Of this, a significant proportion (between US$55.5-82.2 billion) is currently from public coffers. Putting this in the context of the additional investment needed which is in the order of an additional US$262-670 billion annually, it is clear that financing the economic transition to address climate change is no trivial task.
The sheer size of these figures (which are for mitigation costs alone) is so great that it may be tempting for negotiators to set them aside and return to them once clear targets have been locked in. But the EGTT has recommended against this, saying that the Subsidiary Body for Implementation (SBI) and Subsidiary Body for Scientific and Technological Advice (SBSTA) should counsel members under the UNFCCC to consider new and innovative financing options carefully in the negotiations.
The problem facing both developed and developing country governments is that the private sector alone is unable to deliver the volume of investment needed. The reason for this lies in structural market failures which are appearing in the financing of clean technology solutions.
In theory, establishing emission caps and targets should drive market demand for low carbon technologies. These technologies should migrate from research laboratories through to demonstration stage as venture capitalists and large corporate investors make strategic investments in promising new technologies. Once these technologies reach scale, project financiers would be expected to enter the picture to debt finance the deployment of utility projects throughout the region.
In practice, though, a financing block has emerged early on in the innovation pipeline at the venture capital stage – between technology demonstration and technology deployment. This gap exists because the typical cost of demonstrating a new energy generation technology, for example, is in the order of US$100 million. Given that there are only a handful of venture capital firms in the world with more than US$1 billion under management, there has been an inability to syndicate deals between venture capitalists on the size and scale needed for utility-style projects.
This equity gap between venture capital and project finance is a headache for the world’s largest and most sophisticated venture capitalists on the west coast of the United States who are trying to get exits on their deals and make a return. For smaller funds like those found in Europe, Australia and parts of Asia, the capital intensity of energy technology deals has meant that they have had to turn a lot of entrepreneurs away.
It remains unclear how private equity and infrastructure financiers will be able to respond to this equity gap. Even accounting for cyclical improvement in the availability of capital, the cost of equity finance in these utilities-style deals appears to be a structural bump. As long as venture capitalists can continue to find more attractive returns in smaller deals in the biotechnology and communications sectors, the investment environment around clean technology will remain difficult. The exception to this is in the energy demand and energy efficiency space where technologies like smart meters fit neatly within existing venture capital expertise in the digital communications space.
The nature of this market failure suggests that governments will be required to play a robust role in early stage technology financing. This might explain why China and India have been eager to link any emissions commitments to multilateral financing arrangements for domestic technology transfer. Public finance will play a role alongside but additional to carbon trading – the main tool which the Australian Prime Minister, Kevin Rudd, hopes to bring to the negotiating table in the form of a domestic carbon trading scheme (the Australian Carbon Pollution Reduction Scheme).
Carbon trading has undoubtedly demonstrated some success in leveraging private investment into technology transfer. The Clean Development Mechanism currently covers approximately 147 mitigation technologies and about 36% of CDM projects (accounting for 59% of total annual emission reduction from projects) involve technology transfer.
But while putting a price of carbon changes investment decisions at the margin when a technology is proven, it does not address the problems of liquidity and access to capital early on in the innovation pipeline which exist independent of the price of carbon.
Leaving aside for now the important issue of innovative ways to raise new public finance internationally, the public investment vehicles needed to address this problem will likely require looking beyond conventional financing mechanisms such as the funds administered by the Global Environment Facility and the World Bank.
One option with some traction is a multilateral demonstration fund to build pilot projects at commercial scale. Japan has been a strong advocate of such a programme with its US$10 billion ‘Cool Earth’ initiative. This demonstrates a range of technologies in developing countries while also creating a technology road map for these countries.
With China already a global leader in R&D spending with a strong focus on energy technologies, a multilateral demonstration fund may be closely aligned with their economic interests. China’s interest in early stage commercialisation is reflected in its relatively significant R&D target of 2% of GDP by 2010, which places it fourth in the world in terms of public spending on R&D (US$39 billion), behind the United States (US$277 billion), EU (US$198 billion), Japan (US$107 billion), and ahead of the Republic of Korea (US$21 billion).
The current international negotiations to secure emission caps and targets are an important first step in de-carbonising the global economy. But keeping a close eye on the financial mechanisms to get there will help smooth the process both economically and politically.