Clean is Not Free: Tackling Climate Finance

From TheEcologist.org

How to operationalize long-term and stable financing is at the heart of international climate policy; no matter what policy mix is concocted for the warming planet, significant sums of money will be required. Unsurprisingly, it is also one of the most contentious issues. After all, what is climate change controversy if not ultimately a debate over costs and financing?

In the context of the UN talks on climate change, the discussions about finance primarily refer to projects in developing countries. The central question driving policy-makers is this: what is the most effective way to monitor and facilitate North-South monetary flows? Unfortunately, the negotiations have not made much progress toward a satisfying framework for this hugely important policy dilemma. It seems that the only area of consensus in climate financing is that it should exist.

Green Climate Fund: Solution or Cop Out?

Last December in Durban, South Africa, the international community finally established the Green Climate Fund (GCF) after years of acrimonious debate about how best to scale up climate financing. Immediately after its launch, commentators noticed that the agreement was notoriously vague: all work beyond the mere establishment of the fund was left to future conferences. Who would pay? How much would they pay? How specifically was the GCF mandated to monitor or facilitate climate finance? The text provided no answers.

Of course, the importance of the fund should not be understated; indeed, international climate financing is sorely in need of consolidation. Without the centralized governance now provided by the GCF, the financial architecture of climate change is a dizzying alphabet soup of international and domestic agencies. It is perhaps for this reason that developing countries are often unaware of even large-scale projects and investments in their own jurisdictions. It is easy to imagine the deadweight loss that likely occurs as a result of this inefficiency and lack of accountability, a problem which the GCF is now perfectly positioned to address.

Still, the decision reached in Durban creates far more questions than answers. The issue of financing is one of the most cross-cutting in the climate change debates. It requires insights from economics (what is the best way to allocate scarce funds?), international relations (what is the role of the international financial institutions and bilateral schemes?), climate science (what are the most pressing uses for the funds?), business (how can we design high-impact financial instruments?), and even philosophy (is it ethical to focus solely on the low-hanging fruit, so to speak?).

As a result, climate financing requires the intimate collaboration of a multitude of stakeholders. In an attempt to tackle these debates head-on and, perhaps, to assuage the jitters of these stakeholders, the secretariat of the United Nations Framework Convention on Climate Change (UNFCCC) recently convened the first workshop on long term finance. Among the primary topics of discussion were the elephants in the room: how much money is required and where is that money going to come from?

Talking About Those Elephants

The issue of the magnitude of the financing is, as we might expect, a very difficult one to address. On the adaptation side, the most-quoted price tag among the policy circles is $100 billion annually, taken from a 2010 report from the World Bank. This catch-all number includes estimates from widely divergent sectors, including infrastructure, agriculture, human health, fisheries and more. Naturally, every part of society must adapt to the effects of climate change. Meanwhile a 2007 report from the UNFCCC itself estimates that $28-67 billion will be needed annually for adaptation in developing countries. (The report takes special care to note that this is the amount needed in addition to already existing monetary flows.)

For the mitigation calculations, however, there is significantly more variation in the estimates—not least because long-term estimates are highly sensitive to the unpredictable development of new technologies. McKinsey’s influential but much-maligned publications on abatement cost curves estimate that about $200 billion will be needed annually to meet mitigation target. That cost jumps to over $300 billion in the medium term. Other estimates vary from less than $100 billion to over $500 billion.

Even with these huge sums, the Organisation for Economic Co-operation and Development recently suggested (in Helen Mountford’s presentation) that looking at the cost of developing technology and reducing emissions is not enough. To get a complete picture, policy-makers must examine the costs of shifting investments and subsidies from fossil fuel intensive projects to greener, more sustainable and resilient ones. All told, these totals could run in the trillions.

So, how is our progress? According to the Economist and the Climate Policy Initiative, developing countries saw about $97 billion in climate-related inflows in 2009. This is an unexpectedly large amount, especially given that the GCF’s goal is to raise $100 billion annually. Excitement over these figures, however, should be tempered. Disaggregating the data shows that fully 96% of that aid and investment went towards mitigation-related initiatives.

From the 5 Nov 2011 issue of The Economist

This is expected since the private sector is driving the majority of investment. As a result, we should expect that potentially profitable industries like renewable energy will receive the lion’s share of the money. Adaptation, unfortunately, is not so sexy. However, as the impacts of climate change become increasingly apparent, financing for adaptation will be all the more necessary.

In order to shift some of the investments towards adaptation-related projects, governments and multilateral development banks need to be innovative with their limited funding. The United Nations Environment Programme (and, in particular, the division’s Finance Initiative) suggests using public funds to lower the private cost of capital among otherwise risky projects. To do this, the public sector could assume some of the first-stage default risk by issuing mezzanine debt, or it could guarantee a certain portion of an adaptation project. By designing these types of innovative instruments, governments can side step the ever-present issue of limited public funds and use what is available to significantly scale up private investments.

Inflection Point

For all the talk of the paralysis of international climate policy, climate finance is an issue on which the multiple stakeholders are slowly, but surely, beginning to mobilize. India, for example, recently set up a dedicated unit in its Finance Ministry to oversee all its activities in climate change financing. Even Christine Lagarde of the IMF (that “citadel of economic orthodoxy”) has announced her organization’s support for carbon pricing as a way to raise funds for “climate adaptation and mitigation in developing countries—resources that developed countries have committed to mobilize by 2020.” All of this suggests that international support for climate financing is at an inflection point. By effectively leveraging this surge and incorporating innovative and bold financial solutions, policy makers could unlock huge sums for the future of our planet.

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