13.3.3.5 Financing

Funding sources for GHG mitigation in developed and developing countries is a crucial issue in the international debate on tackling climate change. Financing is categorized in the literature in terms of public flows (including Development Assistance and government loan guarantees through export credit agencies), private flows or foreign direct investment (FDI) and financing from multilateral institutions, including the Global Environment Facility (GEF) and international financial institutions. Public financing is the main form of assistance for developing country climate change mitigation, while the private sector provides the technology investments. CDM resources are significant when compared with GEF funding, but small in comparison to FDI resources (Ellis et al., 2007). In addition to these instruments, a World Bank survey of contingent financing and risk mitigation instruments for clean infrastructure projects describes the characteristics and potential use of other instruments, such as insurance, reinsurance, loan guarantees, leases and credit derivatives^[39] (IPCC, 2000; World Bank, 2003). A small percentage of public funds are used to leverage private investment in clean energy projects.

13.3.3.5.1 Foreign direct investments

OECD trade and FDI have grown strongly in relation to GDP during the past decade: cumulative net FDI outflows between 1995 and 2005 amounted to 1.02 trillion US$. As a share of GDP, outward FDI grew from 1.15% of the GDP in 1994 to 2.02% in 2004. However, while the total sums grew, only 35% went to non-Annex I countries – and of that, nearly 70% went to five countries, namely China (including Hong Kong), Brazil, Mexico, Singapore and South Korea.^[40] See also OECD (2005 d) for trends in FDI relative to ODA.

One common assertion in international environmental negotiations is that FDI promotes sustainable development as multinational corporations (MNCs) transfer both cleaner technology and better environmental management practices. However, empirical studies find little evidence that MNCs transfer either significant cleaner technology or better practices. In statistical studies of Mexico (manufacturing) and Asia (pulp and paper), foreign firms and plants performed no better than domestic companies (Zarsky and Gallagher, 2003). According to Jordaan (2004) the externalities from the presence of foreign-owned firms do not occur automatically, but are dependant on underlying characteristics of the industries and manufacturing firms.

Most FDI in developing countries is targeted to activities such as the extraction of oil and gas, manufacturing and electricity, gas and water, which have the aim to improve economic development but also to increase GHG emissions (Figure 13.5). Maurer and Bhandari (2000) report that during the mid- to late-1990s the major developed countries co-financed energy-intensive projects and exports valued at over 103 billion US$ through their export credit agencies (ECAs). These projects and exports included oil and gas development, fossil fuel power generation, energy-intensive manufacturing, transportation infrastructure and civilian aircraft sales. These countries accounted for 90% of the co-financing provided by ECAs to these energy-intensive exports and projects. By comparison, industrialized countries have directed just a fraction of their ECA financing to renewable energy projects. Between 1994 and 1999 ECAs supported a total of 2 billion US$ in renewable energy projects.

Figure 13.5: Total OECD foreign direct investment (FDI) outflows to selected sectors.

Source: OECD (1999)

13.3.3.5.2 Direct international transfers

Official development assistance (ODA) remains an important source of financing for those parts of the world and sectors where private flows are comparatively low, although this is a modest financial resource relative to global private direct investment, which was 106 billion US$ in 2005. Data from the OECD suggest that development assistance for energy projects (approximately 3.2 billion US$ in 2004) from bilateral sources has remained relatively flat over the last 6 years.. There has been a shift in support away from coal technologies to those of gas and some extent renewables^[41] (see Figure 13.6).

The effectiveness of ODA depends on various factors, the most important of which are good governance, policy and institutional frameworks that encourage private investment (macroeconomic and political stability, respect for human rights and the rule of law), minimum levels of investment in human capital (education, good health, nutrition, social safety nets) and policies and institutions for sound environmental management.

Figure 13.6: Development assistance for energy

Source: OECD.

13.3.3.5.3 GEF and the multilateral development banks (MDBs)

The GEF, established in 1991, provides support to developing countries for projects and programmes that protect the global environment. Jointly implemented by the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP) and the World Bank, GEF provides grants to fund projects related to biodiversity, climate change, international waters, land degradation, the ozone layer and persistent organic pollutants.^[42]

Compared to the magnitude of the environmental challenges facing recipient countries, GEF efforts are relatively modest in scope. From 1991 to 2004, GEF allocated 1.74 billion US$ to climate change projects and activities; even when this amount is matched by the more than 9.29 billion US$ in co-financing, the overall scale of the GEF is small.^[43] Funding is given to five project types, namely renewable energy, energy efficiency, sustainable transportation, adaptation, low GHG energy technologies and enabling activities. Hall (2002) analysed the GEF portfolio and noted the focus on incremental, one-time investments in mitigation projects that test and demonstrate a variety of financing and institutional models for promoting technology diffusion. He suggests that this approach should help contribute to a host country’s ability to understand, absorb and diffuse technologies.

According to a review of the GEF by the World Bank (2006), ‘the GEF’s track record in reducing the long-term cost of new low GHG-emitting technologies has not been encouraging’. The continued effectiveness of GEF project funding for technology project types will depend on factors such as the duplication of successful technology transfer models, enhanced links with multilateral banks and co-ordination with other activities that support national systems of innovation and international technology partnerships. It has been suggested that GEF reform will be needed to enhance its effectiveness and transparency, particularly with respect to determining contributions and for evaluating priorities for disbursements (Grafton et al., 2004).

The World Bank (2004a) review of its investments in extractive industries determined that in the future it would be more selective, with a greater focus on the needs of poor people and a stronger emphasis on good governance and on the promotion of environmentally and socially sustainable development. The IFC has revised its performance standards in 2006 to require the reporting of GHG emissions for projects with both direct and indirect emissions of greater than 100,000 tonnes annually. The standards also require the consideration of alternatives or improvements to the energy efficiency of energy intensive projects (see http://www.ifc.org/ifcext/enviro.nsf/Content/ENvSocStandards). However, Sohn et al. (2005) note that the World Bank has continued to both support traditional CO₂-intensive fossil fuels projects and provide relatively limited resources to renewable and low CO₂-emitting energy alternatives. They suggest that Governments may use their leverage to direct the activities of multilateral development banks through their respective Boards and Councils in order to strengthen MDB programmes to account for the environmental consequences of their lending; develop programmatic approaches to lending that remove institutional barriers and create enabling environments for private technology transfers.

The higher perceived risk in developing countries, as reflected in sovereign credit ratings, can be compounded further by including new and emerging technologies. International or regional financing institutions can play a critical role in lowering the risk and leveraging private finance into the sector. MDBs have responded to this challenge by establishing several new initiatives. For example, the European Bank for Reconstruction and Development’s (EBRD) new Sustainable Energy Initiative was launched in May 2006 to address the wasteful and polluting use of energy. The EBRD plans to invest up to € 1.5 billion in energy efficiency, renewables and clean energy projects over the next 3 years, which could lead to up to € 5 billion of total investment. The Asian Development Bank (ADB) launched the Energy Efficiency Initiative (EEI) in July 2005, the core objective of which is to expand ADB’s investments in energy efficiency projects (including renewable energy), with an indicative annual lending target of 1 billion US$ between 2008 and 2010. The World Bank has announced the establishment of the Clean Energy Fund Vehicle with a capitalization of 10 billion US$ and an annual disbursement of 2 billion US$ to accelerate the transition to a low carbon economy.