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Transformational Climate Finance: An Exploration of Low-Carbon Energy

This working paper examines how climate finance can be transformational by gleaning insights from nine low-carbon energy case studies, selected to cover a variety of geographies, energy sources, and degrees of transformation.

Key Findings

Executive Summary

Limiting global warming to below 2°C above pre-industrial levels will require massive reductions in greenhouse gas (GHG) emissions from business-as-usual—on the order of 40 percent to 70 percent in 2050 compared to 2010, and near net zero emissions by 2100. At the same time, new investments will be needed to shift the world to a low-carbon economy. Responding to the scale of the climate change challenge will require a fundamental transformation in our political, economic, energy, and socio-technical systems.

This working paper examines how climate finance can be transformational by gleaning insights from nine low-carbon energy case studies, selected to cover a variety of geographies, energy sources, and degrees of transforma­tion. We provide a series of recommendations for develop­ment finance institutions/contributor governments and recipient governments on how to catalyze transforma­tional change, and a planning framework that lays out a sequence of steps for recipient governments.

Nature of Transformation

A transformation is a long-term fundamental shift in a system, whether political, economic, social, or biological. Transformations are typically viewed as multi-actor, multi-scale processes, where the change is highly non-linear.

We consider low-carbon energy transformation to have three characteristics or criteria:

                        Large magnitude impact. There is a profound change in the energy sector in terms of the shift to low-carbon energy (e.g. installed capacity and/or net generation) that may also have economy-wide impacts.

                        Non-linear change. While the change might begin slowly, the scaling up of low-carbon energy has a non-linear trajectory.

                        Sustained and long term. Transformations typically occur over years and perhaps decades, and there should be no fundamental backsliding.

Case Studies of Low-Carbon Energy Transformation

Although transformation can occur in other sectors (e.g. transportation, agriculture), we focus here on low-carbon energy, which we define to include renewable energy and energy-efficient technologies. We analyzed the most critical elements for transformation by reviewing 20 case studies from both developed and developing countries and across all regions. We then sorted the case studies into one of three categories:

                        Transformational: cases where finance has been used for truly path-breaking, low-carbon energy develop­ment; where there has been a non-linear growth in renewable energy or energy efficiency; and/or where successes have been scaled up and replicated.

                        Potentially transformational: cases where finance has shown promise or early successes in catalyzing low-carbon development; where there has been positive change, but not yet in a dramatic non-linear, sector-wide fashion; where there is potential scalability and replicability.

                        Missed opportunities or early stage development: cases where initial promise has not led to transformational success, or cases where an initial failure has been turned around, but development is ongoing.

From the 20 cases, we selected three from each category for in-depth analysis, trying to maintain a balance between developed and developing country experiences, across regions, and among types of low-carbon energy development. The transformational cases include wind in Uruguay and Denmark, and renewable energy more broadly in Portugal. The potentially transformational cases include solar household systems in Bangladesh, energy efficiency in Thailand, and solar water heaters in Tunisia. Lastly, the missed opportunities or early stage development case studies include geothermal in Indonesia, renewable energy in South Africa, and solar in Spain.

Among the transformational cases, Uruguay illustrates how addressing regulatory barriers and creating a well-designed auction system for renewable energy develop­ment can have a catalytic effect on private sector invest­ment. In Denmark, transformation came about through a confluence of factors, including substantial investment in research and development, clear targets, stable financial incentives, community ownership of wind development, and policies to enhance grid access and management for increasingly high shares of renewable energy. Portugal illustrates the successful use of an innovative feed-in tariff design with variable components to encourage the expansion of renewable energy and the importance of government policies and intervention to ensure that the electricity grid is modernized to handle variable renewable energy generation.

Thailand has used a petroleum tax to create a revolving fund and provide a sustainable source of financing for energy efficiency. However, the Thai economy has been unable to decouple GDP growth from energy consumption; transformational success in energy efficiency thus remains elusive. Bangladesh has effectively combined consumer subsidies and concessional microloans to make small-scale solar installations affordable for millions of rural households, but the challenge remains as to whether the program can continue to expand, while making it more sustainable, maintaining affordability for the poorest, and increasing the quality and reliability of hardware. Tunisia’s Prosol scheme for solar water heaters shows that targeted subsidies can effectively scale up renewable energy adoption and support sustainable financing models, but it remains to be seen whether the past success in solar water heater deployment can be continued in post-revolution Tunisia.

The missed opportunities or early stage development case studies are characterized by some combination of policy uncertainty (South Africa), poor policy design (Spain), lack of government leadership (South Africa, Indonesia), and the continued “headwinds” of fossil-fuel subsidies, which make renewable energy less competitive (Indonesia), although both South Africa and Indonesia have made progress in recent years.

Our case studies point to eight factors that can help facilitate transformational change in low-carbon energy development:

  • National ownership
  • Stakeholder engagement and participation
  • Establishment of a stable enabling environment for investment
  • Alignment of financial incentives to address market distortions
  • Strategic use of public resources to mobilize investment
  • Investment in technology and innovation
  • Use of innovative financial instruments and arrange­ments to catalyze investments
  • Continuous learning and improvement

Recommendations for Recipient Governments and Development Finance Institutions/ Contributor Governments

Low-carbon transformation will require action across many scales. While private sector technology providers, commercial banks, utilities, technical institutions, and community organizations are all vital actors, this paper focuses on recipient governments and development finance institutions/contributor governments. These recommendations can guide both sets of actors on catalyzing low-carbon energy transformation.

Recipient governments

  • Take ownership of the process.
  • Organize government to facilitate low-carbon trans­formation, including creating incentives for govern­ment agencies to work together to implement plans and targets and designating a government champion to coordinate the process.
  • Formulate national plans and targets in an inclusive, multi-stakeholder process.
  • Adopt consistent policies and regulations.
  • Identify barriers to climate investment and gaps in enabling conditions and provide financial resources to address them.
  • Support enabling infrastructure.
  • If resources allow, invest in research and development to adapt technology to local conditions.
  • Use international public finance strategically, for example, to address key capacity gaps and provide training and awareness-raising.
  • Get the prices right—remove fossil-fuel subsidies and internalize externalities through carbon pricing or other instruments.
  • Level the playing field in terms of competitive pro­curement and focus on developing the private sector.
  • Adopt a dynamic approach and continually update and iterate policies, targets, and public financial sup­port in line with evaluations of progress and lessons learned.

Development Finance Institutions and Contributor Governments

  • Make sure that international support is well aligned with local country plans and priorities and provides long-term sustained assistance.
  • In conjunction with recipient governments, identify gaps in enabling factors (e.g. institutional capacity, laws, policies, and regulations) and provide support to address them.
  • Move beyond thinking of transformation at the project level; adopt a portfolio or programmatic approach, and coordinate with other contributors.
  • Identify the barriers and risks to private sector invest­ment and tailor instruments to “crowd in, not crowd out” the private sector.

A Planning Framework for Transformational Climate Finance for Recipient Governments

Our framework for transformational climate finance (Figure 1) builds upon the critical elements for transformation identified in the case studies and lays out a sequence of steps for recipient governments:

  1. Formulate the problem. This includes articulating the long-term goal and vision, identifying metrics for transformation, and examining barriers and potential drivers at different scales.
  2. Engage with a wide array of stakeholders (government, private sector, and communities) and define the roles and responsibilities of the key actors.
  3. Establish a stable enabling environment. While there should be flexibility to increase the ambition of policies to reflect advances in technology, costs, and scientific urgency, the enabling environment should remain stable to ensure investor confidence.
  4. Align incentives by establishing low-carbon energy policy/regulatory and fiscal incentives, supporting research and development, and cutting fossil-fuel subsidies.
  5. Develop pilot projects and test new financial arrange­ments, partnerships, and innovative instruments.
  6. Build monitoring, evaluation, learning, and feedback into the problem formulation and strategic vision. By adopting a cyclical process, low-carbon energy deployment can scale up over time. 

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