Incentivizing Investment In Climate Change Infrastructure
Peter Weisberg, The Climate Trust
As published by TriplePundit – March 2, 2015
To measure environmental impact, carbon markets attempt to predict the future. In order to generate a greenhouse gas (GHG) offset, projects must demonstrate that they would not have occurred without the payment associated with that offset—i.e. that they are “in addition” to what normally occurs in the absence of the carbon market. This is called “additionality.” With additionality defined, carbon projects are able to demonstrate that they represent new greenhouse gas reductions.
Additionality has a role when attempting to measure any sort of impact. Patrick Maloney, an advisor to investors interested in social and environmental results, has a great series of blog posts about why true “impact investments” must be in addition to investments the rest of the market is currently willing to make. The trouble is the rest of the market stays away from these new investments because the risks (real or perceived) are higher than other investments with similar returns. True impact opportunities are often new, novel, or unproven and rely upon new markets, technologies and companies.
However you frame the environmental challenges ahead of us, the need for investment in new infrastructure is staggering. Credit Suisse, World Wildlife Fund and McKinsey estimate that “to meet the need for conservation funding, investable cash flows from conservation projects need to be at least 20-30 times greater than they are today. “ The World Economic Forum reports $5.7 trillion will need to be invested annually by 2020 to build the infrastructure needed to mitigate catastrophic climate change. Much of this investment is additional—meaning it faces new risks and, without intervention, it will not otherwise occur.
Given this context, it’s essential for the public sector to use its limited dollars in a way that mitigates risks and attracts private capital to needed infrastructure investments. The Climate Trust has explored options for raising capital to invest in building new GHG offset projects, and has identified a variety of new models for using public financing to mitigate and manage the risks associated with true impact investments—models that attract private capital to new ideas that otherwise wouldn’t be funded. These concepts think beyond traditional grant making, and offer public sector investors opportunities for capital preservation and returns. Three compelling examples are outlined below:
- Public “tiered or layered” investments. Both public and private investors infuse capital in a project or a fund. The public investment is exposed to the “first losses” associated with the performance of the investment. In other words, private investors are guaranteed to meet their return targets before public investors are repaid. In this way, the public dollars provide a safety cushion, lowering the risk to private investors. This type of public support can be seen in USAID’s $133.8M investment into Althelia, a fund focused on reversing deforestation, or the European Investment Bank’s $10M Euro investment into the Global Energy Efficiency and Renewable Energy Fund.
- Credit enhancements and guarantees. Public entities can issue bonds themselves, or guarantee to repay the principal, or principal and interest, associated with third-party issued bonds. With the balance sheet of a large public entity standing behind the repayment of a bond, the risk to institutional investors purchasing bonds is significantly reduced. Through this guarantee or credit enhancement, proceeds from the bond can give impact opportunities access to low cost capital— with public entities assuming some of the risks associated with the investments. Meanwhile, institutional investors can continue to purchase a product they are very familiar with incorporating into their portfolios—government-backed bonds. An example includes loans issued through the Green Job-Green New York program for energy efficiency improvements, which were financed with a $24.3M bond. The New York State Environmental Facilities Corporation (through its State Revolving Fund program under the Clean Water State Revolving Fund) guaranteed to repay the principal and interest associated with the bond, which was therefore given an AAA/Aaa rating.
- Price floors for ecosystem service credits. Some investments rely upon revenues from environmental markets for carbon offsets, water quality credits or other ecosystem services. While the returns offered by these markets can theoretically be attractive, they present significant risks because they are nascent and created and controlled by policy. To mitigate this perceived risk, the California Bioenergy Association proposed a Green Credit Reserve that would use auction funds from California’s cap-and-trade system to guarantee to purchase environmental credits at a minimum floor price. Given this guarantee from the government of a minimum value, projects would be able to convince private lenders that environmental credits will create real value for a project. The Green Credit Reserve was eventually defeated in the California legislature, but remains an excellent concept for opening the flow of financing to projects that depend upon revenues from nascent environmental markets.
These concepts ask the public sector to take on new risks—because the public social and environmental goods provided by these investments are essential. Those risks have real consequences, as we saw when Solyndra defaulted on a $535M loan guaranteed by the Department of Energy. Yet, as Oregon Public Broadcasting reported, that Department of Energy program overall was a success, collecting $810M in total interest payments and $30M in profit for the US taxpayer while accelerating the development of clean energy technologies.
As Bruce Usher, Director of the Tamer Center for Social Enterprise at Columbia, told The Climate Trust, “If you don’t take any new risk, you don’t change anything.”