In an effort to ‘drive momentum towards Copenhagen’, in the words of EC President Jose Manuel Barroso, the European Union has just agreed that measures to tackle climate change will need €100 billion ($148 billion; £90 billion) a year by 2020, with €22-50 billion coming from international public support. In the short-term, the leaders agreed that up to €7 billion a year would be needed from January 2010 for three years for ‘fast-track’ funding in the developing world – a voluntary commitment that avoids specific funding targets for individual EU countries. This news raises some significant questions and potential concerns regarding how finance will be raised.
What will €22-50 billion mean for taxpayers?
Many Europeans will be concerned about an increased tax burden, as shown by public comments in a recent Guardian article. While some of the burden will fall on domestic taxpayers, there are other ways to raise international public finance to support climate change measures in developing countries. Many are on the table for a Copenhagen deal, and include imposing levies on international carbon market transactions, auctioning off Assigned Amount Units (AAUs) and passing on costs to private sector heavy polluters, taxing international currency transactions, etc. These could reduce the burden on European taxpayers but will take time to implement.
Where will the rest of the money come from?
While the Europeans have said that €22-€50 billion of the €100 billion should be public sector money in annual transfers to the developing world by 2020, it is unclear where the rest will come from. Internationally regulated carbon markets are expected to provide a substantial amount, but not the remainder of the bill. There are serious concerns about overreliance on the private sector to support certain climate change activities, particularly for adaptation. Many climate change interventions are either inappropriate for private sector finance or simply will not attract private finance. Countries with low credit rating and high levels of debt with little institutional financial capacity and significant capital market barriers cannot expect private finance to be knocking at their doors. Strong public sector incentives are needed to mitigate private sector risk and encourage their investment, such as government guarantees, credit lines, or advance market commitments.
What will be the role of the carbon market?
The recent EC staff working document accompanying the EC Communication on ‘Stepping up international climate finance: A European blueprint for the Copenhagen deal’ states that the international carbon market could deliver as much as €38 billion per year in 2020. However, this figure is based on a few assumptions that need to be unpicked. First, this would be based on the creation of a new sectoral carbon market crediting mechanism, which has yet to be agreed. Second, it assumes that all profits from selling offset credits would also be used to mitigate GHG emissions in developing countries.
This massive assumption implies that the market would function as a ‘reverse auction’ whereby emission credits from developing countries would be offered for purchase at close to average cost, purchased by an intermediary bank or fund, and sold on to developed country markets, capturing the spread between the two prices. In classic economics, this is referred to as a monopsonistic approach, which essentially means that there are several sellers (of emission reduction credits) but only one buyer. The resulting rent would be used to buy more emissions reductions or other related activities rather than accruing to emission reduction purchasers. This could undermine the incentives for private sector involvement in the carbon market. Allowing firms to make high profit margins at the outset can compensate new project developers for the risks involved, and encourages competition. But it is likely that some rents will be retained and that developing countries will not receive the entire €38 billion per annum to deal with climate change. Hard questions need to be asked about the role of carbon markets in delivering finance to developing countries.
How predictable are the funding pledges?
Given that the initial pledges for the fast track funding are voluntary, there are concerns over the predictability and timeliness of funding. Experience tells us that pledges are rarely kept and, if they are, tend to take a long time to deliver. While the EU’s commitment may be firm, it is only likely to contribute €0.5-2.1 billion per annum of the €7 billion for the fast track funding, with other finance coming from governments who have not yet made pledges.
Delegates in Copenhagen need to begin to hone in on how the money will be raised. It is critical that, at this stage in the game, assumptions are challenged about the role of the private sector and potential revenue raised from the carbon market. We need a much better understanding of the respective roles of the private and public sector in financing to address climate change.
This blog post features the author's personal view and does not represent the view of ODI.
Comments
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re: The EU climate finance deal: what are the implications? @ Thursday, November 05, 2009 4:58 AM
I paerticularly appreciate the author's distinction between the "pie in the sky" hopefulness and the propable reality of costs and funding. Excellent overview and down to earth.
re: The EU climate finance deal: what are the implications? @ Saturday, November 07, 2009 10:06 PM
For the carbon-market to work globally, poverty and all the social ills, associated with, which force people to use the resources say of the forest indiscriminately, must be combated. Ultimately, nothing but a holistic approach can save the planet from the man-made environmental challenge it faces and the carbon-market must be one of the many policies needed.
re: The EU climate finance deal: what are the implications? @ Monday, November 09, 2009 1:28 AM
Ms. Brown does an excellent job of examining this very optimistic proposal and questioning the sources of funding for climate change mitigation and adaptation projects in the developing world. There are two problems I foresee in the EU's scheme: 1. The problem of offset pricing becoming too low and making little difference in emissions behavior. If the developing countries possess too many offset credits and there are few developed state buyers, then this condition will drive the price of the credits down and cheapen the cost of emitting GHG and defeating the purpose of the whole plan. 2. The idea that current conditions in the developing world make it a hard sell to developed world private investment because of high debt and capital controls implies that the developing world needs a new wave of liberalization policies to attract private investment flows. To liberalize further in the name of climate change adaptation could bring about a skeptical public backlash that could sway developing world publics into campaigning against climate change policies because they do not want to endure more economic pain from liberalization.
re: The EU climate finance deal: what are the implications? @ Monday, November 09, 2009 5:53 AM
Combating climate change by helping developing countries should be a combination of many different financing mechanisms. It is true that the voluntary funding from EU will translate into tax-burden for Eu residents, but it is also true that many of European multinational corporations operating or their subsidiaries operating in the global South are part of this problem; therefore, they should be part of the solution. However, any solutions cannot be reached to this problem if we do not tackle all problems associated with poverty and inequality at the same time with climate change. And again, any solution should include strong states of the global South and also major polluters such as India, China, Brazil and Russia to be on board.
re: The EU climate finance deal: what are the implications? @ Monday, November 09, 2009 9:48 AM
The question marks raised on the efficacy of global carbon markets to deliver finance to developing countries cannot be emphasized enough. As we know, carbon markets are developing similar to other commodity markets (and commodity derivative markets). The lessons learnt from the experience of poor countries with these markets to date should be heeded. As the ‘soft’ infrastructure surrounding carbon markets develops, so should it better take account of the distribution of rents across the carbon value chain, and what this means in terms of value chain drivers.
This is one example of the need to reconcile trade and climate change regimes. Depending on what carbon is classified as, there are a number of implications (e.g. good or service). If carbon is classified as a good, might some type of international carbon agreement may be necessary?
