The promising private sector climate finance debate

Laurent Fabius, president of COP21, is shown solar panels during a tour of one of the theme pavilions at the United Nations Climate Change Conference venue in Paris, France. Photo by: Benjamin Géminel / COP21

With the landmark Paris climate agreement now a month-old and the holiday cheer for its accomplishment a bit more subdued, an earnest debate is fully underway over how to live up to the promises of the accords.

A central piece of the puzzle is the issue of funding. If 2015 and the buildup to COP21 were all about reaching an agreement, the mission of 2016 and its subsequent years is to come up with reliable sources of finance to put the plan into action.

“The private sector” is often the knee-jerk, panacea solution to the problem of insufficient public funds to keep global temperatures in check. But the question then becomes how to entice private capital to take up a large stake in climate finance. And how to ensure some certainty of return that is commensurate with boosting inclusive growth and sustainable development — core pillars of the 2030 Development Agenda that climate action forms a part of.

It is indeed a complex equation that is complicated even more by having two sides of the climate change issue — mitigation and adaptation. Both are critical strategies for action on climate and fortunately, both present an array of options for dealing with the challenge.

Thus far mitigation has overwhelmingly drawn the bulk of investment. According to the Organization for Economic Cooperation and Development, mitigation — investments in renewable technologies, clean energy, carbon sequestration, and other strategies — has historically accounted for roughly 90 percent of private funds mobilized for climate action.

The imbalance makes financial sense. Clean energy and other green assets are more likely to produce concrete returns than investments in climate adaptation and resilience.

The mitigation camp itself further splinters into a debate on the best course of action to produce large scale change. Carbon pricing — though never directly mentioned in the final Paris agreement — has garnered strong support from businesses and governments as being a clear long-term signal for the private sector to invest emission-saving strategies.

The term "carbon pricing" is often thrown around, but what does it mean? And why does it matter? In this video, Devex explains how it is being implemented and the business case behind the policy.

Implementing a price on carbon takes many forms, with influential voices advocating for each of the main options. The International Monetary Fund, for example, endorses the strategy of a carbon tax.

“It is the most natural way to price carbon,” Vitor Gaspar, head of fiscal policy at the IMF, told a recent gathering in Washington, D.C. Road fuel excises and other across-the-board measures that price the consumption of carbon are straightforward and relatively easy to administer, he argued.

The World Bank, meanwhile, generally tends to favor approaches that build carbon markets through tradable carbon offsets and credits. Individual governments, based on their unique circumstances, will determine whether the tax or the markets-based approach will be adopted. And both strategies will continue to be core components of the broader set of policies that fall under carbon pricing.

However, new twists to conventional strategies will also need to be applied. For carbon taxing, that can mean governments phasing out subsidies that artificially suppress fossil fuel prices below their true market and social costs. Global energy subsidies, according to IMF calculations, totaled $5.3 trillion in 2015, or roughly 6.5 percent of global gross domestic product. Raising the price of those fuels will both drive down emissions from consumption and generate considerable revenues for governments to channel into other development-oriented strategies, according to the IMF.

For emissions trading, the Paris agreement may well have laid the groundwork for innovative approaches to finance climate using a critical carbon asset — international forests. Halting deforestation and replenishing deforested lands alone can achieve up to 30 percent of the mitigation pledges put forward in Paris, according to the Center for Global Development, a Washington, D.C.-based think tank.

The agreement itself endorses the principles of carbon trading — officially articulated in the agreement as “internationally transferred mitigation outcomes.” And Article 5 of the agreement specifically encourages the conservation and enhancement of “sinks and reservoirs” of greenhouse gases.

Combining the two, environmental experts say, can eventually lead to carbon trading mechanisms in which greenhouse gas emissions can be offset by the purchase of credits whose proceeds promote forest preservation.

Such a scheme would have to overcome significant regulatory hurdles, namely the creation of an international — rather than domestic — market for carbon trading. But the groundwork exists in places such as California where a state-wide emissions trading scheme allows companies to buy emissions reductions from countries with tropical forests. The implementing rules, however, have not been finalized.

The need to build up investments on the resilience front, meanwhile, are immediate and pressing when considering the lopsided effects that climate change has on the world’s poor. The V20, a coalition of countries most vulnerable to the damaging effects of a warming planet, estimates that roughly half of its 700 million citizens live in extreme poverty. While current aid flows and active investments toward resilience are not as mature as they are for mitigation, financial organizations are building the necessary strategies to leverage large sums of private capital.

Climate change finance will require innovative mechanisms and policies. Devex talks to a group of experts about what’s needed to transform the status quo.

For example, a key priority for the Global Environment Facility is to use the targets agreed in Paris to build multistakeholder partnerships around sustainable energy, land use and urban systems, said Naoko Ishii, the GEF’s chief executive. Having provided funding to 46 countries to devise their Intended Nationally Determined Contributions toward the Paris agreement, the GEF will now gear grant and assistance money toward helping them implement those commitments.

Meanwhile, the Green Climate Fund, the financing facility formed in 2009 where donors committed to contributing $100 billion in overall climate finance, operates on a 50-50 mandate to direct funds evenly between mitigation and adaptation. While the GCF has recently rolled out new innovations on the mitigation front such as green bonds or early venture capital for off-grid solar in Africa, it admits that planning for investment in resilience is a much tougher task.

“Adaptation is very locally driven and trying to understand how to use the marginal adaptation dollar is a tough struggle,” said Leonardo Martinez-Diaz, a U.S. board member to the GCF. Overcoming the hurdle of determining the proper intervention to build climate resistance, he said, requires building up greater inventories of data — of degraded lands or coastal forests, for example — and are tasks that some development organizations can be properly equipped to address.

The Paris agreement has been described in many ways as the start of an ongoing process toward a more sustainable climate. How to finance those ambitions, on all fronts, will be a key debate going forward. Fortunately, the debate is largely dominated by questions of “which” and “what” financing options to choose from rather than a dilemma from a shortage of opportunities.

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About the author

  • Naki mendoza 400x400

    Naki B. Mendoza

    Naki is a former reporter, he covered the intersection of business and international development. Prior to Devex he was a Latin America reporter for Energy Intelligence covering corporate investments and political risks in the region’s energy sector. His previous assignments abroad have posted him throughout Europe, South America, and Australia.