

29

Table A4. Comparison of alternative automotive vehiclesa

Vehicle type BPEVb FCEVC FCEVC FCEVO FCEVC FCEVC FCEVC ICEVdPrimary US Natural Natural Biomass Biomass Wind Photovoltaic Petroleum

energy source average gas gasEnergy carrier Elect. MeOH 2 MeOH H2 H2 H2 Gasoline

1. Lifecycle cost (cents per km):

Base vehicle 7.59 7.22 7.18 7.22 7.18 7.18 7.18 11.17Fuel cell(inc. reformer) - 2.62 2.23 2.62 2.23 2.23 2.23 -

Battery 7.08 2.03 2.15 2.03 2.15 2.15 2.15 --

Fuel storage - 0.02 0.81 0.02 0.81 0.81 0.81Home rech. system 0.04 - - - - - - -

Miscellaneous O&M 6.03 6.09 6.06 6.09 6.06 6.06 6.06 6.71Fuel taxes 0.74 0.74 0.74 0.74 0.74 0.74 0.74 0.74Fuel - 1.14 0.91 1.40 1.23 2.55 3.13 3.00Electricity 1.48 0.22 0.20 0.22 0.20 0.20 -TOTAL 22.96 20.08 20.28 20.34 20.60 21.92 22.50 21.62

2. Gasoline-equivalentfuel economy:

On fuel:miles per gallon - 62.4 74.0 62.4 74.0 74.0 74.0 25.9liters/100 km - 3.77 3.18 3.77 3.18 3.18 3.18 9.08

On electricity:miles per gallon 120.0 131.5 131.5 131.5 131.5 131.5 131.5 -

liters/100 km 1.96 1.79 1.79 1.79 1.79 1.79 1.79 -

Average::miles per gallon 120.0 71.5 84.2 71.5 84.2 84.2 84.2 25.9liters/100 km 1.96 3.29 2.79 3.29 2.79 2.79 2.79 9.08

3. Delivered price of energy carrier:

Fuel:'$/GJ - 11.0 10.5 13.6 14.2 29.3 36.0 9.5$/gal gasoline-

equivalent - 1.45 1.38 1.79 1.87 3.86 4.75 1.25Electricity:$/GJ 19.4 19.4 19.4 19.4 19.4 19.4 19.4$/gal gasoline-

equivalent 2.56 2.56 2.56 2.56 2.56 2.56 2.56 -

Average:.$/GJ 19.4 11.8 11.4 14.1 14.7 28.2 34.3 9.5$/gal gasoline-

equivalent 2.56 1.56 1.50 1.87 1.94 3.72 4.52 1.25

4. Breakeven gasoline price:9

$/gallon 1.81 0.61 0.69 0.72 0.83 1.38 1.62 1.25$/liter 0.48 0.16 0.18 0.19 0.22 0.36 0.43 0.33

5. Lifecycle GHG emissions:` (gr Clkm)

On fuel: - 34.2 28.6 6.2 9.2 4.5 4.5 86.0On electricity: 48.2 43.9 43.9 43.9 43.9 43.9 43.9 -

Average: 48.2 34.9 29.7 12.8 14.5 10.8 10.8 86.0

Index 56.0 40.6 34.5 14.9 16.9 12.5 12.5 100.0

3(0

Table A4. (continued)

Vehicle type BPEVh FCEV FCEV' FCEV' FCEVC FCEV FCEvk ICEVdPrimary US Natural Natural Biomass Biomass Wind Photovoltaic Petroleum

energy source average gas gasEnergy carrier Elect. MeOH H2 MeOH H2 H, H, Gasoline

6. Lifecycle cost of GHG emissions reduction: ($ItC)

+354 -301 -220 -175 -143 +40 +117 -

7. Lifecycle GHG emissions per unit of energy consumed.i (kg C/GJ)

On fuel: - 26.0 25.8 4.7 8.3 4. 1 4.1 27.2On electricity: 70.5 70.5 70.5 70.5 70.5 70.5 70.5 -

Average:e 70.5 30.4 30.5 11.2 14.9 11.1 11.1 27.2

8. Cost of GHG emissions reduction when onlyfuel cost is taken into account:k ($/tC)

n.a. n.a. n.a. 288 423 1161 1540 -

a Based in large part on a cost and performance model for automobiles developed in Mark A. DeLuchi, "Hydrogen Fuel CellVehicles," Institute of Transportation Studies, University of California, September 1992 (draft).

b The battery-powered electric vehicle (BPEV) uses a bipolar Li/S battery, and has the performance and cost characteristicsindicated in table A5. Electricity is assumed to cost $0.07/KWh ($19.4/GJ), the average U.S. residential price.

c The fuel cell-powered electric vehicle (FCEV) uses a proton exchange membrane fuel cell for baseload power and a smallbipolar Li/S battery for peak.ng power. It has the performance and cost characteristics indicated in table A5. It has a fuel economyof 74 miles per gallon (62.4 mpg gasoline equivalent) when operated on compressed hydrogen (methanol) and 131.5 mpg (3.59miles per/KWh) when operated on external electricity. The compressed hydrogen is stored in aluminum canisters wrapped withcarbon fiber at 8,000 psia.

d The gasoline-powered internal combustion engine vehicle (ICEV) is a year-2000 version of the 1990 Ford Taurus. It has theperformance and cost characteristics indicated in table A5. The gasoline price is assumed to be $1.25 per gallon ($9.5/GJ),withouit retail taxes-the expected retail price of reformulated gasoiine in the U.S. for crude oil @ $25 per barrel.

e With methanol (compressed hydrogen) fueling, the fuel cell provides power for 0.787 (0.786) of each kilometer anid exter-nal electricity provides power for 0.181 (0.165) of each kilometer. Thus, regenerative braking provides power for 0.032 (0.049)of each kilometer.

f See table A3.

g The breakeven gasoline price is that gasoline price (excluding retaii taxes) at which the lifecycle cost of gasoline-poweredICEV equals the lifecycle cost of the alternative vehicle.

h The lifecycle greenhouse gas (GHG) emissions, in gr C-equivalent per km, include both CO2 and other GHGs emittedthroughout the entire fuel cycle, as well as the direct emissions from the vehicle. The biomass methanol and hydrogen optionsinclude the GHG emissions from the fossil fuels used to grow, harvest, and transport the biomass to the conversion facility. Thehydrogen cases include the GHG emissions from the power plants that provide the electricity to compress these gases to highpressure at the refueling station, assuming the electricity needed to run the compressors is provided by the average mix of electricpower sources in the year 2000. It is assumed that the electricity for recharging the batteries of the BPEVs and FCEVs is providedby the average mix of baseload power in the U.S. in the year 2000.

i The lifecycle cost of GHG emissions reduction for option i is given by:[(lifecycle cost), - (lifecycle cost),CEv, ]/Rlifecycle GHG emissions)lCEV - (lifecycle GHG emissions),],

where the lifecycle costs are given by line 1 in table A4, and the lifecycle GHG emissions are given by line 5.

j Calculated as: (lifecycle GHG emissions in kg C/km)/(total energy consumed in GJ/km).

k The cost of GHG emissions reduction for option i when only energy cost is taken into account is given by:[(average price of energy i - gasoline price, in $/GJ)] /[(lifecycle GHG/GJ gasoline) - (lifecycle GHG emissions/GJ energy i)],where the average prices are given by line 3, and the lifecycle GHG emissions are given by line 7.

31

Table A5. Characteristics of alternative vehicles

BPEV MeOHIFCEV H/FCEV ICEV

Weight (kg) 1,462 1,275 1,167 1,371km driven annually 22,960 22,960 22,960 17,837Range between refuelings (km) 400 400 400 640Vehicle lifetime (years) 11.2 11.2 11.2 10.8Selling pricea($) 28,247 24,810 25,446 17,302Fuel economy:

1/100 km gasoline-equivalent 1.96 3.77 3.18 9.08mpg gasoline equivalent 120 62.4 74.0 25.9

Maintenance cost ($/year) 388 450 434 516

Source: Mark A. DeLuchi, "Hydrogen Fuel Cell Vehicles," Institute of Transportation Studies, University of Califomia, Septem-ber 1992 (draft).

The retail price breakdown for the BPEV and the hydrogen-powered FCEV is as follows:

BPEV FCEV$ $

Traction battery and auxiliaries 13,625 4,205Hydrogen fuel storage 0 2,692Fuel cell stack and auxiliaries 0 4,496Extra support structure for EV because of added weight 34 (14)Extra weight and drag-reduction measures for EV 107 107Difference between EV and ICEV powertrain (2,839) (3,298)Net increment above ICEV cost 10,924 8,188

32

Table A6. Sensitivity analysis for carbon tax implied by backstop technologyaPrice of

dc electricity delivered Lifecycle Carbonprice hydrogen cost tax

(centslKWh) ($IGJ) (centslkm) ($/tC)

Low-cost FCEV,b high insolation,c+ low pv cost parametersd 4.7 28.8 18.42 - 372

Low cost FCEVb + high insolationc 5.1 30.4 18.56 - 356Low cost FCEVb 6.9 36.0 19.04 - 300High insolationc + low pv cost

parametersd 4.7 28.8 21.88 + 30High insolationc 5.1 30.4 22.02 + 47Base casee 6.9 36.0 22.50 + 102High pv cost parameters' 7.5 38.2 22.70 + 126High fuel cell costg 6.9 36.0 24.73 + 362High fuel cell costg

+ high pv cost parameters' 7.5 38.2 24.92 + 384

a The backstop technology is assumed to be a photovoltaic hydrogen-powered FCEV displacing a gasoline-powered ICEV. Inall cases it is assumed that electricity used for recharging the battery and for the compressor work required at the HI refueling stationis provided at the same cost as for the cases in table A4, but with power sources having zero net CO2 emissions (appropriate for thelong term). For this reason the base case carbon tax ($124/tC) is slightly lower than that shown in table A4 ($141/tC). For thecalculations in table A4, it was assumed that electricity is provided with the average mix of power sources in the U.S. in the year2000.

b In this case the fuel cell, battery, hydrogen storage, and related equipment cost is $3,800 per car (as estimated by Ira Kuhn-see table A7) instead of the base case value of $11,400 (as estimated by Mark DeLuchi-see table A5).

c High insolation = 2,400 KWh/m2/year (typical of the southwest U.S.).

d Low photovoltaic cost parameters are module costs of $45/m2 and area-related balance-of-system costs of $37/l 2.

e In the base case, hydrogen is generated from dc photovoltaic electricity generated in an area of modest insolation (1,800KWh/m 2/year-the average for the U.S.) assuming mid-range values of PV module and balance-of-system costs. The FCEV hasthe performance and cost characteristics developed in Mark DeLuchi's model (see table A5).

f High present value cost parameters are module costs of $50/m2 and area-related balance-of-system costs of $50/m2.g In this case the fuel cell costs $9,000 per car or $360 per KW-twice the cost estimated by DeLuchi (see table AS).

33

Table A7. Cost summary for cruise-design fuel cell electric vehicle by Ira F. Kuhna(year- 2002, 100,000 unitslyear)

Basis Total cost ($i

Hydrogen storage tankb 10.5 cubic feet (cf), 5,000 pounds 1,OOOC

per square inch (psi)aluminum wrapped

with carbon fiber(2 tanks @ 5.25 cf)

Fuel cell system 37.5 KW gross; 30 KW netFuel cell stack plates $8/lb 600Solid polymer electrolyte membranes $5/ft2 260Catalysts $2/KW 75Gas management system $4/lb 180Air compressor system $4/lb 100

Subtotal 1,215

Auxiliary power and controlsUltracapacitor 1.5 MJ 300Step-up transformer $51/b 150Auxiliary battery $2/lb 20Power coniditioner for hotel load $10/lb 50

Subtotal 520

Motor-relatedMotor 75 shaft horse power (shp); 63 shp max. continuous 500

$5/lbController $5/input KW 320Gearbox 10:1 step-down planetary 240

$4/lbSubtotal 1,060

TOTAL 3,795

The cost for the Ford Taurus ICEV parts displaced is $3,000-$4,000. Thus the net extra cost for the FCEV rangesfrom zero to $1,000. The removed parts weigh 935-980 lbs and the fuel cell system would weigh about the same.Thus the average cost of the fuel cell system would be about $4/lb.

Note: Fuel cell capacity is sufficient for sustained 75 mph cruise on 0% grade or 55 mph on 3% grade, with 3 KW hotel load; 34KW battery or 1.5 Mega Joule (MJ) ultracapacitor sufficient for acceleration and brake power regeneration; 75 hp peak poweroutput.

a Ira F. Kuhn, President, Directed Technologies. Inc.. 4001 N. Fairfax Drive, Suite 775, Arlington, VA 22203. Tel.:(703)243-3383 Fax: (703) 243-2724.

b Kuhn estimated that the alternative of a methanol storage tank plus reformer would cost $1,300, weigh 300 Ibs, and occupy10 cubic feet, compared to S 1,000 for a compressed hydrogen storage system weighing 200 lbs and occupying 13 cubic feet.

c Cost estimates provided by Structural Composite in Pomona. CA. Tel.: (714) 594-3939, a specialty tank manufacturingcompany.

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The GEF Administrator

1 818 H Street, NWWashington, DC 20433 USATelephone: (202) 473-1053Fax: (202) 477-0551

United Nations Development Programme

GEF/Executive CoordinatorOne United Nations PlazaNew York, NY 10017 USATelephone: (212) 906-5044Fax: (212) 906-6998

UNEP

United Nations Environment Programme

GEF Unit/UNEPPO Box 30552 -

Nairobi, KenyaTelephone: (254-2) 621-234Fax: (254-2) 520-825

The World Bank

GEF/Operations Coordination DivisionEnvironment Department1818 H Street, NWWashington, DC 20433 USATelephone: (202) 473-6010Fax: (202) 676-0483

3 Printed on recycled paper ISBN 1-884122-05-1