Public Climate Finance Should Fund Regions, Not Projects

In the coming decades trillions of dollars will be spent on climate change mitigation and adaptation, and a significant portion of those funds will flow from the developed world to the developing world, for reasons both ethical and economic.   Successfully mapping diverse sources of funding from the developed world onto politically, geographically, and technologically diverse developing regions will be a complex task, however, and we must learn from the shortcomings of current climate finance efforts to be successful.  This article 1) highlights how poorly most existing international climate finance handles the complexity of the regions where it invests, especially when it funds isolated projects, 2) examines a very important success story of region-based support of wind energy in Kazakhstan, and 3) concludes with a recommendation that public climate finance prioritize large, systematic evaluations of regions before funding individual projects within them, to close knowledge gaps and eliminate barriers that currently hinder both public and private investment.

Introduction

It is increasingly clear that trillions of dollars will flow from the developed world to the developing world in the coming decades as a result of global climate change.  Some of this will be for mitigation, especially due to the low mitigation costs found in the developing world, including some of the lowest costs in the world for renewable energy (Krewitt 2009, WEC 2013) and two thirds of the world’s revenue-positive efficiency improvements (Farrell and Reemes 2009). Some will be for ethical and humanitarian reasons, especially given the developed world’s responsibility for the bulk of GHG emissions to date and the difficulty developing regions have adapting and/or developing sustainably on their own.  A large fraction will also have to occur for economic reasons, as investors and companies find opportunities in emerging markets, especially in the form of profitable investments in renewables and efficiency.

This diversity of investment sources widens the pool of available funds and will be necessary for securing the large amounts of funding needed for effective action, but managing the complexity of many different funding sources, especially timing and scaling them alongside each other, presents a significant challenge.  This challenge is further compounded by the complexity of the regions where money will be invested – geographically, environmentally, developmentally, and politically diverse areas often very different from developed countries, and often without the full range of robust physical and political infrastructures (i.e. electric grids, regulatory agencies, governmental stability) that are the basis for change in the developed world (IPCC 2012).

Fortunately, there have been many early international climate finance efforts, which provide us with valuable lessons (in this article we define climate finance broadly, to include both public and private funds).   This article covers the scale of current efforts, then examines their most pervasive difficulty, namely Northern investors’ lack of deep knowledge about regions where they might invest, and Southern developers’ lack of knowledge about available finances or difficulty acquiring and coordinating them.  These factors have caused significant inefficiency in performance of investments to date, and have reduced the scale of investment, especially by risk-averse private investors.   Lastly, we examine a significant success story in Kazakhstan, where public finance was used to close knowledge gaps, remove local barriers to investment, and reduce risk, paving the way for large private investment in wind energy.  We conclude with recommendations for a “region-based” approach where public sector financing is used to 1) conduct holistic evaluations of high-need or high-economic-potential regions, working closely with local governments and organizations to close knowledge gaps and note unique difficulties for investment, 2) then create long-term “roadmaps” and sequences of actions needed for effective development, mitigation, and adaptation in each region, and 3) make clear to public and private investors what steps are needed and who is best positioned to fund each one, and work with local governments and developers to help them find and integrate different sources of funding.  While this is surely an ambitious undertaking, we think recent international climate finance efforts show that closing knowledge gaps in both the North and South in a systematic way is mandatory if we want to make investments efficient and large enough in scale.

Current International Climate Finance

Currently around $359 billion is spent yearly on climate change mitigation and adaptation (94% and 6% of the total, respectively) (Buchner 2013).  Only 25% flows internationally (mostly from the global North to the South), and the vast majority of this international flow is from public sources, as the private sector perceives investment in regions with unfamiliar geography and regulatory frameworks as risky (Buchner 2013).   This is in spite of the aforementioned opportunities for low-cost renewables and profitable energy efficiency improvements in emerging markets, but unfortunately the performance of publicly funded projects in these regions shows that this risk-aversion by private financers may be warranted.

The Clean Development Mechanism (CDM) provides an instructive example of the mixed results of publicly funded international climate finance.  It is the most prominent public effort to fund mitigation in the global South, allowing Kyoto Protocol signatories to meet their emissions reductions targets in part by funding mitigation projects in developing countries.  This should allow for low-cost mitigation with lots of important knowledge transfer and developmental co-benefits, and it has leveraged an estimated $315 billion to date (UNFCCC 2013).

Unfortunately, its performance on these projects is questionable.  While mitigation costs have often been reported near $20/tCO2, these low-cost projects are dominated by large scale hydro power projects in China (the country where 68% of funds have gone), which critics say are not “additional,” meaning that they would have still been executed in the absence of CDM funding (CDM Policy Dialogue 2012).  The kinds of “additional” projects that are most seriously needed at scale, like industrial and energy system efficiency improvements, biomass energy, and solar installations, have had mean costs over $200/tCO2 and sometimes well into the thousands of $/tCO2.

Many of the CDM’s difficulties result from significant knowledge gaps – for example, investors do not fully understand all of the relevant geophysical, regulatory, political, and economic factors in different regions (CDM Policy Dialogue 2012).   This makes assessment of additionality and reliability a prior assessment of mitigation costs very difficult, and is especially problematic given that even local efforts funded internally by developing countries can be derailed for reasons that international investors may not expect.  One example is the lack of well-maintained roads and effective public utilities that has undermined Malaysia’s expansion of micro-grids (Bullis 2012).   This lack of regional knowledge also leads to relatively small, uncoordinated investments which may not be nearly as effective as coordinated support of large, long-term regional changes to basic infrastructure and energy systems that will be needed for serious and cost-effective mitigation(Creutzig and Kammen 2009).

Unfortunately, a lack of knowledge is also pervasive amongst potential recipients of funds, who are often unaware of opportunities or not adept at completing the full CDM application cycle.  This causes some regions to be systematically ignored (only 7% of funds have gone to India), while large, well-funded developers (especially in China) attract the majority of funds (CDM Policy Dialogue 2012).

Closing Knowledge Gaps, Planning Long-Term for Whole Regions: Success in Kazakhstan

To be sure, knowledge gaps and uncoordinated funding are not only a problem for the CDM.   The percentage of climate finance going to adaptation (6%) is lower than it could be due to knowledge gaps regarding the exact definition of adaptation, the best ways to promote adaptation, and the needed investments and outcomes (Buchner 2013).   Developing countries have made it clear that integrating diverse, unpredictable sources of international aid over time is challenging, and can even lead to macroeconomic problems (Strand 2009).  And lastly, private finance actors have also made clear that they will need to partner with local governments and research institutions to help them close knowledge gaps and reduce risk before they can invest (UNEPFI 2011).

Interestingly, in 1998 the UNDP and Global Environmental Facility (GEF) launched a very successful effort to promote wind energy in Kazakhstan, which focused mainly on identifying knowledge gaps and investment barriers and then addressing them directly.  Their goal was to facilitate the installation of approximately 250 MW of wind capacity by 2015 and 2000 MW by 2030, and while it was clear that Kazakhstan has some of the best wind resources in the world, it was also apparent that there were many barriers to utilizing this potential, including 1) artificially low electricity prices from locally mined coal burned in old Soviet-era power plants whose capital costs were ignored, leading to prices in the range of 2.3-3.5 c/kWh (USD), 2) lack of local technical expertise in wind power and local experience building wind farms, making feasibility studies and bankable proposals impossible to execute, 3) no detailed maps of wind potential with the kind of precision needed for investment choices, 4) hesitancy of utilities to add intermittent renewables to the grid (GEF 2011).

Over the course of a decade, the UNDP and GEF worked with local institutions to address these issues.   This included 1) making maps with detailed measurements of wind potential across the country, overlaying these maps with information about the existing grid and power facilities in each region, and disseminating this information as widely as possible 2) making more detailed pre-feasibility assessments of especially attractive regions, employing local Kazakhstanis whenever possible to build local skills and knowledge, 3) training local engineers and utility companies in the basic operation and costs of wind turbines and wind farms, and helping them make the best possible estimates of component costs, operations, maintenance, and distribution costs, etc, 4) working with local utilities to assess how well the existing grids could handle intermittent wind farms, finding that even 2000 MW of capacity (the 2030 goal) could be handled with no substantial changes to the grid, and that only moderate changes would be needed thereafter, and 5) perhaps most importantly, creating attractive markets for wind power by helping the government craft feed-in tariffs to guarantee enough revenue for wind farms even in the presence of artificially low coal electricity prices.  This was a multi-step effort, as the first feed-in tariff had no fixed value and was determined by costly assessments and calculations by developers, who did not want to risk paying for feasibility studies and tariff calculations, only to possibly end up with a tariff too low to make development of a farm worthwhile.  The UNDP and GEF worked with local utilities to determine what minimum feed-in tariff would be worthwhile (settling on 15 c/kWh), and helped legislators enact it.

This kind of long-term commitment to working with all relevant regional partners and identifying and overcoming local barriers is certainly uncommon.  However, the costs and outcomes are well worth noting.  After a decade of work and $2.5 million spent to change local policies and close knowledge gaps (IRENA 2013), Kazakhstan is seeing significant investment in wind energy – a $94 million 45 MW project in the Yereimentau region, funded by the Eurasian Development Bank and the local Samruk Energy, to be completed by 2015 with plans to expand up to 300 MW; a $100 million 50 MW project funded by the China Development Bank (financer of major projects like the Three Gorges Dam); and another project being considered by Samruk Energy which would start with 60 MW in the Shelek corridor and possibly expand to 300+MW.

It seems unlikely that Kazakhstan will meet the UNDP’s original goal of 250 MW installed by 2015, but investor confidence is increasing as more projects are funded and constructed, and with the Kazakhstani government being increasingly vocal and ambitious in its efforts to promote expansion of wind, energy efficiency, solar, and hydroelectric projects, the future of wind power in Kazakhstan is certainly much brighter than it was before the UNDP’s involvement.  The success of this long-term, knowledge-building and barrier-reducing effort also stands in contrast to the many billions of dollars spent so far on individual projects in poorly-characterized regions via the CDM, which has often been spent inefficiently and has not been well integrated with long-term plans in a region or led to large amounts private investment.  We certainly should expect replicating these successes from Kazakhstan in other diverse world regions to be difficult, with unique local challenges (especially in regions with less stability of government or infrastructure) and with even longer timelines if more challenging or costly barriers need to be overcome.  However, given the severe problems climate finance has faced without such robust regional evaluations, and given the very high benefits that can be obtained for very low costs, it seems that these kinds of evaluations should be a main focus of public climate finance in the future, and should be at the forefront of international plans as we construct new mechanisms like the nascent Green Climate Fund.

Closing Remarks, Recommendations

Here we have seen the scale of current climate finance efforts and their mixed success to date.  In particular we have seen the pervasive knowledge gaps and lack of cohesive long-term regional planning that have led to serious inefficiency in public financing, and a lack of private financing altogether.  We have also seen the very large successes possible when money and sustained engagement and effort are used to appropriately evaluate a region or country, identify major opportunities and barriers, and work with local stakeholders and investors to reduce them.   We must keep these lessons in mind as we plan the coming decades of climate finance, to give ourselves the best chance of making investments that are efficient, well suited to each region, and likely to spur large amounts of public and private investment for many decades afterwards.

Daniel Thorpe PhD candidate, Harvard School of Engineering & Applied Sciences.

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