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In-Focus article on Investment and financial flows to address climate change

Investment and financial flows to address climate change

Addressing climate change in the next 25 years will require significant changes in the patterns of investment and financial flows. The UNFCCC secretariat has launched a project in 2007 to review existing and planned investment and financial flows in a concerted effort to develop an effective international response, with particular focus on the needs of developing countries.

The experience and views of a number of international financial institutions were sought, including United Nations agencies, IGOs, NGOs and representatives of the private sector.

The main background paper related to the project assesses the investment flows needed in 2030 to meet worldwide mitigation and adaptation requirements under the different scenarios of social and economic development, and the resulting impacts on developing countries.

The paper draws on existing work and analysis wherever possible, including the Intergovernmental Panel on Climate Change (IPCC) Fourth Assessment Reports of Working Groups I, II and III, International Energy Agency (IEA), World Energy Outlook (WEO-2006), Stern Review and other published literature.

Future investment and financial flows needed

According to the study, the additional estimated amount of investment and financial flows needed in 2030 to address climate change is large compared with the funding available under the Convention and its Kyoto Protocol, but small in relation to estimated GDP (0.3 to 0.5%) and global investment (1.1 to 1.7%) in 2030. In particular:

• Mitigation measures needed to return global GHG emissions to current levels in 2030, require an increase in global additional investments and financial flows: between USD 200-210 billion in 2030.
• For adaptation, additional investment and financial flows needed for in 2030 amount to several tens of billions of USD.

The fact that total investment in new physical assets is projected to triple between 2000 and 2030 provides a window of opportunity to direct the financial and investment flows into new facilities that are more climate friendly and resilient. The investment decisions that are taken today will affect the world’s emission profile in the future.

Particular attention will need to be given to developing countries, because although they currently account for only 20–25 per cent of global investments, their expected rapid economic growth means that they will require a large share of investment and financial flows:

• More than half of all the energy investment needed worldwide is in developing countries.
• Investment flows needed for developing countries is estimated at about 46% of the total needed in 2030. The resulting emission reductions achieved by these countries in 2030 would amount to 68% of global emission reductions.
• Additional investment and financial flows for adaptation in developing countries is estimated between USD 28 to 67 billion.

Potential for enhancing investment and financing mechanisms

When considering means to enhance investment and financial flows to address climate change in the future, it is important to focus on private-sector investments, as they constitute the largest share of investment and financial flows (86 %).
In order to mobilize the investment and financial flows necessary to address climate change, there must be an improvement in, and optimal combination of, mechanisms such as the carbon markets, the financial mechanism of the Convention, ODA, national policies, as well as new and additional resources.

Potential of carbon markets: The carbon market is already playing an important role in shifting investment flows, which demonstrates how quickly these flows can respond to changes in policies and incentives. The CDM is showing significant potential, with CDM project activities in the pipeline in 2006 estimated to have generated investment of about USD 25 billion. The analysis suggests that the supply of Kyoto units will be abundant compared with the level of compliance demand for the period 2008–2012. A high post-2012 demand for emission reduction credits (market of USD 100 billion per year) could allow the expansion of existing market mechanisms, which would in turn stimulate additional credits. Since policy certainty is important for investors, a longer-term international agreement on climate change broadens the range of mitigation measures that are attractive investments.

Potential of the adaptation fund: The level of funding available to the Adaptation Fund depends on the quantity of CERs issued and their price. Between 2008 and 2012, funding is estimated at about USD 80-300 million. For post 2012, the Fund depends on the continuation of the CDM and the level of demand in the carbon market. Assuming that the concept of share of proceeds for adaptation continues to apply post 2012, the level of funding could be USD 100−500 million for low demand by Annex I Parties in 2030 for credits from non-Annex I Parties, and USD 1−5 billion in 2030 for high demand. Since the funding available to the Adaptation Fund would fall short of estimated needs, the Fund could be expanded from additional sources.

Potential of the financial mechanism: If the funding available under the financial mechanism of the Convention remains at its current level and continues to rely mainly on voluntary contributions, it will not be sufficient to address the future financial flows deemed necessary for mitigation and adaptation.

Potential of ODA: Least developed countries, such as Sub-Saharan Africa, and smaller developing countries, are likely to attract very limited private sector investment and will continue to rely on ODA and soft loans from international financial institutions.

Options for new sources of funding

Some of the options suggested in the study, such as the expansion of the carbon market, could generate revenues commensurate with the additional investment and financial flow needs, but would require further analysis and agreement at the intergovernmental level.

International coordination of policies

Since governments set the rules for the markets in which investors seek profits,
international coordination of policies by Parties in an appropriate forum will be most effective. Areas where international coordination would be beneficial include technology R&D and deployment, and energy efficiency standards for internationally traded appliances and equipment.

Due to the complexity of the systems involved, it is critical that some widely supported, relatively simple and actionable themes be developed around which post-2012 agreement can be constructed. Doing so will give the investment community both the rules it needs to predict risks and returns, and the necessary room for innovation in order to realize both financial and social returns.

For more information see: http://unfccc.int/cooperation_and_support/financial_mechanism/items/4053.php