New instruments touted for climate change projects

A paper from Climate Change Capital identifies instruments that the United Nations’ Green Climate Fund could use to mobilise private sector investment into climate change mitigation projects. At present, it says, various barriers and risks are preventing the flow of capital required.

The use of various instruments for different types of project can help to unlock the private sector capital that is currently failing to find its way into climate change mitigation projects in the volume  required. That’s the conclusion of a publication produced by Climate Change Capital, the investment management and advisory firm.

The paper highlights instruments that could be applied by the private sector facility of the Green Climate Fund (GCF), which was launched last year at the United Nations Climate Change conference in Durban, South Africa as a means of assisting developing countries to counter climate change. The fund aims to raise $100 billion a year by 2020 and was given $30 billion of “fast start funding” for the period 2010 to 2012.

“Financing instruments employed by the private sector facility of the GCF can either help mitigate specific risks associated with investments in climate change mitigation projects, lower the cost of capital or help support the economic signal, directly impacting the revenue of a project,” says the paper.

It suggests different approaches for four different types of project:

1. In renewable energy projects, such as wind power, the GCF private sector facility could “enhance or fund the payment of the tariff in cases where the economic signal is inadequate”. If the economic signal is sufficient but there are significant counterparty risks, the facility could guarantee or insure the power purchasing agreement (PPA). A first-loss guarantee could achieve this “which could be modelled on the monoline insurance model”.

2. For energy efficiency projects, where the economics are often adequate, the GCF private sector facility “should consider instruments that guarantee or insure agreements covering loss from default”. Where energy prices are distorted through subsidies “it may not be efficient for the GCF to provide performance-based payments for energy savings through a PPA”. The GCF should look to provide funds “for the refinancing of performance contracts or guarantee the receivables, which would help recapitalise Energy Service Companies to develop further energy efficient projects”.

3. For industrial gas projects, where incentives to reduce emissions may not exist, the GCF could provide “an economic signal to incentivise emission reductions”. This could be done through an Emission Reduction Underwriting Mechanism (ERUM), a type of performance- or results-based payment to projects.

4. An ERUM could also be applied to the waste sector, “where the economic signal is generally inadequate or inexistent, to stimulate the development of a competitive waste management industry”. For non-captive projects, the facility could provide “an insurance mechanism that can insure against counterparty risk”.

“There is a significant opportunity for the GCF to mobilise private capital to invest in climate change mitigation projects. However, in order to be effective, it is critical that the GCF private sector facility considers the requirements of investors and the variation of risk across project types and stages,” the paper urges.

The publication – entitled The Green Climate Fund and private finance: Instruments to mobilise investment in climate change mitigation projects – was written by Climate Change Capital senior executives Steven Gray and Nicholas Tatrallyay.