Policy options for financing climate change technologies

Financing options for climate change technologies vary according to specific technology and country circumstances. Different financial vehicles target technologies in each stage of technological maturity. Typically, a complex mix of types of finance and financial instruments must be used simultaneously. It is important to tailor financing policy options to closely match the types of finance and financing instruments needed.

There are many different types of financing that can be applied to a climate change technology project or programme of activities; however, in general, there are three main types of finance: equity, mezzanine and debt finance. In practice, firms often acquire much more complex financing arrangements than this general typology of finance suggests.

Figure 24.5 illustrates the characteristics of each major type of finance.

Public financing mechanisms can be tailored to address each type of finance. Measures that aim to support early stage technology development tend to be equity-based financial instruments; mezzanine financing is particularly suited to assist in the commercialization of technologies; and debt-financing measures are often applied to low-risk technologies and are suited to deployment and diffusion of technologies. An example of the latter is the World Bank's Climate Change Bond, which was issued in November 2008 and raised US$344 million for investment in climate change mitigation projects in developing countries. These types of initiatives, while small in comparison to financial needs, are particularly important in the context of the state of the financial institutions and markets in 2008 to 2009 and the need to ensure growth in climate change investments.

A company will typically attempt to finance its operations with a maximum of debt financing because this will allow the company to minimize the cost of finance, and to maximize its ongoing control of the company and the amount

- Highest risk and return on investment

- Often take management stake in company

- Unsecured; last to be recouped in case of bankruptcy

- Medium risk and return on investment

- Typically has public sector component

- Combines features of equity and debt

- Unsecured; recouped after debt in case of bankruptcy

- Management control/profit sharing relationship varies

- Low risk and return on investment

- First recouped in case of a bankruptcy

- Does not take a management stake in company

Figure 24.5 Characteristics of the major types of finance of revenue that it will retain for future development of the company. However, debt financing may be difficult to obtain due to the inherent risks involved in new technologies or new companies.

Figure 24.6 shows the type of financing instruments required by stage of technological maturity. Companies in the early stages of development are heavily dependent upon government grants, angel investors and the personal funds of the technology developer. As a company takes its technology closer to commercialization, venture capital and private equity financing become more common, and then in the commercial stage, debt financing tends to dominate.

The level of early stage venture capital has not grown significantly since 2001. Analysis by UNEP (2008) has demonstrated the need for public-sector venture capital financing tools to fill these gaps due to the reluctance of the private sector to bear the significant risks associated with early stage financing.

The vast majority of early stage venture capital is the public investment needed to stimulate later stage private investments, suggesting that a global

Stage 1 R&D

R&D support

Stage 2 Demonstration

Stage 3 Deployment

^Valley of deaths

Lack of project development ^capacities and capital

Angel

Venture

investors

capital

Innovation prizes

Grants

Incubators

Public/private equity funds

Public/private VCfunds

Stage 3 Deployment

Lack of project development ^capacities and capital

Public/private equity funds

Commercial financing vehicles

Public finance vehicles

Commercial financing vehicles

Notes: R&D = research and development; VC = venture capital; NAMAs = nationally appropriate mitigation actions.

Source: adapted from UNEP (2008)

Figure 24.6 Financing vehicles by stage of technological maturity public venture capital fund capitalized with US$28.6 billion to $34.8 billion is required to help leverage subsequent venture capital and private equity investments to bring new technologies into deployment.

The International Energy Agency (IEA, 2008b) and the UNFCCC (2007, 2008b, 2009) have estimated that an additional US$100 billion to $120 billion per annum in early deployment support for technologies in developing countries will be necessary as part of an overall financing strategy to meet a 500 to 550 parts per million carbon dioxide equivalent stabilization level.

Under the convention these are additional or incremental costs that are to be financed by developed countries (Annex II parties). However, the types of mechanisms that can most efficiently drive the early deployment of technologies are national market-based mechanisms which subsidize these more expensive technologies and make them attractive relative to the cost of incumbent technologies that are more emissions intensive. Project-based approaches such as the CDM have not been designed to support early stage technologies, and project-based mechanisms such as the Global Environment Facility (GEF) would need to be scaled up by an order of magnitude and may be unwieldy. For these reasons, a policy-based approach is more desirable.

A policy-based approach would support developing countries to finance national policies such as renewable energy targets through policy instruments such as feed-in tariffs or renewable energy obligations for electricity generators. With technical assistance from developed countries, the national government would develop strategies for implementing national policies to drive early deployment of climate change technologies. A financial mechanism under the convention would provide the appropriate financing package to support the implementation of the policy. This may involve a combination of financing instruments, including direct grants, concessional loans, carbon crediting and other forms of support. The financing may be conditional upon national policy reforms and drive the necessary improvements to the 'enabling environments' of developing countries (Metz et al, 2000).

Another option for early deployment of technology may be to allow for a portion of a developed country's renewable energy obligations to be fulfilled from new renewable energy projects in developing countries (UNFCCC, 2007). This would have the benefit of reducing the overall cost of renewable energy obligations in developed countries (IEA, 2005) and would provide an additional source of financing for early deployment of technologies in developing countries.

Parties to the convention have suggested a wide range of options to create new financing sources and vehicles to enhance technology development and transfer. The processes that have been instigated through the Bali Action Plan have also stimulated the development of many proposals from international organizations and experts.

Only the proposals relating to technology development and transfer are considered here. Table 24.5 contains a list of the proposals and options relating to technology development and transfer submitted by parties or organizations. Elements of proposals with strong similarities are combined. The proposals and options have been classified by the stage of technological maturity they address.

Many of the options have strengths that make them suitable for specific purposes. No single option is intended to address all of the financing gaps and barriers across all sectors and stages of technological maturity. Rather, enhanced financing for technology development and transfer will consist of a package of options. In constructing such a package, complementarity between the options needs to be kept in mind. It is also important to include sunset clauses and exit strategies for many financing policies because, over time, it is expected that most climate change mitigation technologies will became fully commercial and will no longer require public financial support.

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