Climate Finance: Regulatory and Funding Strategies for Climate Change and Global Development

Chapter 14 Incentivizing Private Investment in Climate Change Mitigation

Climate Finance 135 Chapter 14 Incentivizing Private Investment in Climate Change Mitigation Marcel Brinkman Associate Principal, McKinsey & Company Key Points • Reducing greenhouse gas emissions will require significant levels of investment, both private and public. • Investment in developed countries offers greater investment security due to efficient capital markets and investment processes not found in developing economies, although the latter present more opportunities due to greater rates of economic growth and infrastructure development. • Up-front capital investment likely will not be attractive to the private sector unless governments provide sufficient cash flow support. Because only a minority of such investments are inherently financially viable, government-mandated incentives such as carbon pricing , standards, and direct subsidies/feed-in tariffs would be required to generate greater investments in mitigation. • The private sector could respond to incentives that provide a high degree of regulatory certainty into the future and that effectively counter principal/agent problems. Leaders in many countries are seeking ways to reduce greenhouse gas (GHG) emissions; ever increasing attention is being focused on how the necessary reductions will be achieved. The challenge is significant; if the proposed cuts are to be achieved, the power sector must find new, clean ways of generating electricity; automobile fleets must be replaced with 136 Marcel Brinkman more fuel efficient or electric alternatives; and old and inefficient buildings must be phased out and replaced with new, energy efficient ones. The global scientific community asserts that the world needs to reduce its carbon emissions to limit global warming to 2°C above 1990 levels. To achieve this limit, the world’s nations must stabilize atmospheric concentrations of carbon dioxide equivalents (CO2e) at 450 parts per million per volume (ppmv), as compared to approximately 385 ppmv today. This requires limiting global emissions to 44 Gt CO2e in 2020 and to 35 Gt in 2030—a large reduction from business-as-usual scenarios and lower than today’s levels (approximately 46 Gt in 2005). The investment needed to achieve this reduction is significant and presents challenges for investors. National governments do not have the means to invest the amounts required, especially given current economic conditions. Private capital must play a major role in climate change investments , but will only do so within a stable, favorable regulatory and market framework. This means that a key challenge for governments will be to provide sufficient cash flow support to make up-front capital investment by the private sector attractive. The clear implication of this: to create a lower-risk environment that encourages capital investment, policymakers will likely need to provide income support to mitigation projects via domestic regulation. Where Is Investment Needed? The McKinsey Green House Gas Abatement Cost Curve (see Figure 14.1) assesses the technical opportunities to abate CO2e emissions that cost under €60/tonne in the period to 2020, as shown in the graph. Abatement opportunities examined fall into three categories: • Energy efficiency (buildings, transport, industry), representing 5 Gt • Low-carbon energy supply, representing 4 Gt • Terrestrial carbon (forestry and agriculture), representing 10 Gt Investment in these sectors would start to turn these opportunities into real reductions. McKinsey estimates that in order to reach a desired 450 ppmv pathway, €350 billion of incremental capital investment is needed between 2010 and 2020, and €595 billion between 2020 and 2030. Sector estimates are shown in Table 14.1. 137 Fig. 14.1. Opportunities to achieve a 450 ppm pathway exist at under €60/t. (Source: McKinsey Global GHG Abatement Cost Curve v2.0 (2009)) Table 14.1 Developing Nation Global Investment Need Investment Need € bn in € bn in € bn in € bn in Sector 2010–2020 2020–2030 2010–2020 2020–2030 Buildings (mainly energy efficiency) €125 €155 €25 €45 Transportation (mainly energy efficiency) €70 €215 €25 €100 Industry (mainly energy efficiency) €75 €80 €40 €50 Power €65 €125 €30 €70 Waste €10 €10 €5 €5 Forestry and agriculture (terrestrial carbon)* €5 €5 €5 €5 * Forestry and agriculture (terrestrial carbon) represent a very significant abatement opportunity (10 Gt), but require less up-front capital investment as most of the changes are behavior based, e.g., changed agricultural practices or avoiding deforestation through increased economic activity in and around the forest. The capital expenditure figures shown in the table relate to afforestation, i.e., the investment required to plant trees. 138 Marcel Brinkman What Are the Differences in Investment Conditions between Developing and Developed Nations? When considering the investment needed for low-carbon...