How can we scale up the finance needed for climate action?

Climate action requires policy changes and also has enormous financing needs that come at a time when the world is facing immense fiscal challenges.  Even with the right policy environment, low-carbon and climate-resilient infrastructure in low- and middle-income countries could require investments of around $1.6 trillion annually from now to 2030, or 4.5% of their GDP.^[1] Other sectors – from agriculture to industries – will only increase this financing need. Some of this can be delivered through private capital toward commercially viable projects, but some cannot and will require public support. Core to the challenge is that some of the needed interventions currently lack the incentives and capacities to make them happen, and may require concessional and/or grant financing, especially in low-income countries.

While all countries are expected to contribute to global public goods (GPGs), including emissions reduction, their responsibilities and need for support differ.  Low-income countries have contributed little to historical greenhouse gas (GHG) emissions, have lower institutional capacity and other pressing development needs. They cannot be expected to contribute to emissions reductions to the same extent as richer countries and will need more concessional resources.

In this post, we try to identify the investments and interventions that are key to successful and cost-effective climate action but may need some additional support , especially in low-income countries, acknowledging that putting in place the right policy and regulatory environment will be critical to maximize the GPG impact of the concessional resources. We also provide ballpark estimates of the concessional resources needed and canvass the possible sources of finance. 

What types of interventions are needed?

Many interventions that are efficient and essential to reduce global GHG emissions would not meet private sector investment criteria, even with below-market financing and risk absorption (de-risking) from development finance institutions. Such interventions would require concessional resources and/or grants based on their ability to reduce emissions. This support may come from domestic or international resources, with different shares for countries at different income levels. There are three main types:

1. Some projects reduce emissions but will not be implemented without initial concessional and/or grant support for system planning or project preparation. These kinds of projects are difficult to launch due to large preparation costs and high risks, so early stage technical assistance and concessional support and/or grants can help, including the preparation of infrastructure masterplans.^[2] Such support is currently provided through Trust Funds (TFs) or Financial Intermediary Funds (FIFs), such as the Global Infrastructure Facility (GIF), Climate Investment Funds (CIFs), Energy Sector Management Assistance Program (ESMAP), City Climate Finance Gap Fund, Global Facility for Disaster Reduction and Recovery (GFDRR), and the Public-Private Infrastructure Advisory Facility (PPIAF). But their support is fragmented, and their funding is dwarfed by the number and scale of projects of this kind that are needed.
    
2. Some projects reduce emissions and generate GPGs, but they are not commercially viable if only their domestic benefits are accounted for: these projects face a funding and affordability challenge. In such cases, a public subsidy, either from domestic sources or from international sources, can monetize the GPG benefits. This is especially relevant for low-income countries, for example, for investments in electricity grids or storage that will enable private investments in renewable energy. While technical progress and economies of scale are likely to increase the return of such projects over time,^[3] they often make economic sense even before commercial viability. In these cases, concessional resources can reduce the cost of the transition. Funds like the Green Climate Fund (GCF), TFs like ProGreen, ProBlue, ProClean or the Climate Emissions Reduction Facility (CERF), and the grant component of FIFs and CIFs, such as the Forest Carbon Partnership Facility (FCPF) and the IBRD GPG Fund, provide a subsidy to cover the GPG component of a project. But again, these funds do not have the volume of finance, nor the capacity or mandate to address the enormity of the transition needs. Carbon markets may over time also provide a complementary flow of financial benefits to increase expected returns of projects that reduce carbon emissions.
    
3. Some interventions are compensations and may bring no financial returns, even though they bring large GPG benefits and/or social benefits essential for a just transition: these need public resources, including concessional or grant support in lower-income countries. From a government’s perspective, these entail explicit or implicit liabilities. Explicit liabilities include the renegotiation of power purchase agreements (PPAs) and compensations to asset owners when coal-fired power plants close before the end of their lifetime. Implicit liabilities include social expenditures, such as support to workers and communities affected by mine closures, through retraining programs and infrastructure. While explicit liabilities can be objectively quantified, the value of implicit liabilities will depend on several more factors, including the country’s approach to just transition and the role of the coal sector in the economy.

One intervention may include several of the types above. The complexity, while having its own set of challenges, creates opportunities for creative financial arrangements and blended finance solutions and can benefit from the broad WBG suite of solutions. For instance, a project to close a coal power plant might include: (1) the renegotiation of the PPA, which is an explicit liability; (2) the compensation of the workers and affected communities, which are implicit liabilities; (3) the construction of a utility-scale solar power plant for the future, which is a bankable project; and (4) investments in transmission and storage. Similarly, a landscape management project could include a mix of: (1) investments that are attractive to the private sector in sustainable forest management; (2) the management of a protected area that could benefit from flows from carbon markets, concessional resources, or grants; and (3) the implicit liability of workers and affected communities who have few if any alternative livelihoods.

How much will be needed in low- and middle-income countries?^[4]

First, we want to emphasize that the estimates proposed here are partial and uncertain and should be used as orders of magnitude. They depend heavily on the country and sector context, such as the details of PPAs, the distribution of effort between private and public sectors, and the extent of social expenditures that governments provide to affected workers and communities. They are also partial because they focus on the energy sector and especially coal, whereas in some countries other sectors may be affected just as much as coal.^[5] Furthermore, a country’s circumstances and income status will affect its access to concessional support, with higher-income countries expected to contribute more their own resources to emissions reduction and the management of transition costs.

It is also important to recognize that policy reforms are key to bringing down costs across the board: countries need to ensure that policy incentives for new investments are aligned with their long-term climate and development objectives.^[6] These reforms often face significant transaction and transition costs and can be politically sensitive, which often results in costly delays. Concessional resources can help to reduce these costs, accelerate reforms, promote development, and have large impacts on GHG emissions by affecting all investments in a country. With current policies and regulations, the need for concessional resources increases over time, but with prompt policy action, the costs will be lower.

Depending on the context, exit from coal could be accelerated with support toward:

• Explicit liabilities from coal power plants that will be retired before the end of their lifetime. The total stranded value (i.e., lost income from existing coal power plants between now and 2050) ranges from $100 billion to $1 trillion, depending on how quickly the transition takes place and whether new coal power plants are being built.^[7] This would suggest compensation to owners of between $3 billion and $35 billion per year. Actual financing needs would depend on contractual arrangements. Much of this would be for coal power plants located in middle-income countries in East and South Asia, particularly China and India.
• Implicit liabilities to support affected communities and workers. Social costs from closing coal power plants and mines are estimated at about $60 billion per year, so around $1 trillion from now to 2040.^[8] These liabilities focus on roughly ten countries that are home to most of the world’s coal workers. Notably, many coal mines are already unprofitable and buttressed by public subsidies, so repurposing those funds may reduce the amount of external support needed. Meanwhile, the economic viability of coal is declining due to changes in technologies, so not all the transition costs are genuinely GPGs. In addition, there are considerable uncertainties regarding the additional costs to support workers that are indirectly, or informally, employed in coal mining areas and their communities.
• Large investments are also needed to accelerate clean energy and improve energy efficiency, which will in time prevent new coal generation projects and replace existing coal power plants. The availability of concessional resources can help make alternative power generation projects (along with needed investments in storage and the grid) more attractive for private investors. Based on past-experience, the scaling up of clean energy projects may require 10% in grant-equivalent financial support, placing the needs assessment at about $100 billion per year, with significant uncertainties depending on the policies and regulations in place in each country, the pace of emission reductions, and the distribution of efforts before and after 2030.^[9]

What are possible sources of funding?

Clearly, emissions reduction will require enormous investment from a global coalition of actors. The categories of concessional finance include:

• Multilateral climate finance – these resources support projects and interventions through many channels, including Multilateral Development Banks, GCF, CIFs, and other dedicated funds.^[10] These are large vehicles, each with their track record. However, their volumes remain relatively small compared to the scale of the challenge, and they could be scaled up.
• Users through user fees – for instance fees on energy expenditures or ratepayer-backed “securitized” bonds. Rates paid by electricity customers include tariffs that are currently directed toward coal plant investors but could contribute to emissions reduction.^[11]
• Taxpayers – the public finances social protection in most countries and can contribute to the social expenditures needed for a just transition, although this contribution will differ for lower-income countries compared with richer countries. But fiscal space is tight in many countries, and the amounts available will depend on domestic resource mobilization and spending priorities.

• Philanthropies – these can provide support, especially in terms of technical assistance, project preparation, or blended finance. While philanthropies have historically allocated relatively small funds to climate change, there is increased interest.
• ESG capital markets – as institutional investors make climate commitments, these investments are growing. Innovative financial products such as the Rhino Bond facilitated by the World Bank can enable private sector investment in GPGs with pay-for-success mechanisms.
• Bespoke contracts can connect the global community to projects that reduce GHG emissions – for example, companies making net-zero commitments may want to enter direct contracts that demonstrate a reduction in emissions relative to a baseline, trend line or status quo ante.
• Carbon markets, including regulatory and voluntary markets – over time, these may grow enough to provide substantial resources for emissions-reduction projects, but they require robust eligibility and compliance standards. One such solution we have put forward, for which we are currently doing a market sounding, is a financing platform that would pool private sector contributions in support of their climate action and net zero commitments. The platform could finance high impact GHG emissions-reducing investments with high carbon offset generation potential in emerging markets, including coal decommissioning, nature-based solutions, new and emerging technologies, and energy efficiency.

The scale of the challenge cannot be underestimated. For its part, WBG is actively exploring ways to mobilize international public and private finance to integrate climate and development. But in parallel, the GPG nature of climate change and the challenges faced by lower-income countries make concessional resources a requirement to an efficient and just transition. Existing instruments have a track record of efficiently channeling funds to projects that will reduce GHG emissions, but need significantly more funding from the global community. Ensuring a cleaner and sustainable world for all will require unprecedented levels of finance and cooperation. 

[1]World Bank (2019), Beyond the Gap Report. https://openknowledge.worldbank.org/handle/10986/31291.

[2] Such plans are the basis for the development of good projects. For instance, ESMAP has supported power sector planning, a pre-requisite for the integration of renewable energy in the grid. GFDRR grants are used to help governments ensure that their investments are resilient to current and future climate and disaster risks, therefore reducing future maintenance and repair costs and improving expected returns.

[3] In the sense that the size of the subsidy for their contribution to global public goods can decrease over time, as was observed for technologies like solar photovoltaics.

[4] This section provides estimates for funding needs for projects with a strong GPG component. However, it is critical to keep in mind that these needs are not written in stone and depend on the policy environment, regulations, and prices. Further, the estimates provided in this section are uncertain and partial, as needs estimates in some important sectors are missing and cannot be assessed at this point. These estimates should therefore be considered as orders of magnitude -- provided to inform the debate on the support needed to achieve objectives.

[5] Methane emissions are important and offer opportunities for low-cost reduction, but these projects can be made attractive to private sector investors with the right policies.

[6] According to recent studies, “about two-thirds of the required stranding [of coal power plants] is linked to electricity that will be generated in plants that have not been built yet but are in the pipeline”.[1] Avoiding new construction of coal power plants is a priority to keep these costs manageable.

[7] https://www.sciencedirect.com/science/article/pii/S0040162514000924; and World Bank estimates

[8]There are 2,000 GW of coal power in the world. Assuming 500 workers per GW, it means around one million workers in coal power plants. There are 5 million coal miners in the world (3 million in China, 400,000 in India, 250,000 in Indonesia, 150,000 in Russia, and between 40,000 and 110,000 each in South Africa, Poland, Vietnam, Ukraine, Australia, Colombia, Turkey, and the US. See the “Global Perspective on Coal Jobs and Managing Labor Transition out of Coal: Key Issues and Policy Responses” Report -https://openknowledge.worldbank.org/handle/10986/37118). We assume that each supported person receives the equivalent of 2 years of annual income (estimated at $10k per year on average). To account for people indirectly employed and the effect on the broader community, we assume that support needs to go to 2 persons per worker in a coal power plant and 10 persons per coal miner (i.e., a total of 52 million people).

[9] In AR6 IPCC scenarios consistent with the 1.5-degree objective, global annual investment needs by 2030 are between $700 to $1,600 billion in the power sector and between $500 to $1,700 for energy efficiency, with 2/3 of the needs in developing countries. The total reaches $800 to $2,200 billion in low- and middle-income countries. The need for concessional support (here at 10%) may go down as technologies improve, or up as we move to more difficult decarbonization sectors. As mentioned earlier, appropriate policies could reduce this need (and bad policies, such as poor public spending efficiency, could increase it markedly).

[10] In the case of IBRD, its long maturities also help to align financing needs and repayment flows over the NDC horizon.

[11] Such bonds have been used to raise more than $38 billion in the US.