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Douglas Marett

204 w

Climate Finance in 5 Minutes: There is More to Climate Finance than US$ Trillions


On Earth Day (April 22nd) We Don’t Have Time will host the virtual event “Finance the Race to Zero”, this should be very informative and everyone is encouraged to attend. This article is not coordinated with We Don’t Have Time, but it is offered in the hope that it will underpin the message and common understanding gained during the virtual event.

Boiling Down Climate Finance

If one does a news and information search on climate finance, one quickly runs into broader public communications addressing global negotiations, large expert events, and general media articles about high dollar programmes. The majority of this communication is disproportionately focused on macro-level climate finance efforts. These efforts include topics such as the US$ 100 billion annual support goal for developing countries under the Paris Agreement, the European Green Deal, and the American Jobs Plan amongst others. All of which attempt to address the large amount of capital needed for the paradigm shift to a global green economy. These efforts, and related discussions, are critical to securing this capital. However, there is not enough discussion and public understanding of the finance efforts and actions which ensure implementation of climate actions. In simpler words how does all this capital of US$ Trillions actually work to reduce climate impacts for the everyday person and their neighbours.
To make it simple we must boil one hundred litres of water down in to one litre, by using only one concrete example. This means that of the many elements of climate finance, this article only focuses on three: incremental finance needs, financial instruments, and blended finance.
For this article we use the example of a mitigation action for instituting an e-bicycle programme for households in a hypothetical small city called Greenhaven. The goal of the Greenhaven government is to reduce the use of cars on its roads by encouraging a greater use of e-bicycles, to bring bicycle use from the current 10% to 40% of all person-trips, which are on the average 5 km. Greenhaven's goal will both address GHG emissions and lower traffic congestion as the city’s population increases over time. This action is on top of the city’s other goal to increase public transport availability which has a very high capital need and will not start operation for at least another five years. To simplify this example, it is assumed that GHG emission from the use of electricity for transport will always be lower than the use of petrol / diesel fueled cars. This example also disregards the possibly that major infrastructure changes are also needed for the increase in bicycle use (e.g. bicycle lanes for existing road and bicycle paths).


Incremental Cost

An incremental cost is the difference in cost between what a household in Greenhaven would normally pay for the most common used transport service or product in their city and what would be paid for the greener service or product. An example of incremental cost is the difference between buying and operating a standard model Toyota car and a Mercedes-Benz car. Figure 1 illustrates this incremental cost, where Option 1 shows the incremental cost between operating a standard bicycle (incl. investment, maintenance…etc.) and operating an e-bicycle from day one when the improved public transport system is not available. While Option 2 shows the incremental cost between the future public transport service and operating an e-bicycle. In both Option 1 and Option 2 the operating cost are higher than the operating cost of the standard bicycles. Note that the incremental cost in both options includes the soft costs of capacity building and technical assistance that the city and households will need to cover in some way in addition to the investment and operating costs of e-bicycles.

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Financial Instruments

The capital of US$ Trillions discussed in the beginning of this article will eventual be distributed in the form of different financial instruments. In climate finance there are over thirty types of commonly used financial instruments, many structured in different ways to meet the needs of the action and the parties involved, and for brevity this article presents only nine financial instruments. Figure 2 illustrates how these nine financial instruments are used to finance both the implementation and operation & maintenance of the action for e-bicycles in Greenhaven.
Since the e-bicycles are substantially more expensive than normal bicycles, the bicycle shops who import the e-bicycles benefit from a Lower Import Duty of 0%. The bicycle shops also benefit from a low interest Commercial Loan Facility that provides part of the capital to pay for the bulk import of e-bicycles, and this loan facility is backed by an International Guarantee which insures a lower interest rate for the loan. In addition, the bicycle shops put in their own Commercial Equity (the cash they have available) to cover the remaining cost after the loan of importing the e-bicycles. The combination of the financial instruments supporting the bicycle shops lowers the overall investment cost for shops and eventually the consumer.
Image of post in post detailed view


Consumers then receive a Direct Subsidy when purchasing an e-bicycle which covers part of the investment cost and is usually equal to the incremental cost mentioned previously, after the benefit of other financial instruments are considered. This Direct Subsidy is paid for by an International Grant provided free of charge by a development agency or foreign government partnering with Greenhaven. This Direct Subsidy will only last until the improved public transport is implemented (e.g. when incremental cost Option 2 becomes effective). Consumers then pay for the remaining cost of the e-bicycles through their own Household Equity (Savings), and if the financial instruments are well prepared the remaining cost is equal to the cost of a standard bicycles as indicated in Figure 1.
During the operation of the e-bicycles consumers use a part of their Household Equity (Savings) to pay for the cost of maintenance. The maintenance cost is lowered slightly through a programme on Capacity Building for E-bicycles Maintenance provided to the bicycle mechanics for free and is supported by a different International Grant. Both investment and maintenance costs are further lowered through the economies of scale (e.g. greater volumes of e-bicycles in the city) via Capacity Building for Behavioural Change that encourages the greater use of e-bicycles and is paid for annually by the Annual State Budget. Then the state gains tax revenues from a 2% Higher Fuel Tax which covers the lose of sate revenues from the lower import duty and pays for the behavioural change activities.


Blended Finance

Blended finance is the act of using several financial instruments under one scheme as shown in Figure 2, and also when several sources provide capital for a single financial instrument. For the later this may be the case of the guarantee shown in Figure 2 which covers the risk of a loan facility, where the capital needed for the guarantee is partially covered by an International Financial Institution and the remaining capital need covered by the national bank of the government where Greenhaven is located.
Blended finance will increasingly become more common in climate finance because different sources of capital have different criteria and targets on how money should be used. This creates complication, and in effect means that financing long term and broader actions for climate change is like piecing together a puzzle of different financial instruments from multiple sources.
The e-bicycle action in Greenhaven presented in this article shows that climate finance is more than just big-ticket government programmes and development aid. Climate finance requires a lot of initial work to develop the financial instruments needed to address climate actions, and many sources of capital to fill those financial instruments. The e-bicycle action in Greenhaven also shows that for long-term sustainability of climate actions, climate finance is continuous and that more than just money is needed to ensure that climate actions happened effectively over time (e.g. capacity building, technical assistance, and technology transfer).

About the author: For nearly two decades Douglas Marett has participated in, or lead teams for, addressing GHG mitigation, adaptation, and climate finance for climate actions in more than thirty countries worldwide. Douglas’s more recent activities focus on national and sector investment planning and measuring, reporting, and verification of climate actions.

  • Muhammad Fahd Khan

    •

    204 w

    Very good article!

    1

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