Small-scale CDM projects in a competitive electricity industry: How good is a simplified baseline methodology?

Setting baseline emissions is one of the principal tasks involved in awarding credits for greenhouse gas emission (GHG) mitigation projects under the Clean Development Mechanism (CDM). An emission baseline has to be project-specific in order to be accurate. However, project-specific baseline calculations are subject to high transaction costs, which disadvantage small-scale projects. For this reason, the CDM-Executive Board (CDM-EB) has approved simplified baseline methodologies for selected small-scale CDM project categories. While the simplified methods help reduce the transaction cost, they may also result in inaccuracies in the estimation of emission reductions from CDM projects. The purpose of this paper is to present a rigorous economic scheduling method for calculating the GHG emission reduction in a hypothetical competitive electricity industry due to the operation of a renewable energy-based power plant under CDM and compare the GHG emission reduction derived from the rigorous method with that obtained from the use of a simplified (i.e., standardized) method approved by the CDM-EB. A key finding of the paper is that depending upon the level of power demand, prices of electricity and input fuels, the simplified method can lead to either significant overestimation or substantial underestimation of emission reduction due to the operation of renewable energy-based power projects in a competitive electricity industry.