Bridging the climate finance gap: Challenges and opportunities for sustainable growth
Negotiations at COP29 might head towards a bigger commitment on climate finance, but emerging economies must also rely on mobilising private capital for climate adaptation and mitigation.
A “cruel arithmetic” lies behind the quest for a global green transition. Even if OECD countries stop all emissions tomorrow, the rest of the world will still need to reduce emissions by 85% by 2100 to keep warming within a 2 degrees Celsius band. On top of this, large investments into climate adaptation are required.
The plummeting costs of renewables, batteries, and other innovations is making this challenge feel less remote. Falling costs, however, do not guarantee investments. The financing gap remains immense.
Finance is at the heart of the COP29 negotiations that are currently underway in Baku, Azerbaijan. A new New Collective Quantified Goal on Climate Finance (NCQG) is on the table. By 2035, USD 1.3 trillion a year may be needed, well above the USD100 billion of the previous commitments. For comparison, new capital expenditure in offshore oil and gas alone has exceeded USD 100 billion in the past two years, with the trend only increasing.
Despite potential international agreements, emerging economies might have to draw climate investments on their own
One week in, negotiations have hit the hard wall of politics and collective action problems. The talks have agreed on standards for international voluntary carbon markets, an important step given revelations on the lack of quality offsets. A new, higher amount for climate finance may also be agreed upon. Yet the uncertain global political situation looms large, watering down action.
Donors and development banks will gradually fill the flask of climate finance. Their contributions will have to be bolstered by private investments. Therein lies the difficulty: today’s emerging economies, which already grapple with attracting investment for development, now must do the same to adapt to and mitigate climate change.
Why investment and finance for climate adaptation remains challenging
Private adaptation financing is woefully underprovided because it deals with avoiding losses rather than delivering returns. A solar park can be set up to provide a reasonably predictable return for an investor. How do I sell my adaptation technology which hinges on avoiding something that may be years away? The adaptation finance gap ranges between USD 187-359 billion per year.
Conceptually, one could invert the insurance model. Instead of paying you when things go wrong, I can give you better technology today – and we split the gains from avoided losses when shocks do occur. However, bringing such a contract to the field seems riddled with measurement difficulties. Markets for insurance raise resilience by lowering the impact of shocks, but they can create perverse incentives to not invest in adaptation, which lowers shock exposure altogether.
Even if an investor or insurer finds an adequate financing vehicle, there may be challenges in finding buyers. Farmers, for instance, are unlikely to encompass all the future changes in climate when making decisions. They may, hence, be less willing to pay for such technologies today. Inevitably, the state will need to play a leading role in adaptation.
A bird’s eye view of the adaptation challenge reveals a simple fact: those who are richer suffer far less from the consequences of hotter days. Much like we can invest in technologies to reduce our emissions, we can reduce our exposure to the whims of the weather. Growing incomes will allow the expansion of cooling technologies to protect against deadly heatwaves or the adoption of new technologies to shield crop yields. Therefore, the best thing a country can do to protect itself against climate change is to grow.
Innovation makes mitigation easier, but financial and regulatory obstacles slow uptake
The “cruel arithmetic” tells that how this growth happens matters enormously. Fortunately, in many respects, the picture for mitigation is more straightforward. Low- and middle-income countries have scarce resources and capacities. Rapid technological innovation has meant that solar or wind are now the cheapest forms of electricity generation in these countries, even when accounting for the additional burden their intermittency places on the grid.
Cheap electric two-wheelers are upending urban transportation. Yet the uptake of these innovations has been slower than their cost declines. One reason is that capital costs remain stubbornly high, a challenge compounded by the fact that many public utilities in emerging economies are skating on thin financial ice. A secondary reason is a lack of technical, regulatory, or institutional capacities to integrate such innovations quickly.
Emerging economies hold the most opportunities for sustainable growth
Opportunities still abound. What matters is an overall reduction in emissions, regardless of where or from what source. The cost of lowering emissions is not equal. If reducing emissions becomes incrementally more expensive as we reduce them, then there should be an abundance of relatively cheap “easy wins” in reducing emissions in areas that are only beginning their mitigation efforts. This argument extends to areas that are naturally well-suited to preserve or restore carbon sinks, like tropical rainforests.
For emerging economies, most emissions are still to come. This opens a separate opportunity for sustainable growth: to adopt the latest innovations in energy technologies that can provide affordable access without adverse environmental impact. A power plant lasts decades; the relative speed of cost declines in renewables plus storage means that, in many instances, they are already at cost parity. At worst, parity may be a few years away. Realising this opportunity hinges on being able to raise risk capital and for governments to invest into expanding public infrastructure. This creates an important space for donors.
Bridging the climate finance gap is essential to transforming the "cruel arithmetic" of climate change into a solvable challenge. Doing so will require mobilising investment, enhancing capacities, and fostering international cooperation.