The EU Climate Finance Deal: What are the Implications?

By Jessica Brown

In an effort to ‘drive momentum towards Copenhagen', in the words of EC President Jose Manuel Barroso, the European Union has just agreed that measures to tackle climate change will need €100 billion ($148 billion; £90 billion) a year by 2020, with €22-50 billion coming from international public support. In the short-term, the leaders agreed that up to €7 billion a year would be needed from January 2010 for three years for ‘fast-track' funding in the developing world - a voluntary commitment that avoids specific funding targets for individual EU countries. This news raises some significant questions and potential concerns regarding how finance will be raised.

What will €22-50 billion mean for taxpayers?

Many Europeans will be concerned about an increased tax burden, as shown by public comments in a recent Guardian article. While some of the burden will fall on domestic taxpayers, there are other ways to raise international public finance to support climate change measures in developing countries. Many are on the table for a Copenhagen deal, and include imposing levies on international carbon market transactions, auctioning off Assigned Amount Units (AAUs) and passing on costs to private sector heavy polluters, taxing international currency transactions, etc. These could reduce the burden on European taxpayers but will take time to implement.

Where will the rest of the money come from?

While the Europeans have said that €22-€50 billion of the €100 billion should be public sector money in annual transfers to the developing world by 2020, it is unclear where the rest will come from. Internationally regulated carbon markets are expected to provide a substantial amount, but not the remainder of the bill. There are serious concerns about overreliance on the private sector to support certain climate change activities, particularly for adaptation. Many climate change interventions are either inappropriate for private sector finance or simply will not attract private finance. Countries with low credit rating and high levels of debt with little institutional financial capacity and significant capital market barriers cannot expect private finance to be knocking at their doors. Strong public sector incentives are needed to mitigate private sector risk and encourage their investment, such as government guarantees, credit lines, or advance market commitments.

What will be the role of the carbon market?

The recent EC staff working document accompanying the EC Communication on ‘Stepping up international climate finance: A European blueprint for the Copenhagen deal' states that the international carbon market could deliver as much as €38 billion per year in 2020. However, this figure is based on a few assumptions that need to be unpicked. First, this would be based on the creation of a new sectoral carbon market crediting mechanism, which has yet to be agreed. Second, it assumes that all profits from selling offset credits would also be used to mitigate GHG emissions in developing countries.

This massive assumption implies that the market would function as a ‘reverse auction' whereby emission credits from developing countries would be offered for purchase at close to average cost, purchased by an intermediary bank or fund, and sold on to developed country markets, capturing the spread between the two prices. In classic economics, this is referred to as a monopsonistic approach, which essentially means that there are several sellers (of emission reduction credits) but only one buyer. The resulting rent would be used to buy more emissions reductions or other related activities rather than accruing to emission reduction purchasers. This could undermine the incentives for private sector involvement in the carbon market. Allowing firms to make high profit margins at the outset can compensate new project developers for the risks involved, and encourages competition. But it is likely that some rents will be retained and that developing countries will not receive the entire €38 billion per annum to deal with climate change. Hard questions need to be asked about the role of carbon markets in delivering finance to developing countries.

How predictable are the funding pledges?

Given that the initial pledges for the fast track funding are voluntary, there are concerns over the predictability and timeliness of funding. Experience tells us that pledges are rarely kept and, if they are, tend to take a long time to deliver. While the EU's commitment may be firm, it is only likely to contribute €0.5-2.1 billion per annum of the €7 billion for the fast track funding, with other finance coming from governments who have not yet made pledges.

Delegates in Copenhagen need to begin to hone in on how the money will be raised. It is critical that, at this stage in the game, assumptions are challenged about the role of the private sector and potential revenue raised from the carbon market. We need a much better understanding of the respective roles of the private and public sector in financing to address climate change.

Re-published with permission by the Overseas Development Institute.