I want to say some words about a very complicated and unsolved and unsettled area: climate finance. This is a complicated topic because it covers a tremendous range of issues, but involves broadly speaking the question of how the world both individually as governments and collectively through international organizations and institutions and through market forces internally within a country and internationally will finance the transition to a low-carbon world economy and also will finance other parts of the climate challenge including adaptation to ongoing climate change.
There are many categories of need and many issues about how this financing can be allocated, who’s to pay, who would be the recipients, what are the terms of the financing?
There are many kinds of financial instruments that might be considered and there are aspects of financial regulation as well. All of this points to the underlying fact that the category of climate finance is a big one and it means a lot of things and a lot of different things to a lot of different groups.
I want to sort out some key aspects of the climate finance issue, but don’t pretend in any way to find a clear bottom line because as of now there are still too many issues in play and not yet the clarity of either concept or magnitude of financing that will be needed for the whole transition process. Well what are the kinds of areas that need financing when we consider the transformation to a low-carbon economy and when we consider life in the midst of anthropogenic climate change?
The first category is the core financing of our energy-related infrastructure. This is the biggest single item of finance. It is a multi-trillion dollar amount of financing each year. Remember that we are in a world economy of nearly a $100 trillion per annum at this point. And the economy globally continues to grow at around three to four percentage points per year, meaning that it doubles roughly every twenty years. Maybe by 2035 or 2040 it will be at a scale of $200 trillion.
Typically, infrastructure would be a few percentage points of that. That means the investments in power generation, in transmission, in roads, in rail, in airports, in port facilities and in other physical infrastructure, dams, levees, coastal protection, inland waterway infrastructure and so forth might total somewhere between three and five percent of the world economy.
So we’re talking about total investments on the order of roughly three to five trillion dollars a year. And that’s why when we think about climate finance, which does not include the totality of infrastructure, but certainly includes power generation, the transmission grid, the road and rail network which constitutes the core of the domestic transport, ports and airports, those are expensive and large amounts of investment. And in this sense, climate finance is a trillion, trillions of dollar a year activity.
Many questions are raised as to how this financing will get done, especially given the fact that we’re going to have to direct a lot of that financing towards investments that may be at a higher market cost than traditional investments, in other words, costs of power generation that may be more expensive apparently than investing in a coal fired power plant, but less expensive when we take into account the social cost of carbon.
And so to direct massive amounts of investment to sustainable low carbon infrastructure will require all of the normal means of financing, budgets of the government, state financial institutions, the private capital markets, the retained earnings of private companies that may be generating power or managing rail and so forth, plus new instruments of regulation and carbon pricing such as of course tradable emissions permits or a carbon tax.
But the basic idea is that this universe of trillions of dollars of infrastructure finance must continue, but change course under the pressures of regulation, carbon pricing, and other systematic parts of the deep Decarbonization pathway and be directed towards a low-carbon core infrastructure. This is one part of the overall climate finance puzzle. Some of the others of course are ways to pay for other categories of activities that we’ve been talking about at length.
Another part of the climate financing is the financing of the research, development, demonstration and diffusion of low carbon or zero carbon technologies. So this is another category, the RDD&D financing. Then there is a category of financing which is financing for infrastructure in part, but is directed towards the needs of the poorest countries.
And here the Green Climate Fund that has been established under the U.N. Framework Convention on Climate Change is under the agreements that have been reached by the parties to be a major instrument for financing infrastructure and climate adaptation of low-income countries. It is to be one of the main ways that a specific pledge of a $100 billion per year from high income countries for low income countries should be implemented. But the details of the role of the Green Climate Fund and how it will be financed, which countries will contribute, whether it will go to the market and how are still being debated and, and are as yet unresolved.
Then it’s been recognized under the Framework Convention that in addition to the financing of the new power sector or a new low-carbon transport there will have to be considerable financing for adaptation itself. Some of that is for the soft infrastructure of behavior and redesign of settlements ensuring that people are living outside of what will become new flood plains under changing climate conditions.
But also the hard infrastructure that protects low-lying areas such as The Netherlands, or New York City which are each implementing very large scale, tens of billions of dollars hard infrastructure. And I’ve just added a picture for you of many of the so-called Delta Works for this most famous of low-lying countries, The Netherlands, the low-lying lands of Europe, which has been battling the sea level for all of its existence, but as ocean’s levels rise and as storms become more intense, The Netherlands, which is perhaps the world’s leader in the technology of adaptation to sea level pressures has, is now implementing a project of more than a hundred billion dollars over the coming decades to protect itself against the changing ocean conditions. This famous Delta Works program is cutting-edge technology. It includes dikes, dams, levees, storm surge barriers of tremendous innovation and creativity because the designers and engineers are always balancing the physical protection with the protection of the ecosystems as well.
Now in New York City, we don’t have Delta Works quite in the same way, but Manhattan and other parts of New York City are also low-lying coastal zones that experienced a tremendous flooding during Super Storm Sandy. And in response to that, the New York City government under former Mayor Bloomberg put forward a twenty billion dollar plan like Delta Works, just illustrated in part here with new flood walls and surge protection barriers and so forth, showing that the adaptation agenda is partly behavioral and it’s partly hard physical infrastructure and financing of adaptation is going to be also a very pricey item given of course the fact that the climate related hydro meteorological disasters are now claiming also massive, massive losses of infrastructure and not to mention lives per year.
This brings us to another category of funding, agreed, but still not designed for losses and damages, experienced especially by poor countries. We don’t have an adequate global insurance system against hydro-meteorological disasters.
The low-income countries demanded it, they got assent in COP19 in Warsaw. And such a financing of losses and damages is now on, on the table for design. We also need financing for more general ecosystem protection and resilience. And here the global environment facility, which was created in part under the Framework Convention and partly under the Convention on Biological Diversity plays the unique role in the official world of financing resilience and protection of natural ecosystems and also human managed ecosystems. Well I hope that the list makes clear how complex this topic is from hard physical infrastructure of power generation and transmission and roads and rail to ecosystem functioning, protection against storm surges, research and development, help for the poor and compensation for losses and damages. The climate finance agenda is obviously extraordinarily complex.
What does financing even mean in this context? Of course it means financial resources devoted to these challenges, but the nature of those instruments is also extraordinarily varied and heavily debated I might add. The rich countries have promised the poor countries a hundred billion dollars in finance by the year 2020. But what do they mean by that? Do they mean private sector financing? Do they mean foreign investment? Do they mean loans? Do they mean grants? There are many categories of finance and some require repayment, others are essentially transfers. And when it comes to something as significant as the hundred billion dollars promised by the rich to the poor countries, the answer is we don’t know because it hasn’t been negotiated yet.
And there are very, very different opinions about it. I mention here some of the categories of finance, hardly exhaustive. Of course grants mean direct transfers of money that don’t need to be paid back. Loans are moneys that require repayment. The interest rate on those loans can be below market at which, in which case these loans are called concessional loans, or they could be at market terms.
There are also ways to extend guarantees to an agent, could be a city government that wants to borrow on the market in order to build infrastructure. And an outside entity, say the World Bank or the African Development Bank or another government could say, we will guarantee the repayment of the loan so you can borrow that funding on preferred terms.
And there is neither a grant, nor a loan but a credit guarantee which may come to almost the same thing as a loan. There can be insurance protection against various kinds of risks. There can be liability protection where a government says you build the carbon capture and sequestration facility, we will bear any of the liability that results if there’s an accident, if there is leakage, if there is loss of life. If there’s some other industrial problem, we’ll bear the responsibility. This is a, a big issue for nuclear power also where often governments take the liability of nuclear power even though the power company itself is in the private sector.
There are specific instruments on a flow basis where governments may say, we’ll buy directly from you a renewable energy producer at a preferred price, a so-called feed-in tariff. This is another powerful instrument of financing, it’s using the public purse itself, not in handing out a loan or extending a grant, but in paying for a service. And government procurement of machinery or government procurement of infrastructure or government payment for energy services is also part of climate financing.
Project financing means to finance a complex project such as the grand Inga Falls that I discussed earlier where perhaps $50 or $60 billion dollars could produce a 40-megawatt, sorry, gigawatt facility in.of hydropower in Central Africa. And that kind of project financing is itself a very complex challenge with multiple kinds of financial instruments included within the single project and the money coming from all different kinds of partners.
And as I discussed briefly about public-private partnerships for research and development, in general RDD&D programs are also multi-stakeholder. They have their own distinctive financial arrangements. Sometimes an inventor is given a prize, sometimes an inventor is given a patent, sometimes an inventor is told, if you make this invention, we extend your patent on another invention. Sometimes an inventor is just given a grant, use this money, hire staff and run your laboratory. So there are many, many ways to finance research and development programs.
All of this is to say that when we think about climate finance, not only are there multiple categories of financing, but there are many instruments of climate financing as well.
And finally I want to emphasize how many potential actors there are in financing, in providing in essence the saving that will go into the new low-carbon infrastructure and other low-carbon systems that are part of the deep Decarbonization pathways. So some of the actors of course include the private sector, the financial sector which raises bonds or equity for private investors. A lot of the financing is public. For instance the role of the public in building roads and rail in most countries and power in some countries. In the United States the power sector is heavily private, but in other countries the power sector is largely public investment.
Then there are many international financial institutions whose job it is, backed by governments, to provide funding to member governments. And the International Bank for Reconstruction and Development, the IBRD, colloquially known as the World Bank is a major funder of infrastructure projects in its developing country member states. Other multi-lateral development banks include the Inter-American Development Bank, the African Development Bank, the Islamic Development Bank, the Asian Development Bank. And now there are some new development banks that are started also. The BRICS Infrastructure Bank that is being created.
So there are many multilateral players as well. Many countries have national development institutions which are specialized institutions, either for tapping the market or collecting deposits where the loans are for usually public sector infrastructure. And this form of institution will play a major role as well. There are the new sovereign wealth funds, especially of natural resource exporting countries that collect their revenues in, at a very large scale and invest these public revenues in the private international marketplace. And sovereign wealth funds command vast, vast sums now, some of which will be directed towards the low-carbon infrastructure. There is the new Green Climate Fund which I mentioned briefly just a moment ago which has been established under the Framework Convention to Finance Low-income Countries. The Global Environment Facility which I mentioned earlier. And distinctively within the private sector financing are a set of institutions that are almost by nature oriented or at least should be oriented towards long-term investments.
These are institutions that take not the site deposits of a commercial bank, but long-term inflows that don’t pay out for decades to come. Pension funds would be the quintessential example of this. And pension funds have vast asset bases at this point of trillions and trillions of dollars. And they are natural investors in long-term infrastructure such as low-carbon power generation or electric public transportation and so forth. Similarly insurance companies that are providing for example life insurance would take in vast sums and make investments for the long-term. And they’re another candidate for transforming long-term international saving into the long-term investments that will be required for financing a low-carbon infrastructure.
The final point that I want to mention about climate financing is it’s not only about the money, but about the rules for deploying the money. And one of the most interesting and perhaps powerful ways that funding can be directed towards low-carbon projects and away from high-carbon and high climate risk projects is through new reporting and disclosure requirements on the private sector itself.
Many companies bear a tremendous amount of climate risk that isn’t necessarily exposed to the marketplace. An oil company bears the risk that it may end up having to strand its res…its, its oil reserves because as we’ve discussed, we can burn all of the oil, gas and coal reserves that we have, but those reserves are typically reflected in the market capitalization of companies.
And there is now an effort to say to companies, you must disclose your vulnerability to assets being stranded. There is an important carbon tracker initiative which is battling out in, in public right now with the different companies saying, your assets are at risk of stranding and your investors need to know it. And the companies often come back and say, we’re going to burn all that we want or we’re going to ship all that we want. But in fact there is a carbon budget and investors are going to need to know about it and the oil companies are going to be priced with an appropriate understanding of the true carbon budget.
More generally, even outside of the fossil fuel sector companies have a lot of exposure. They may be big carbon using countries–companies and big CO2 emitting companies. And in the event that the price of CO2 charged to these companies goes up through a carbon tax or through a tradable permit system, or implicitly through regulation, companies that are big energy users are going to find that also they are going to bear the cost of their heavy CO2 emissions. And a number of disclosure initiatives such as the Carbon Disclosure Project are saying to companies, you must describe your CO2 emissions in detail so that investors know what the risks are.
And very recently the large-scale global insurance and reinsurance industry has said the same thing, companies must disclose their risk to climate-related disasters, both so that insurance can help to cover those risks so that investors know what the potential losses are and so that investments that shouldn’t be made in flood plains or in areas of great risk of drought or great risk of other kinds of extreme events shouldn’t be undertaken in the first place and disclosure can warn away investors who otherwise might naively invest in such projects.
I wish I could draw a bottom line. The only bottom line I can tell you is that we have tens of trillions of dollars of investment at stake over the coming decades in climate financing. This is a highly varied, very complex, a multiple actor framework that we’re going to need. A lot still needs to be built. A lot of new institutions will form and a lot of thought is going to have to go into ensuring that the financial resources are available to carry out what the world needs to accomplish and that is the transition to a low carbon world energy and infrastructure system