It’s urgent to fund climate solutions in developing nations. The risk of climate-related adversities particularly affects the poor, who already suffer disproportionately from these impacts. Direct government funding is scarce in the least-developed countries. Hence, climate change investment needs are significant.
One way to address this gap and also reduce investment risks is to use results-based climate finance. This is a financing model designed for projects in which payment is made only when the desired outcome is achieved.
According to the World Economic Forum, $5.7 trillion in green investment is needed annually by 2020 in developing nations. This is equivalent to shifting $5 trillion in business-as-usual global investments into green investments – including $1.5 trillion into climate finance. To realize this vision and mobilize resources at the scale required, public and private players need to work together effectively.
Significant Gaps Still Exist
According to the 2017 United Nations Climate Press Release, significant gaps still exist in funding at the scale required to deliver a fully decarbonized and resilient global economy by 2050. Climate Policy Initiative estimates that of the total $331 billion dedicated to climate finance in 2013, only $34 billion went to the developing countries. This left a gap in the annual commitment of about $70 billion.
World Bank, the private sector, and financial institutions are working on ways to mobilize the remaining $70 billion by 2020. The Green Climate Fund, established by developed countries in 2010 to provide finance for developing countries, has raised $10 billion in climate finance.
Finance mechanisms such as green bonds with low risks for investors are becoming steadily more attractive for climate-friendly funding in developing countries. Policy choices such as carbon pricing or carbon taxes are used for raising revenues as well as encouraging emissions reductions in low-income countries.
Results-Based Climate Finance Is Expanding
A report published by the World Bank and Frankfurt School, “Results-Based Climate Finance in Practice: Delivering Climate Finance for Low-Carbon Development,” reviews 74 results-based climate finance programs implemented in developing countries. The report assessed the characteristics and overall volume of funding flowing through programs using this model. According to this report, this model can facilitate carbon pricing and market building.
This financing model can leverage private-sector activity. Therefore, it can play a critical role in mobilizing the resources and supporting the actions needed to achieve the objectives of the Paris Agreement. These projects come from many regions: Sub-Saharan Africa, Latin America, the Caribbean, and the Asia-Pacific.
Despite progress with results-based crediting mechanisms, significant hurdles still remain. The major gaps, as shown by the report, are lack of transparency, monitoring, evaluation and scaling. Another barrier is the lack of implementation pathways due to the existing political framework in least-developed countries. Also, most projects are designed to address climate change mitigation rather than adaptation. This is because the desired outcome of the latter is harder to measure and evaluate in monetary terms.
This Model Can Play an Important Role
Clean Energy Finance Forum reached out to the PR team of World Bank to discuss the successes, assess the future, and discuss barriers to this model.
According to World Bank staff, this model is an effective tool for mobilizing resources that help improve energy access in the least-developed countries by partnering with the private sector, nongovernmental organizations, local communities, and government agencies. The approach helps to overcome institutional, financial and structural hurdles for the development of small-scale renewable energy projects.
A key to success is the effective use of various sources of funding, World Bank staff said. Understanding the complementarities of these sources is also important. It’s also crucial to develop the ability to share risk to get the funding off the ground.
In addition, another success factor is the enabling policy and regulatory framework, according to World Bank. This includes standardized power purchase agreements and simplified regulatory rules. These can relieve some of the transaction costs for small renewable power projects. Another key element is the dedication of rural communities who collaborate with these agencies to run small renewable energy power plants.
However, World Bank staff said there are still major challenges that need to be addressed for better implementation. Lack of financing and equity investment for renewable energy projects still remain a major barrier for developing nations. Banks and investors are hesitant to provide credit for projects with longer payback periods. This method of blended financing is a complex one. It will require tremendous effort to achieve scale and measurable impact.
CEFF: Can you provide some recent examples of successful results-based climate finance programs?
World Bank: World Bank’s Carbon Initiative for Development (Ci-Dev) delivers results-based climate finance to innovative energy-access projects in the least developed countries. One example of such a project is Inyenyeri.
The Inyenyeri system pairs fuel-efficient gasification stoves with sustainable biomass fuel pellets made in Rwanda. The stoves require 90 percent less biomass compared to charcoal. This dramatically reduces greenhouse gas emissions from the households. However, Inyenyeri struggled to find the funding to scale up the project beyond a pilot.
The results-based finance model delivered by Ci-Dev was the solution. In June 2017, the trust fund signed a purchasing agreement to buy up to 1 million certified emissions reductions generated by Inyenyeri through the end of 2023. This results-based guarantee helped the business secure a €8 million loan from private-sector investor Althelia Ecosphere.
This provided a solid financial foundation. Inyenyeri received the means to scale up its operations and provide thousands of Rwandan households with clean cooking. Apart from reducing air pollution and improving respiratory health, this also led to free time for income-generating activities. By 2018, Inyenyeri’s customer base grew by 70 percent.
Another successful results-based climate finance venture is the Tanzania Renewable Energy Program. The Tanzania Rural Energy Agency, in collaboration with the World Bank’s Carbon Partnership Facility, designed an innovative financing scheme.
It monetizes carbon credits from private renewable energy projects to fund part of their equity needs. This is a blended carbon finance model to raise equity for small renewable energy projects in Tanzania.
This funding mechanism supports small rural renewable energy projects. It simplifies the regulatory rules and procedures for power purchase agreements thereby reducing transaction costs. It also creates a subsidy scheme for new connections in the form of performance grants and technical assistance in the form of matching grants for project developers.
The Rural Energy Agency also provides a line of credit to Tanzanian financial institutions for long-term lending to the projects.
This program resulted in lowering 17,000 tons of CO2e in 2016. It generated over 27,000 MWh of electricity which is enough to power about 53,000 Tanzanian households. Additionally, around 20,000 carbon credits were generated.
CEFF: What is the future of results-based climate finance for clean energy markets in developing countries?
World Bank: Results-based climate finance is gaining momentum as a financing modality to support greenhouse gas mitigation activities in developing countries.
Results-based climate finance has characteristics that are of particular importance in climate change mitigation such as:
- It has the potential to catalyze domestic carbon pricing and international market solutions. Results-based climate finance purchases mitigation outcomes, provides a price signal, and can pilot new market mechanisms.
- It increases country ownership and supports mitigation policy implementation. An example is the feed-in tariff policy – as in the case of the Uganda Getfit program.
- It crowds-in private sector activity including commercial financing.
CEFF: Are there any barriers to implementation? Are there ways to measure them?
World Bank: There are two main barriers to results-based climate finance: Monitoring/Reporting/Verification (MRV) capacity and access to upfront financing.
The Clean Development Mechanism created some MRV capacity in developing countries. Under this initiative, emission-reduction projects in developing countries can earn certified emission-reduction credits. Historic participation rates in the CDM are a good indicator of MRV capacity. Another MRV tool is the existence of domestic carbon pricing schemes.
The market for project financing is a good indicator of the availability of upfront financing. In a country where even traditional forms of project financing (i.e., based on power purchasing agreements) is not available, monetizing results-based climate finance payments will be difficult.
CEFF: How can organizations mitigate or reduce these barriers?
World Bank: Successful results-based climate finance programs are integrated with broader support programs. They can be combined with capacity building and upfront financing where required.
Note: Report authors from Frankfurt School were unavailable to comment.