68491 A WORLD BANK STUDY Green Infrastructure Finance FRAMEWORK REPORT W O R L D B A N K S T U D Y Green Infrastructure Finance: Framework Report ©2012 International Bank for Reconstruction and Development/The World Bank East Asia and Paci�c Region/East Asia Infrastructure Unit (EASIN) 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org 1 2 3 4 15 14 13 12 All rights reserved World Bank Studies are published to communicate the results of the Bank’s work to the development community with the least possible delay. The manuscript of this paper therefore has not been prepared in accordance with the procedures appropriate to formally-edited texts. This volume is a joint publication of the staff of the International Bank for Reconstruction and De- velopment/The World Bank and the Australian Agency for International Development (AusAID). 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HC79.C3.L3 2012 332.67’22 -- dc23 2012008110 Contents Foreword ......................................................................................................................................v Acknowledgments .................................................................................................................. vii Acronyms and Abbreviations ..............................................................................................viii Executive Summary ................................................................................................................... 1 The Financing Challenge of Green Infrastructure Investments ................................... 1 Status of Green Infrastructure Finance............................................................................. 1 Bene�ts of a Green Infrastructure Finance Framework ................................................. 2 Conceptual Methodology for Assessing and Allocating Risks ..................................... 3 Assessment of the Green Investment Climate in EAP Countries................................. 5 Conclusions and Next Steps .............................................................................................. 5 1. Rationale for Green Infrastructure Finance Framework ............................................ 7 Introduction.......................................................................................................................... 7 Main Conclusions from the Research Report .................................................................. 9 Green Infrastructure Finance Framework ..................................................................... 13 Objectives and Scope of the Report ................................................................................ 14 Audience ............................................................................................................................. 14 2. Economic Rationale of Green Investments ................................................................. 15 Climate Change: The Greatest Market Failure .............................................................. 15 Economic Policy Solutions for a Global Externality ..................................................... 15 Economic Principles for the Efficient Use of Green Infrastructure Finance ............. 16 Practical Principles for Green Infrastructure Finance Mechanisms ........................... 19 Summary of Economic Design Principles for Green Infrastructure Finance ........... 21 3. Conceptual Methodology for Assessing and Allocating Risks ............................... 23 Rationale for Methodology .............................................................................................. 23 Similarities and Differences between Conventional Infrastructure and Low- Emission Investments ....................................................................................................... 25 Understanding the Financial Viability Gap—A Wind Farm Case ............................. 31 Making Green Infrastructure Finance Work to Close the Viability Gap ................... 33 Combining Instruments for Effective Financing Solution ........................................... 35 Examples of Green Finance Financial Structures ......................................................... 41 4. Assessment of Green Investment Climate in EAP Countries.................................. 46 The Role of Country Assessment Methodology ........................................................... 46 Evaluation of Overall Green Investment Climate in EAP Countries ......................... 47 Detailed Assessment of Country Green Investment Climate ..................................... 49 iii iv Contents 5. Conclusion and Next Steps............................................................................................. 52 Appendix: Green Investment Climate Matrix .................................................................... 56 References.................................................................................................................................. 58 Boxes Box 1: Disaggregating a Concessional Loan into a Commercial Loan and Grant Components ................................................................................................................... 17 Box 2: Calculating the Cost of Carbon Abatement ...............................................................18 Box 3: Characteristics of Project Finance ...............................................................................26 Box 4: Capital Market Gap for South East Asia Biomass Plant ..........................................31 Box 5: Feed-in Tariffs ................................................................................................................42 Box 6: Mechanism to Subscribe Emission Subsidy Costs....................................................54 Tables Table 1: Additional Risks of Low-Emission Investments ....................................................28 Table 2: Technical and Financial Factors for Coal and Wind Energy Investments..........28 Table 3: Public Sector Policies and Instruments ...................................................................38 Table 4: Financial Structure for Wind Energy Project—Needed CTF Support ................42 Table 5: Alternative Financial Structure for Wind Energy Project .....................................43 Table 6: Financial Structure for Geothermal Energy Project ...............................................44 Table 7: Financial Structure for Building Energy Efficiency Project ..................................45 Table 8: Key Clean Energy Indicators in EAP Countries ....................................................47 Table 9: Financial Products and Their Use ............................................................................48 Table 10: Energy Consumption and Imports for the Republic of Korea: 2000–07 ...........48 Table 11: Green Investment Climate Matrix..........................................................................57 Figures Figure 1: Investments in Green Technologies and Emission Trajectory .............................8 Figure 2: Why Low-Emission Projects Are Not Ge ing Financed? ...................................23 Figure 3: Project Finance for a Power Plant...........................................................................26 Figure 4: Energy Efficiency Projects May Be Less A ractive than Core Business Projects .......................................................................................................................30 Figure 5: Explaining the Financial Viability Gap for a Wind Farm ...................................32 Figure 6: Filling the Viability Gap with Public Bene�ts: Wind Farm Case ......................34 Figure 7: Filling the Viability Gap with Public Bene�ts: Bus Rapid Transit Case ...........35 Figure 8: Green Finance Interventions in a Project Finance Structure ..............................39 Figure 9: Example of Wind Energy Project ...........................................................................41 Figure 10: Example of Geothermal Project ............................................................................43 Figure 11: Example of Energy Efficiency Project ..................................................................44 Figure 12: A Breakdown of the Elements of Green Investment Climate ..........................49 Figure 13: Process for Pilot Implementation of the Green Infrastructure Finance Framework ..............................................................................................................53 Foreword I n 2010 we published Winds of Change, a report that examined the carbon pathways fol- lowed by the rapidly developing countries of the East Asia and Paci�c region (EAP), and what it would take to bend the carbon emission curve between now and 2030. The report concluded that embarking on a low-carbon pathway was feasible through strin- gent energy efficiency measures and innovations in renewable energy and other low-car- bon technologies, but with a substantial price tag. The report estimated that in the EAP region alone about US$80 billion a year of additional investments would be required in low-emission projects (green investments), resulting in a signi�cant �nancing challenge. The recent �nancial crisis affected a highly interconnected world, exacerbating the �- nancing challenges overall and especially those for advancing the green growth agenda. Moreover, developing countries in the EAP region are witnessing major shifts in demo- graphic and consumption pa erns, with hundreds of millions of people moving to cities, investing in housing, personal transportation and various energy-using appliances. This places additional pressure on adopting best available technologies, building smarter cit- ies, investing in low-emission mass transit systems, and in greening infrastructure. The international community and national governments have compelling reasons to provide �nancial support to low-emission projects and to help them raise the need- ed �nancing, but public resources are limited. Moreover, the intrinsic characteristics of low-emission projects make them less �nancially a ractive when compared against tra- ditional but less eco-friendly alternatives. Elevated perceived risks and distortions in economies can further widen this �nancial viability gap. The report argues that the solution lies in understanding the causes of the �nancial viability gap, and then investigating how speci�c actions, including strategic subsidies, concessional �nancing, and public policy interventions and reforms, can bridge this gap to make green investment transactions viable. More explicitly, the approach introduced in the report provides a framework for appropriately allocating risks and responsibili- ties, and demonstrates how to combine effectively multiple public and private instru- ments in a complementary fashion to maximize the leveraging effect of limited public sources of �nancing. The green infrastructure �nance framework also underscores the bene�ts of valuing and monetizing carbon externalities. Moreover, it recognizes the effects of policy dis- tortions and other negative factors that impinge on �nancial viability, emphasizing the need for an approach to analyze and explain the gap and to a ribute its components to different stakeholders. This report shows that it is essential to measure global and local externality bene�ts against the causes of the viability gap such as perceptions of added risks, cost differentials, policy distortions, and other factors. Once these elements are fully considered, policy makers can identify practical ways to be er structure the �nanc- ing of green investment projects that can be supported by the market. The analytical framework lays out a simple and elegant way in which scarce global public �nancing can leverage market interest in “greening� infrastructure. It suggests mechanisms by which limited global public funds can leverage both national public v vi Foreword funds as well as private �nancing in order to accelerate investments in low-emission technologies. Three key principals have guided the development of the framework: (i) targeting green �nance resources on sectors that have large numbers of projects with low abate- ment costs; (ii) se ing ceilings on the value of support that will be provided for a tonne of greenhouse gas (GHG) abatement in any sector or project; and (iii) using competi- tive mechanisms to ensure that projects do not receive more support than needed to make them �nancially a ractive. A fundamental prerequisite of this architecture is the establishment of a robust but easily understood and practical monitoring, reporting, and veri�cation (MRV) system. This report is the second of a continuing series of green infrastructure �nance pub- lications. The �rst part undertook a stocktaking of leading initiatives and literature re- lated to the green infrastructure �nance theme. This second part is a conceptual piece that bridges ideas and concepts between environmental economics and project �nance practices. Work will continue over the next months by operationalizing this framework (analytical methodology and assessment of green infrastructure investment climate) through a pilot in a selected EAP developing country. Given a be er understanding of the �nancing challenges of different green projects, work will also continue in devel- oping more customized and innovative �nancing instruments that can be speci�cally tailored to address the requirements of these projects. It is hoped that the results of this work will help policy makers understand more clearly how to utilize global green in- frastructure �nance for scaling up investments in low-emission projects in their own countries. John Roome Director Sustainable Development East Asia and Paci�c Region The World Bank Group Acknowledgments T his framework report has been prepared by East Asia and Paci�c Region of the World Bank. The work was led by Aldo Baie i, Lead Infrastructure Specialist (EAS- IN) under the overall guidance of John Roome, Sector Director (EASSD) and Vijay Jagan- nathan, Sector Manager (EASIN). The team and co-authors included Andrey Shlyakht- enko and Roberto La Rocca (EASIN) from the World Bank, and David Ehrhardt, Alfonso Guzman, and Paul Burnaby from Castalia Advisors. The team wishes to acknowledge those peer reviewers and other contributors inside and outside the World Bank Group including, Marianne Fay, Chief Economist (SDNVP), Veronique Bishop, Senior Financial Officer (CFPMI), Kirk Hamilton, Lead Environmen- tal Economist (DECEE), Dejan Ostojic, Sector Leader, Sudipto Sarkar, Sector Leader, Alan Coulthart, Lead Municipal Engineer, Dhruva Sahai, Senior Financial Analyst, Migara Jayawardena, Senior Infrastructure Specialist, Xiaodong Wang, Senior Energy Specialist, Urvaksh Patel (EASIN), Magda Lovei, Sector Manager, Christophe Crepin, Sector Leader, Johannes Heister, Senior Environmental Specialist, Jaemin Song (EASER), Charles Feinstein, Sustainable Development Leader (EASNS), Richard Hosier, Senior Climate Change Specialist (ENVGC), Maria Vagliasindi, Lead Economist (SEGEN), Daniel Kammen (SEG), Ari Huhtala, Senior Environmental Specialist (ENV), Monali Ranade, Carbon Finance Specialist, Alexandre Kossoy, Senior Financial Specialist, Jose Andreu, Senior Carbon Finance Specialist (ENVCF), Russell Muir (CICIS), Moustafa Ba- her El-Hefnawy, Lead Transport Economist (ECSS5), Carter Brandon, Lead Environ- mental Specialist, Gailius J. Draugelis, Senior Energy Specialist (EASCS), Victor Dato, In- frastructure Specialist (EASPS), Rutu Dave, Climate Change Specialist (WBICC), Robert Do, President (Solena Group), Kumar Pratap (Consultant), 10EQS, Ltd, Salim Mazouz, Director (EcoPerspectives), and Tilak Doshi, Principal Fellow and Head, Energy Studies Institute (National University of Singapore). Edward Charles Warwick edited the report. Finally, the team wishes to acknowledge the generous support from the Austra- lian Agency for International Development (AusAID) provided through the World Bank East Asia and Paci�c Infrastructure for Growth Trust Fund (EAAIG). vii Acronyms and Abbreviations AGF High-Level Advisory Group for Climate Change Financing BAU Business as Usual BRT Bus Rapid Transit CCS Carbon Capture and Storage CDM Clean Development Mechanism CEG Clean Energy Group CIF Climate Investment Funds CO2 Carbon Dioxide CTF Clean Technology Fund EAP East Asia and Paci�c EE Energy Efficiency ESCAP United Nations Economic and Social Commission for Asia and Paci�c ESCO Energy Service Company ETS Emissions Trading Scheme FiT Feed-in Tariff GCF Green Climate Fund GDP Gross Domestic Product GEEREF Global Energy Efficiency and Renewable Energy Fund GEF Global Environment Facility GHG Greenhouse Gas IBRD International Bank for Reconstruction and Development IDA International Development Association IEA International Energy Agency IFI International Financial Institution IIGCC Institutional Investors Group on Climate Change kWh Kilowa -hour LE Low-Emission LSE London School of Economics MDB Multilateral Development Bank MRV Monitoring, Reporting and Veri�cation MW Megawa MWh Megawa -hour NDRC National Development and Reform Commission, China NEF Bloomberg New Energy Finance OECD Organisation for Economic Co-operation and Development OPIC Overseas Private Investment Corporation PV Photovoltaic R&D Research and Development RE Renewable Energy RPS Renewable Portfolio Standards SCF Strategic Climate Fund SEFI UNEP Sustainable Energy Finance Initiative viii Acronyms and Abbreviations ix SPC Special Purpose Company TA Technical Assistance UN United Nations UNEP United Nations Environment Programme UNIDO United Nations Industrial Development Organization Executive Summary The Financing Challenge of Green Infrastructure Investments T he International Energy Agency (IEA) estimates that to halve energy related car- bon dioxide emissions by 2050, investments in energy supply and use should be increased by US$46 trillion over the business as usual (BAU) scenario. This requires ad- ditional investments of US$750 billion a year by 2030 and further investments exceeding US$1.6 trillion a year from 2030-2050. In particular, the energy portfolio mix should shift toward a signi�cantly greater contribution by low-emission projects. The Winds of Change, published by the East Asia and Paci�c Region (EAP) of the World Bank in 2010, estimated that in the EAP region alone approximately US$80 bil- lion a year of additional investments would be required in low-emission projects (green investments). While the recent investment trends have been promising, the actual volume of in- vestment is still well below desired targets. Bloomberg New Energy Finance (NEF) not- ed that investment in clean energy soared from US$34 billion in 2004 to approximately US$150 billion in 2007 and 2008—maintaining investor interest even during the global recession. However, while analysts differ in the exact �gures, their conclusions are simi- lar. Essentially, the current level of investments, and its anticipated growth, will not be sufficient to meet the challenge of global warming and the shortfalls are immense. The question of �nancing green infrastructure investments, particularly how these in- vestments are evaluated, designed, and �nanced, has still not received sufficient a ention. Status of Green Infrastructure Finance To address this �nancing challenge, the EAP region of the World Bank conducted fur- ther work to assess the constraints in �nancing green infrastructure investments and to explore how investment opportunities could be improved in client countries. The �rst step of this work resulted in publishing Green Infrastructure Finance: Leading Initiatives and Research. This report not only summarized the status of activities in green infrastruc- ture �nance but also provided an analytical insight. A number of salient conclusions emerged from that study including: ■ Public instruments and concessional funding are essential to leverage private flows. ■ Green infrastructure �nance requires country-speci�c public policies and in- struments with the public sector taking the lead. ■ Public and private sectors need to work together to develop unique solutions. ■ In combining interventions some are more important than others. ■ Many green investments are less �nancially a ractive when compared against traditional but less eco-friendly alternatives. ■ The �nancial and institutional interventions to accelerate green investments are numerous. ■ Many green investments present unique risks because of their cash pro�les. 1 2 Executive Summary ■ Distortions in economies can widen the �nancial viability gap of many green investments. ■ While there are strong hopes that carbon markets can be revived, there is also great uncertainty. The research report also concluded that a comprehensive “bo om-up� framework was necessary to assess the green investment climate in a given economy and to deter- mine the appropriate mix of measures and instruments needed to best leverage limited public funds to accelerate private flows. Bene�ts of a Green Infrastructure Finance Framework The focus of this report is the green infrastructure �nance framework. This framework bridges ideas and concepts between environmental economics and project �nance practices. Three key principals have guided its development: (i) targeting green infra- structure �nance resources toward sectors that have large numbers of projects with low abatement costs; (ii) se ing ceilings on the value of support that will be provided for a tonne of greenhouse gas (GHG) abatement in any sector or project; and (iii) using com- petitive mechanisms to ensure that projects do not receive more support than needed to make them �nancially a ractive. A fundamental prerequisite of this framework is the establishment of a robust but easily understood and practical monitoring, reporting, and veri�cation (MRV) system. The two-part framework consists of an analytical methodology for determining the �nancial viability gap and assessing and allocating risks associated with green invest- ments as well as a comprehensive approach for assessing the green investment climate in a given country environment. By combining these two components, the framework aims to produce the following four bene�ts. First, the evaluation and explanation of the viability gap can determine whether an investment can be justi�ed on the grounds of climate change bene�ts through GHG emission abatement. It also explains how price distortions in an economy can have an impact on the viability of green investments. Second, an analysis of the components of the viability gap suggests to policy mak- ers how �nancing responsibilities can be shared between the national government, local government, and the international community. Third, apportioning the viability gap among various stakeholders determines more accurately the mix of instruments that can be used to close the gap. This can combine international �nancing mechanisms with government instruments such as feed-in tariffs (FiT), direct subsidies, and �scal incentives. The methodology also provides insight on how to use these instruments for maximum effect and at least cost to governments. Fourth, the framework also helps identify actions that governments can take to im- prove various elements of their own investment climate, and thereby increase the scope for �nancing a greater number of investments to promote a low-emission economy. The framework provides a basis for identifying green investments that can be �- nanced and implemented within a current country policy framework as well as ongoing international programs. Such an approach helps identify investment projects that are not currently viable, but which can be made viable in the short term through blending �nancial instruments. In addition, non-viable projects that require substantive change in Executive Summary 3 the investment environment can also be identi�ed, along with the corresponding set of required policy interventions. Overall, the framework will allow policymakers to evalu- ate projects and develop a country-led green infrastructure �nance plan. Conceptual Methodology for Assessing and Allocating Risks There are two main reasons why low-emission projects do not receive �nancing. First, the risk-reward pro�le of many low-emission projects is not �nancially a ractive, either in absolute terms or in comparison to alternative investment choices. If these investment transactions were to occur, a �nancial viability gap would result or other investment choices would simply be more a ractive. Second, even in situations where green investments might be �nancially a ractive, capital markets and information gaps may prevent private capital from flowing to these projects. For example, capital market gaps in low-emission projects are often the result of the “newness� of the technology or the process, and thus generate unfounded percep- tions of excessive risk. Factors preventing private �nancing flows are generally related to either high per- ceptions of risk, or high project or capital costs (for a given level of returns), or price distortions favoring fossil fuels, or a combination of all three. If it is the la er, then all three factors need to be analyzed so the risks are be er allocated to the appropriate party and each party bears their equitable share of the �nancing challenge within a credible policy framework. The outcomes of this analysis may vary for different types of low-emission proj- ects. In general, low-emission projects can be separated into two categories: (i) capital intensive, infrastructure-like projects; and (ii) less capital intensive, corporate energy efficiency-type projects. Capital intensive, low-emission projects occur predominantly in power generation or in major transportation infrastructure. These include renewable power generation, such as wind energy, solar, hydro, or geothermal power plants. They also include en- ergy efficient transport infrastructure, such as bus rapid transit systems and rail projects. As with all major infrastructure investments, these capital intensive projects have large �nancing requirements and, like other major infrastructure investments, they are usu- ally �nanced as standalone projects, utilizing “project �nance� structures. In contrast, less capital intensive, energy efficiency-type projects have traditionally been �nanced on-balance sheet, and are �nancially distinct from the more capital intensive conven- tional infrastructure investments. Capital intensive infrastructure projects have a number of distinctive features: (i) they require signi�cant upfront capital and take many years to payback; (ii) output is typically sold on the basis of long-term contracts; (iii) and permi ing risks can be sig- ni�cant. However, low-emission projects tend to have higher upfront costs; produce less output per unit of capacity; and have higher perceived risks than conventional infra- structure projects. In summary, low-emission investments are more costly and have higher associated risks. For less capital intensive energy efficiency projects, the situation is different, and the extent of the barriers and �nance challenges for various technologies differs mark- edly (as illustrated by the McKinsey GHG marginal abatement cost curve). Energy ef- �ciency (EE) projects, such as street lighting, retro�t of buildings, and replacement of 4 Executive Summary energy-using plants, machinery and equipment generate negative costs or positive re- turns and are typically considered �nancially viable with short payback periods. Yet, investment levels in these projects, particularly in replacement projects, could also be improved considerably. Despite these challenges, low-emission projects generate more GHG emission and local pollution abatement bene�ts compared to a conventional infrastructure project and, therefore, create substantial public interest to monetize these bene�ts. The international community and national governments have compelling reasons to provide �nancial support to low-emission projects and help them raise the needed �nancing. The international community has demonstrated signi�cant interest in re- ducing global GHG emissions and has increased its role in funding investments on a concessional basis in order to reduce the effects of global warming. For example, the Clean Technology Fund (CTF), a US$4.3 billion trust fund with contributions from eight countries, was created speci�cally to support the development of low-emission projects. Other funds supported by the international community are also available or are in the process of being developed. Nonetheless, the amounts contemplated are still well below the required level of investment support. National governments, while also interested in supporting global GHG emission reduction, recognize the speci�c bene�ts of low-emission projects, especially the ability of these projects to reduce other damages resulting from local air pollution and other local negative externalities. To realize these bene�ts and stimulate private investments in green infrastructure, governments could rebalance their own policy distortions with a mix of domestic instruments such as feed-in tariffs, direct subsidies, domestic carbon taxes, and other �nancing and �scal incentives, thereby no longer disadvantaging low- emission investments. In contrast, the international community could contribute international instruments for monetizing the global externality bene�ts of green investments through concessional �nancing and direct grants. Additionally, for projects that also propose to reduce local ex- ternalities, such as domestic pollution effects, governments could use an array of local and international �nancing instruments or even �scal incentives to monetize those bene�ts. The analytical framework lays out a simple way for appropriately allocating risks and responsibilities, and demonstrates how to combine effectively multiple public and private instruments in a complementary fashion to maximize the leveraging effect of limited public sources of �nancing. It suggests mechanisms by which limited global public funds can leverage both national public funds as well private �nancing in or- der to accelerate investments in low-emission technologies. Moreover, the approach not only identi�es the �nancial structures that make investments viable, but also ensures that these structures are �rmly grounded on economic principles and, therefore, that actions and contributions of each stakeholder do not create or amplify distortions in the economy. In addition, green concessional �nance could be used to monetize the value of net GHG emission bene�ts, while governments introduce other instruments to monetize the bene�ts of reduction of local negative externalities. The international community and governments should create a workable, if not necessarily optimal, combination of �nancing instruments that can a ract private capital at least cost to the public. Executive Summary 5 This methodology guides policy makers toward be er allocating risks and ultimate- ly structuring the �nancing of these transactions while making use of multiple sources of funds. This requires the design of hybrid �nancing arrangements where parties bring in instruments for which they have a comparative advantage, and apply those to portions of the �nancing gap that are most appropriate. Assessment of the Green Investment Climate in EAP Countries Governments can play a pivotal role in promoting investments in climate-friendly tech- nologies by adopting a wide range of interventions. Many EAP countries have proposed policies, programs, legislation, institutions, �scal and �nancial interventions, and other measures designed to promote green growth of their economies through improving the investment climate. A country’s ability to alter the green investment climate and the effectiveness of their policy interventions differs according to the level of sophistication of a country’s private �nancial markets, and the overall a ractiveness of the country’s investment cli- mate. While in many cases the effort and the scale of public sector interventions is sig- ni�cant, the measures are often implemented in a piecemeal fashion without an over- arching framework that includes a detailed assessment of the green investment climate. The second part of this framework calls for an assessment of the green investment climate of a given country in order to develop country-speci�c recommendations. The overall evaluation of the investment climate of countries will provide general under- standing of the a ractiveness, prevailing trends, strengths, and other aspects affecting the ability of the country to alter the green investment climate. The framework is flexible and adaptive to the status and trends of the current investment climate of a given country. The proposed assessment of a country’s green investment climate consists of four main components: (i) policies and legislation; (ii) �nancial and economic instruments; (iii) programs and institutions; and (iv) regulatory environment. Conclusions and Next Steps The report presents a green infrastructure �nance framework that can stimulate a great- er flow of funds for green investments in EAP countries. It is primarily oriented toward promoting private investments, but can also accelerate public-private partnerships as well as purely public engagements. The two components of the framework should be utilized together in order to identi- fy green investments that can already be �nanced and implemented, given the country’s current conditions and ongoing international programs. The approach can determine the investment projects that are not currently viable, but which can be made viable in the short term through blending �nancial instruments. Non-viable projects that require sub- stantive change in the investment environment can also be identi�ed, along with the cor- responding set of required policy interventions. Overall, the framework will allow policy makers to evaluate the projects and develop a strategic green infrastructure �nance plan. Work will continue by operationalizing this framework in selected EAP developing countries. Given a be er understanding of the �nancing challenges of different green projects, more customized and innovative �nancing instruments will be developed and speci�cally tailored to address the requirements of these projects. 6 Executive Summary More tradable permit schemes are being developed and emerging-country govern- ments should examine how to establish a cost efficient system of monitoring and veri�- cation in order to access the potential �nancial bene�ts and support that these schemes can offer. Finally, developing a framework for improved collaboration between public and private sectors could greatly bene�t green infrastructure �nancing mechanisms. This might occur through the development of a practitioners’ network that would focus on knowledge exchange and on building working relationships. CHAPTER 1 Rationale for Green Infrastructure Finance Framework Introduction T he International Energy Agency (IEA) estimates that to halve energy related car- bon dioxide emissions by 2050, investments in energy supply and use should be increased by US$46 trillion over the business as usual (BAU) scenario.1 This translates into US$750 billion of additional investments a year by 2030 and over US$1.6 trillion of additional investments a year from 2030 to 2050. Additionally, the energy portfolio mix should shift toward a signi�cantly greater contribution by climate friendly technologies. While such an investment trend has already begun, it is estimated that by 2020 invest- ments will be at least US$150 billion a year short of the required levels.2 Recent World Bank and IEA studies have noted that a large proportion of this in- vestment shortage will need to be provided by East Asia and Paci�c (EAP) region coun- tries. Thus, up to US$80 billion a year3 of additional investments in low-emission proj- ects and technologies (green investments) is needed to achieve these objectives, thereby “bending� the carbon emission curve (see Figure 1). The Copenhagen Accord, followed by the Cancun Agreement, took signi�cant steps toward mobilizing the necessary funding reaching an agreement to raise US$100 billion a year by 2020.4 A High-Level Advisory Group on Climate Change Financing (AGF), established by the UN Secretary General, categorized the sources of funds into four groups: (i) public sources for grants and highly concessional loans, including the removal of fossil fuel subsidies, direct budgetary contributions and a variety of taxes on carbon and other transactions; (ii) the development of bank-type instruments; (iii) car- bon �nance; and (iv) private capital, as a major source of the total funding.5 The Advisory Group also indicated potential sources of �nancing that would allow scaling up investments in the developing world. In addition, the AGF emphasized the importance of maintaining a carbon price between US$20 to US$25 per tonne of CO2, which would in turn generate an estimated US$100 billion to US$200 billion of gross private capital flows. However, the question of �nancing green infrastructure investments,A particularly “how� green infrastructure investments are evaluated, designed, and �nanced has still not received due a ention. In order to address the �nancing challenge, the EAP region of the World Bank initi- ated work on assessing �nancing of green infrastructure investments and exploring how investment opportunities could be improved in client countries. The �rst step of this 7 8 World Bank Study Figure 1: Investments in Green Technologies and Emission Trajectory The Sustainable Energy Path: Affordable but Facing Major Financing Challenges ■ Annual additional capital investment: US$80 billion ■ But it can be offset by energy savings 140 120 Low-carbon 100 US$35 bil Investment (US$ billion) 80 60 Energy efficiency 40 US$85 bil 20 0 Avoided thermal –20 plants (–US$40 bil) –40 –60 Additional annual investment cost US$80 bil Alternative: CO2 Emissions Can Peak in 2025 ■ Energy efficiency making the largest contribution ■ With significant expansion of low-carbon technologies 16 14 Energy efficiency Low-carbon technologies 12 CO2 emissions (Gt) 10 8 6 4 2 0 2009 2012 2015 2018 2021 2024 2027 2030 Year Source: Winds of Change, World Bank, 2010.3 Green Infrastructure Finance: Framework Report 9 work resulted in publishing Green Infrastructure Finance: Leading Initiatives and Research,6 which not only summarized the status of activities in green infrastructure �nance but also provided an analytical insight. Main Conclusions from the Research Report As previously indicated, green infrastructure investment demands are signi�cant and the shortfalls in �nancing are immense. Essentially, “the current level of investments, and its anticipated growth, will not be sufficient to meet the challenge of global warm- ing.�7 A solution can only be a ained by a joint guided effort by public and private sectors, and a number of instruments should be combined for maximum effect. The re- search report further highlights the following key points: Unfortunately, many green investments are less �nancially attractive when compared against traditional but less eco-friendly alternatives. One of the principal barriers to a racting green investments is that many technologies and projects are not �nancially appealing, and as such, they will not a ract investments purely by private �nance without some level of support from the public sector. In ad- dition, traditional GHG emi ing investments, notably in the energy sector, are cost-ef- fective to users, and therefore are supported by a �nancing and investment framework that is sophisticated, well organized, and well established. In contrast, the framework for �nancing green infrastructure investments is still in its infancy and its �nanciers have limited experience in scaling up to the required extent in this market. The �nancial and institutional constraints to accelerating green investments are numerous. Many studies 8, 9, 10 have focused on this speci�c point and show that low-emission in- vestments differ from conventional energy projects “in �ve important areas: (i) transac- tions tend to be smaller, (ii) development activity tends to be led by non-traditional proj- ect developers, (iii) the availability and assessment of resources is very project-speci�c, (iv) projects tend to rely heavily on regulatory support and carbon pricing mechanisms, and (v) in some instances, projects rely on new or emerging technologies.�11 Further, green investments confront a range of additional challenges including information or knowl- edge gaps, con�dence gaps, uncertainty over the protection of intellectual property rights, and political and regulatory risks. All of these challenges decrease the ability to reliably estimate the required rate of return and increase the associated risks and uncertainties. Many green investments present unique risks because of their cash flow pro�les. Green infrastructure investments possess risks that conventional projects do not, or at least not to the same degree. These typically include demand and regulatory risks, risks associated with resource availability and quantifying bene�ts, and technology risks, among others. Moreover, green investments generally tend to be more upfront loaded with lower operating costs and, therefore, exhibit different cash flow streams than the traditional less eco-friendly technologies. For example, the initial upfront cost for energy efficiency replacement investment presents a greater burden in the initial �nancing deci- sion, even though the project may be considered viable through a stream of offset sav- ings in energy cost in the operational years. In addition, risk factors associated with dif- ferent technologies need explicit consideration on a project-by-project basis. Such risks heavily influence the “hurdle� rate used by private sponsors to assess �nancial viability. 10 World Bank Study An elevated hurdle rate, in turn, further increases the disadvantages of the projects with greater upfront-loaded cash outlays.12 While there are strong hopes that the carbon markets can be revived, there is also great uncertainty. Many proponents of green growth place great hope in a well-functioning carbon market with a predictably stable and appropriate global price for carbon. However, cap-and- trade regimes or tradable permit schemes have been difficult to operationalize because of political challenges in concluding a negotiations process. Nonetheless, developing countries that rely more on international assistance and which could potentially bene�t from these schemes, should establish a credible and cost-effective system of veri�cation, reporting and monitoring of GHGs. The Clean Development Mechanism (CDM), Climate Investment Funds (CIF) and Global Environment Facility (GEF) have made major contributions to the �nancing of green investments and improvement of carbon markets. However, re�nements are nec- essary to make these instruments more effective. For example, CTF’s desire to maximize the leveraging of other �nancing depends substantially on the cash flow characteristics of individual projects as well the extent of the total externality costs inherent in a given green investment. As such, CTF funding of one investment can achieve a very different leverage ratio than another. Moreover, CTF might conceivably support projects already viable on their own, or alternatively, reward policy distortions in a given economy. Distortions present in an economy can widen the �nancing viability gap of many green investments. Policy distortions in an economy can favor traditional technologies. Several notable ex- amples are subsidies for fossil fuels, and politically set tariffs that do not recover ap- propriate costs, as in the case of many infrastructure services (such as electricity, urban transport, water supply, and sanitation, among others). Depending on the magnitude of such subsidies, these may have a negative impact on the �nancial viability of a proposed green investment, or extend the required payback period beyond a level that investors and �nanciers are willing to accept.B While most green investments confront similar �nancing constraints, the extent of such barriers facing different technologies differs markedly. As illustrated by the McK- insey & Co. study in its GHG marginal abatement curve cost, the �nance challenges for green investments can vary widely between different approaches and technologies.13 One set of investments—generally those involving improving energy efficiency initia- tives—generates negative costs or positive returns, while another set, including renew- able energy investments as well as the newest and unproven technologies such as carbon capture and storage (CCS), are fundamentally more costly, making them the least likely to a ract �nancing from private �nancial markets. Currently, few instruments are avail- able that can effectively shoulder “technology� risks in a cost effective manner. Public instruments and concessional funding are essential to leverage private flows. Most experts agree that concessional �nancing needs to be utilized strategically and that approximately 85 percent of the capital needed must come from private �nance.14 However, private �nancial markets behave rationally and require adequate returns after factoring in the various country, institutional, and project risks. Green Infrastructure Finance: Framework Report 11 These “hurdle rates� are substantially higher in developing countries, especially if there are any perceived institutional and regulatory governance weaknesses. In addi- tion, there are other more a ractive investment opportunities (such as high-income real estate development) where the returns are higher compared to the perceived risks. Under these circumstances, the private sector alone does not possess the incentives to mobilize �nancing to the scale necessary to lead this agenda. The private sector in- stead requires collaborative support from public �nance as well as from international donors if the requisite magnitudes of �nancing are to flow into low-carbon investments. Green infrastructure �nance requires country-speci�c public policies and instruments with the public sector taking the lead. The public sector needs to play a pivotal role in leveraging private �nancing because the “greening� of investments essentially requires mitigating externalities that are con- ventionally not valued by markets and investors. Public policies need to address issues related to carbon markets and taxes, regulations and standards, and �nancial support mechanisms as well as correcting policy distortions.15 Currently, private investors con- sider that public funds (i) should be spent when commercial entities are not willing to invest; (ii) would be best utilized to make low-carbon technologies commercially viable; and (iii) should be used strategically at different stages of the technology development/ diffusion process to leverage and a ract private investments.16 In May 2010, the Organisation for Economic Co-operation and Development’s (OECD) Council of Ministers interim report on green growth strategies articulated that both demand and supply sides must be addressed by policy interventions.17 On the supply side, the interventions would include introduction of environmentally related taxes, tradable permits, charges, and fees, and the removal of environmentally harmful subsidies. On the demand side, the interventions would seek to influence the behavior of �rms, households, or individuals through regulations and policies to support green technologies and innovation. In addition, voluntary approaches based on the dissemina- tion of information and agreements between government, subnational entities, and spe- ci�c industrial sectors should be considered. Other mechanisms and initiatives, includ- ing public education, are needed to stimulate more direct, rapid behavioral shifts among both the consuming public as well as producers with high energy needs.18 Public and private sectors need to work together to develop unique solutions. The most recent collaborative approaches between the public and private sector have focused on speci�c issues or concerns rather than on developing broad arrangements for working together.19 Private sector investors appear to be strongly motivated by the busi- ness opportunities available in green technologies provided—as long as the public sec- tor demonstrates its steady and consistent support. In November 2010, the Institutional Investors Group on Climate Change (IIGCC), along with other organizations, jointly issued a simple but powerful message: “Investors are interested in the potentially large economic opportunities presented by a transition to a low-carbon economy. However, as governments lack strong, stable policies, investors do not yet see clean technology �nancing as viable.�20 12 World Bank Study In combining interventions, some are more important than others. Due to the distinct characteristics of green investments, some instruments and measures are more effective than others in closing the �nancial viability gap. For example, while the CDM provides bene�t after the investment has been �nanced and is operational, a reduction of import duties lowers the initial capital requirements, yielding a more sub- stantial return in terms of present value than another measure that amounts to the same nominal cost but instead enhances the revenue stream only in later years. Apart from the effects on the rates of return for a given investment, the reduction of the capital cost can actually facilitate the closing of the transaction �nancing as it reduces the initial sum of cash that would have to be raised. The international donor community, together with multilateral development banks, has developed some innovative �nancial instruments and programs to offset the higher costs of viable clean technologies. However, more clarity is needed on how these �nanc- ing mechanisms can be blended in a more effective and complementary fashion to ad- dress the inherent �nancing difficulties of green investments. Governments still lack a comprehensive framework for assessing their investment climate for green investments and for determining an appropriate mix of measures required to accelerate capital flows. A signi�cant number of governments have proposed approaches in order to classify the broad array of possible public interventions. However, these a empts have not yet yielded a comprehensive framework tailored to country-speci�c environments to pro- mote green investments. Countries with well-developed capital markets are adopting pro-green policies at increasing rates and are also developing �nancing schemes and instruments for fund- ing clean investments. Not only are they focusing on improving the global environment in addition to their own, but are also recognizing a major opportunity to develop and deploy as well as export their own green technologies to foster industrial growth along with its related income and employment bene�ts. For less-developed nations, the options for national interventions are signi�cant- ly fewer. Not only do these countries have limited capacity to compete in the �eld of technology, but their own public funding is constrained by budgetary restrictions and competing commitments from other important initiatives such as health, education and other basic services, including water supply and sanitation. Moreover, local capital mar- kets and �nancial institutions of less developed economies still lack the capacity to cre- ate sophisticated instruments or mobilize long-term �nance. Consequently, many less-developed nations rely heavily on donor support through a number of international �nancing mechanisms. Nonetheless, governments could con- tribute to close the �nancing gap, especially in addressing policies that distort prices and disadvantage green investments in their own economies. It is therefore, essential that country governments are guided by a proper benchmark that sets realistic expecta- tions for what can be accomplished in the short term and provides appropriate actions to make progress in both the medium and longer term. The need for a structural approach in synchronizing and harmonizing the actions of all stakeholders is clear. Reliable methodology that can serve as basis of discussion is needed. Green Infrastructure Finance: Framework Report 13 Green Infrastructure Finance Framework In order to meet the need for such a framework, the EAP region of the World Bank has advanced its work on assessing the �nancing of green infrastructure investments and developed a green infrastructure �nance framework aimed at delivering the following bene�ts: ■ Explain and analyze the �nancial viability gap and, therefore, determine wheth- er the investment can be supported based on emission abatement bene�ts. While any given investment may possess many facets and bring bene�ts along a number of different dimensions, the green infrastructure �nance framework allows focus solely on the bene�ts generated through GHG emission reduction. ■ Recognize explicitly the role of local and global externalities. The framework can provide insight into how to forge strategic support through policy reforms and international donor involvement in order to rebalance distortions, address local and global externalities, and a ract private �nance on the scale required. ■ Through understanding of the components that comprise the �nancial viabil- ity gap, provide be er guidance on which stakeholder is responsible for which portion of the gap. This may help initiate dialog between stakeholders capable of enacting measures to reduce corresponding parts of the gap. ■ Identify green investments that are already viable as well as propose �nancial instruments that are required to make these investments a reality. ■ For those investments that are not viable, formulate the spectrum of policy re- sponses, including options that place a heavier (or lighter) burden on the in- ternational community, thereby alleviating the work for country governments or vice-versa. The framework may also provide insight into how to compare different integrated policy responses in order to choose an “optimal� one or the one with the highest funds mobilization impact. ■ Tailor a balanced mix of solutions to a speci�c country context including those that can be implemented immediately (short-term solutions) and those that re- quire policy dialog and building consensus (medium-term solutions). The for- mer can be often achieved through blending existing and novel �nancial instru- ments while the la er require policy interventions aimed at altering speci�c aspects of green investment climate. ■ Improve collaboration between public and private sectors through the devel- opment of a practitioners’ network. Green infrastructure �nance is a new area for policy analysis, and invariably involves a considerable amount of “learning by doing.� In this context, this initiative is a welcome development along with those started by the World Business Council for Sustainable Development,21 the C40 initiative,22 the Carbon War Room,23 and others. ■ Help establish credible systems of validating that the green growth targets are actually being achieved. For this to occur, a cost-effective system of monitoring, veri�cation, and independent disclosure is essential, to assure �nanciers that the GHG reduction outcomes are consistent with their targets. 14 World Bank Study Objectives and Scope of the Report The objective of this report is to present a framework for accelerating �nancing of green infrastructure investments in EAP countries. The framework is divided into two main components: 1. An analytical methodology that provides an explanation of green investment opportunities in terms of market failure concepts and discusses how monetiz- ing of local and global externalities can help close the �nancial viability gap.C It then proposes how a rational and efficient mix of policy and �nancing instru- ments could be developed in order to make these investments �nancially viable. 2. The second part of the framework focuses on what constitutes the key elements of a green investment climate in a given country environment. This makes it possible to identify investment opportunities, along with policy actions that can a ract market interest in �nancing green investments. This report focuses on mitigation investments in renewable energy (RE) and energy efficiency (EE), and is intended to bene�t developing countries in the EAP region. This chapter presents an overview of the economic rationaleD of green investments while chapter 2 lays out the foundation for developing a green infrastructure �nance frame- work. Chapters 3 and 4 respectively discuss the components of the framework: �nancial viability gap analysis and country assessment. Chapter 5 concludes with a discussion on how these two elements can be integrated in a country context and lead to an action plan that promotes green infrastructure �nance. Audience The results of this work are primarily intended to bene�t governments throughout the EAP region and potentially will have spillover effects to other developing nations that are seeking to improve their approach for assessing and �nancing green investments. In addition, it is hoped that this work will also be useful to practitioners in this area, including existing fund managers seeking to acquire a be er understanding of how to shape their criteria and operation guidelines for the utilization of their respective funds. Notes A De�ned herein, “green infrastructure �nance� is a combination of �nancial and non�nancial interventions and instruments deployed by national governments and international donor com- munity aimed at making low-emission investments in infrastructure more affordable and less risky to private sponsors and �nancial markets. The de�nition is applied broadly and beyond solely �nancial instruments on the conviction that �nancial interventions on their own can only deal with a limited set of solutions and complementary policies and programs are equally needed to make green infrastructure investments a ractive. The term is used interchangeably with “green �nance.� B Assessment methodologies not only need to consider what makes up the viability gap of many green projects, but also determine the respective roles of the various stakeholders including gov- ernments for closing it. C The �nancial viability gap is de�ned here as a difference between net present value of project revenues and net present value of project costs. Net present values are calculated applying oppor- tunity cost of capital commonly used by private investors for �nancing projects of similar nature. D This report only focuses on certain aspects of economic bene�ts and does not account for others (such as health bene�ts). It is conceivable that some projects determined to be not “economically� viable and not justi�able may, in fact, be justi�ed on other grounds not considered in this report. CHAPTER 2 Economic Rationale of Green Investments Climate Change: The Greatest Market Failure T he Stern Review on the Economics of Climate Change states: “Climate change presents a unique challenge for economics: it is the greatest example of market failure we have ever seen.�24 Climatic changes, which can damage economies and livelihoods across the world, are caused by GHG emissions that are considered a “global negative externality� as the emi ers do not pay for the costs they impose. A GHG negative externality is, therefore, a “market failure� because market solu- tions are not socially optimal. For most products available in a well-functioning market, the market system works as a kind of cost-bene�t calculator. The revenue received from the sale of the product reflects the economic bene�ts the products provided to consum- ers, while the costs reflect the economic value of the resources used. In this case, the pro�t criterion—that a �rm will only make products where the revenue exceeds the costs—also performs a social cost-bene�t function. However, when some of the costs are not included in the market mechanisms—as happens with negative externalities—the pro�t calculus of the market is no longer socially optimal. Economic Policy Solutions for a Global Externality There are standard economic tools for the prevention of negative externalities. These tools involve imposing monetary burden, for instance in form of pollution taxes, cap- and-trade systems, and, of course, regulation making it illegal to emit pollution above certain levels. However, these standard solutions rely on governments having the ability to impose regulations, taxes, or subsidies and the power to enforce them. These solutions become difficult to apply to a global externality, because there is no global government. Instead, such interventions require voluntary agreement between nations. The Kyoto Protocol represented a step toward such coordinated action. However, not all countries signed the agreement, and the Protocol only imposes limits on some of those countries that did. The Kyoto Protocol is set to expire in 2012, but has not yet been replaced with any other global and binding agreement to limit emissions. In the interim, the international community and national governments continue to work toward ways to cooperate in reducing GHG emissions. For example, the inter- national community has commi ed to provide US$30 billion for the period 2010-2012 through a Green Climate Fund (GCF).25 Another initiative, the Climate Investment Fund 15 16 World Bank Study (CIF), has current spending capacity of US$6.5 billion.26 Such initiatives, collectively re- ferred to as green infrastructure �nance, are growing in importance. However, it is clear that this level of funding does not meet the level needed to �nance required volume of low-emission investments. As discussed above, the estimated annual investment short- fall for climate mitigation and adaptation actions by 2020 will reach at least US$150 bil- lion.27 Only a fraction of the needed investments can be provided by actual commit- ments from the GCF and CIF. As a result, the international community has recognized that the majority of new in- vestment �nancing will need to come from private sources. Global �nancial markets can easily supply the volumes of �nance required, but will only do so if the investments are a ractive. However, many environmentally desirable investments do not offer a com- mercially a ractive return. Economic Principles for the Ef�cient Use of Green Infrastructure Finance Green infrastructure �nance resources are limited. Therefore, economic efficiency re- quires that green �nance maximize its contribution to its intended objective of GHG emissions abatement. There are three key economic principles that, if followed, will tend to increase the efficiency with which green �nance is used: ■ Economic principle 1: Green infrastructure �nance should reduce costs (or in- crease revenues) for low-emission investments, thereby offse ing the external- ity of GHG emissions, increasing returns on low-emission projects, and leading to more investments in low-emission projects. ■ Economic principle 2: Funding should be concentrated on investments with the lowest cost per tonne abated. ■ Economic principle 3: Financial support should not exceed the amount that is needed to cause investment in the project. Economic Principle 1: Green Infrastructure Finance Offsets the GHG Externality The lower costs, higher revenues, or lower risks offered by green �nance offset the mar- ket failure that GHG emissions are not priced. This contributes to making conditions, which are currently tilted against low-emission projects, more equitable. Such a devel- opment will increase investment levels in low-emission projects. One way public �nance achieves this is by lowering the costs of projects, includ- ing reducing the costs of �nancing. By offering concessional terms—for example, below market interest rates, and longer tenors—green �nance changes the returns available on projects. Other green �nance mechanisms, such as CDM or feed-in tariffs, can increase the revenue investments earn. Green �nance is sometimes viewed as a means of providing additional capital. However, provision of capital is not the most important role for the public sector. Rather, the concessional terms that green �nance offers can leverage private �nance through changing the returns on projects. Since concessionality is the a ribute that makes green �nance powerful, it is useful to be able to measure the value of the concessionality offered. By comparing the cash flows under a concessional �nance option with the cash flows under a �nancing on mar- ket terms, the value of the concessionality can be derived. Any concessional �nancing can be considered as a blend of a grant and a loan on market terms (see Box 1). The grant Green Infrastructure Finance: Framework Report 17 Box 1: Disaggregating a Concessional Loan into a Commercial Loan and Grant Components Green �nance is often provided in the form of concessional �nance, such as CTF conces- sional loans. Concessional loans differ from commercial loans in a number of ways including lower interest rates, longer maturity periods, and payment grace periods. All of these factors are a form of concessionality—or subsidy—compared with commercial loan terms. Therefore, the value that concessional loans provide can be considered as a value of commercial loan plus a value of subsidy component. The subsidy component can be calculated as follows: Where: PV = Present value (at commercial loan interest rate) i = Interest payment p = Principal payment n = Number of payment periods The subsidy component of the concessional loan provides the additional �nancial resource to a low-emission investment, and therefore recognizes the value of the GHG emissions reduc- tions. However, the commercial component of the concessional loan can also be important where capital market imperfections can lead to a capital market gap—meaning that even commercial loans of desired tenor cannot be raised. For the remainder of this section, references to the value of green �nance for low-emission investments indicate the subsidy element provided by green �nance. Source: Authors. component captures the value of the concessionality. This “grant equivalent� essentially makes the difference as to which investments a ract private �nance. The grant equiva- lent also represents the real cost to the public sector of the �nancing, and therefore is the scarce resource that must be used as efficiently as possible. In the following analysis, references to allocating green �nance resources are pri- marily references to allocating the concessionality. For simplicity, the analysis at this stage treats all green �nance as though it were grants. The next chapter discusses the actual concessional �nance structures that can be used. Economic Principle 2: Projects with Lowest Cost per Tonne Abated Should Receive Priority There will not be sufficient green �nance to leverage private investments into all possible low-emission projects. Therefore, the scarce resource of public green �nancing must be used judiciously, to maximize the GHG abatement achieved. The guiding principle will be to target resources on those projects with the lowest abatement cost—the lowest cost incurred to abate GHG emissions by one tonne (see Box 2). This is illustrated by a simple example. If building energy-efficiency projects need �nancial support of only US$5 per tonne of GHG abated, but solar photovoltaic genera- tion needs subsidies of US$50 per tonne of GHG abated, then obviously US$50 dollars of 18 World Bank Study green �nance could abate ten tonnes if applied in building efficiency projects, and only one tonne if applied to solar photovoltaic generation. In practice, the abatement costs of all projects cannot be known. Information costs prohibit any approach that requires all projects in an economy—or ultimately in the world—to be ranked from lowest abatement cost to highest and funded accordingly. A similar result can be achieved in an information-economizing manner by se ing ceilings for support. If a ceiling per tonne of GHG abated is set at a level that roughly equilibrates the demand for support from projects below the ceiling with the total value of support available, then the objective of concentrating scarce green �nance resources on the projects with the lowest abatement costs will be achieved. The problem of se ing the ceiling is nontrivial and is discussed further below, but this approach is clearly more analytically tractable than an approach requiring an actual ranking of all projects. CAVEATS ON USE OF ABATEMENT COSTS This report suggests that targeting green �nance on the projects with the lowest abate- ment costs will be efficient. Given the importance of the abatement cost concept, it is worth clarifying some crucial points. Box 2: Calculating the Cost of Carbon Abatement The GHG abatement cost speci�cally examines the cost per tonne of abating carbon dioxide emissions for a low-emission investment. The abatement cost can be calculated by comparing the net extra cost of a low-emission (LE) investment and dividing this by the amount of carbon saved. If a 2 MW solar photovoltaic farm costs US$7 million to build and has a useful life of 20 years, the cost of electricity generated by the solar farm can be calculated at 27 cents per kWh. The solar farm displaces electricity generated by a coal-�red power plant, but the cost of electrici- ty from the coal plant is only 7 cents per kWh. However, the coal plant has GHG emissions of 1 kg per kWh, of which the solar PV plant will abate. The abatement cost of GHG emissions by building the solar plant is therefore US$200 per metric tonne of carbon dioxide abated. In this case, the abatement cost is positive, but abatement costs can also be negative. This happens when the project abates carbon while saving money at the same time. For example, consider a homeowner who pays a retail electricity tariff of 15 cents per kWh, uses conven- tional 100-watt incandescent light bulbs, and wishes to install 40-watt energy ef�cient light bulbs throughout this house. The ef�cient bulbs cost US$5 each and last for eight years. Therefore, the cost of energy savings through installing the ef�cient bulbs is 1 cent per kWh. Furthermore, the ef�cient bulbs displace coal-�red electricity, which has GHG emissions of 1 kg per kWh. The abatement cost of the ef�cient light bulbs is US$140 per metric tonne of carbon dioxide abated: Source: Authors. Green Infrastructure Finance: Framework Report 19 ■ Economic versus �nancial abatement costs. Most published estimates of abate- ment cost use economic cost concepts—they consider the real resource cost and bene�ts of projects, regardless of whether those economic costs and bene�ts are �nancial costs and revenues for an investor in the project. When leveraging private investments, however, only �nancial costs and revenues ma er. As a result, this report references �nancial abatement costs, rather than simply abate- ment costs. ■ Static versus dynamic abatement levels.A Traditional project evaluation tends to underestimate the dynamic effects of investments. In some cases, this can un- derestimate the levels of the GHG abatement that the investments will achieve. For example, evaluation of mass transit systems such as metros and bus rapid transit tends to assume that the urban form is constant. However, some transit system investments can alter the shape of a city. If the resulting urban form is more energy efficient, these dynamic effects can generate emissions abatement far beyond the static effects of traffic diversion to a new energy efficient mode. Similarly, some low-emission technologies—for example carbon capture and storage (CCS)—currently have very high abatement costs. However, if invest- ments in early high-cost projects can rapidly drive costs down to competitive levels, then the dynamic bene�ts of future cost reductions should be considered when assessing the early projects. Economic Principle 3: Only a Minimal Amount of the Financial Support Should Be Provided Maximizing abatement for any given amount of concessional �nance also requires that no project receives more support than the minimum amount needed to achieve �nancial viability and a ract private investments. This is illustrated by a simple example. If a building energy efficiency project needs a �nancial contribution of US$5 per tonne to proceed, but actually receives US$10 per tonne in �nancial support, some green �nance resources has been wasted. It would have been preferable to pay the project only the US$5 per tonne needed to allow it to a ract private capital to cover the investment cost. The remaining US$5 could then be used to support another project by leveraging more private �nance and abating more emissions for the same amount of green �nance. Practical Principles for Green Infrastructure Finance Mechanisms The above analysis shows that the economic objective for green �nance should be to con- centrate scarce concessional resources on projects with the lowest abatement costs, and to provide no more support to a project than is needed to make the project �nancially viable. A strict application of this approach would suggest that all low-emission projects should be ranked from the lowest abatement costs to the highest. Green �nance re- sources should then be provided to each project, exactly equal in value to the abatement costs, starting with the lowest abatement cost project. Progressively higher abatement cost projects would be funded, until the green �nance resources were exhausted. If this method was used, total GHG abatement would be maximized for any given level of green �nance available. 20 World Bank Study However, such a theoretically ideal approach is simply not possible. Policy makers cannot determine the exact abatement cost for all projects. Given limitations on infor- mation and government capacity, green �nance programs need to be designed so that they can approximate the theoretical ideal, while recognizing that they cannot achieve it perfectly. Three useful tools can be applied: choosing sectors judiciously, se ing ceilings for the value of support, and using competitive mechanisms where possible. Focus Support on Sectors and Technologies That Have Many Projects with Low Abatement Costs In any given country, some sectors will contain numerous projects with low emissions costs, while projects in other sectors will typically have higher emissions costs. Targeting green �nance on the more promising sectors is likely to be the preferred option. Simi- larly, within any given sector, some technologies will tend to have low abatement costs, while others will typically have high abatement costs. Sound judgments about which technologies to support can therefore optimize the use of green �nance The sectors and technologies with the greatest promise will vary from country to country. In a country with abundant unexploited hydro or geothermal resources, the power sector may have strong potential for efficient abatement. Conversely, in a rapidly urbanizing country, the best options for efficient emissions reduction may be to ensure that new buildings are energy efficient, and to create efficient mass transit systems. Set Ceilings for Support Provided per Tonne of GHG Abatement In the theoretically optimal approach, green �nance resources would be expended �rst on the lowest abatement cost projects, then on higher abatement cost projects, until re- sources were exhausted. All projects below a certain level of abatement cost would be supported, with no support for projects above that level. The theoretically optimal result may be approximated by se ing a ceiling on the grant equivalent value of concessional �nance provided per tonne of GHG abatement. If the ceiling is about the level (in dollars per tonne) that would be reached under the theoretically optimal approach, then the �nal level of abatement achieved for any given level of resources will be close to optimal. Se ing such a ceiling can help ensure an optimal allocation of green �nance re- sources between sectors, and across technologies. It would be inefficient to spend only US$10 per tonne on energy efficiency projects if solar photovoltaic projects were being supported with resources worth US$60 per tonne of abatement. Se ing a ceiling would help optimize sectoral allocations. In this example, resources would be transferred from solar projects to energy efficiency projects until the abatement achieved from a dollar spent in each sector approximately equalized. In this way, the total amount of abatement would be increased.B Similarly, within a sector, se ing ceilings for support can help to maximize effi- ciency by improving the allocation of green �nance across technologies and projects. In the renewable generation subsector of a particular country, for example, there may be many geothermal projects with an abatement cost below US$25 per tonne, while most solar projects have an abatement cost of US$60 per tonne or more. Se ing a ceiling for support in such a case would help to direct resources to where they are best used—in this case, efficient geothermal projects. Green Infrastructure Finance: Framework Report 21 This suggestion obviously raises the question of what level at which to set the ceil- ing. This is a ma er for further analysis. However, it is worth noting that the UK govern- ment set a ceiling for internal government use in 2007 of £25 (US$40) per tonne of carbon emissions.28 Another relevant value is the trading range of the EU-ETS. Also relevant is the UN High-Level Advisory Group on Climate Change Financing’s recommendation of a carbon price between of US$20 to US$25 per tonne of CO2.29 (Solely for indicative purposes, this report assumes ceiling price of US$25 per tonne in subsequent chapters.) Use Competitive Mechanisms to Avoid Excessive Support Even within a given sector and technology, the actual abatement costs vary in ways that are difficult for policy makers to observe. Some energy efficiency projects will make a pro�t, while others need a subsidy before a racting private sector investments. One wind generation project might have an abatement cost of just US$20 per tonne, while another—in an area with a different wind pa ern—might have an abatement cost of US$80 per tonne. The problem for policy makers is that the actual abatement costs are often hard to verify. Private investors, although generally aware of their expected costs and revenues, and their abatement costs, may overstate their abatement costs, in order to increase prof- its by a racting additional �nancial support. From an economic perspective, this is a classic information revelation issue. There is no perfect way to solve this problem. However, experience suggests two useful techniques. The �rst has already been mentioned—se ing an appropriate ceil- ing on the level of support that will be offered. The second is to use competition. In a competitive se ing, investors have an incentive to reveal their true abatement costs. For example, if a challenge fund for renewable energy generation was created, then all renewable projects would wish to maximize the funding they received. However, if the funding was allocated to those projects with the lowest abatement costs, then the temp- tation to overstate abatement costs is offset by the disincentive that this might result in the project not being awarded at all. Achieving the right balance between se ing ceiling prices and using competition will vary between sectors, technologies, and countries, depending on transaction costs and deal sizes. However, judicious use of these two approaches can result in green �- nance that is both practical and efficient. Summary of Economic Design Principles for Green Infrastructure Finance Effective green �nance requires that limited public funds are used carefully to leverage private �nance for low-emission projects. To achieve this, green �nance needs to make a �nancial contribution to projects that reduce GHG emissions, thus making them suf- �ciently �nancially viable to a ract private investments. In principle, emissions reductions can be maximized if scarce public funds are con- centrated on projects with the lowest abatement costs. In addition, no project should be provided with concessional funding beyond what is needed to make it �nancially viable. In practice, it is not possible to identify precisely abatement costs for every low- emission investment. Effective program designs need to recognize this, and use other mechanisms to promote the efficient use of public funds. These mechanisms will gener- ally include some combination of the following: 22 World Bank Study ■ Targeting green �nance resources on sectors which have large numbers of proj- ects with low abatement costs; ■ Se ing ceilings on the value of support that will be provided for a tonne of GHG abatement in any sector or project; ■ Using competitive mechanisms to ensure that projects do not receive more sup- port than needed to make them �nancially a ractive. The next chapter sets out how to calculate the level of green �nance support needed by low-emission projects so that the principle of se ing ceilings and limiting support to the minimum can be put into effect. It also outlines how to convert these economic prin- ciples into practical �nancial structures. Notes A An additional idea elaborated later in this report is the distinction between global and local abatement costs. Local abatement costs refer to the Sox, NOx and suspended particulate ma er that require �nancing from local or national governments. Abatement costs referred to in this report are only those related to reducing global GHGs. B This rule can have greater leverage when local and global pollution abatement takes place jointly because technologies that reduce GHG abatement very often also “clean� the local environment. CHAPTER 3 Conceptual Methodology for Assessing and Allocating Risks Rationale for Methodology T here are two main reasons why low-emission projects do not receive �nancing. First, many low-emission projects are not �nancially a ractive either in absolute terms or in comparison to alternative investment choices. This means there is either a “�nancial viability gap� so the project is not viable at all, or other investments are simply more at- tractive. Second, many green investments could be �nancially a ractive, but because of other reasons, such as capital market gaps (or information or experience gaps), private capital does not flow to these projects. Capital market gaps in low-emission projects are often the result of the “newness� of the technology or the process, and thus excessive perceptions of risk. All these impediments need to be analyzed so that the risks are be er allocated to the appropriate party and that each party bears their equitable share of the �nancing challenge within a credible policy framework. Despite the challenges, however, low-emission projects generate more GHG emission and local pollution abatement bene�ts compared to a conventional infrastructure project and, therefore, may create substantial public policy interest to monetize these bene�ts. Thus, the international community and national governments have compelling reasons to provide �nancial support to low-emission projects and help them raise the needed �nancing. Figure 2: Why Low-Emission Projects Are Not Getting Financed? Financial viability gap—project delivers Not Financially negative net present value Attractive Alternative investments more attractive— Low-Emission the risk-reward profile is not as financially Projects attractive as other investment options Capital market gaps—lack of financial Financially instruments information and coordination Attractive problems, and others Financially viable, attractive and bankable projects Source: Authors. 23 24 World Bank Study The international community has demonstrated signi�cant interest in reducing global GHG emissions and has increased its role in implementing international instru- ments for monetizing the global externality bene�ts of green investments through con- cessional �nancing and direct grants in order to reduce the effects of global warming. For example, the Clean Technology Fund (CTF), a US$4.3 billion trust fund with con- tributions from eight countries, was created speci�cally to support the development of low-emission projects. Other funds supported by the international community are also available or are in the process of being developed. Nonetheless, the amounts contem- plated are still well below the required level of investment support. National governments, while also interested in supporting global GHG emission re- duction, recognize the speci�c local bene�ts of low-emission projects, especially the abil- ity of these projects to reduce other damages resulting from local air pollution and other local negative externalities. To realize these bene�ts and stimulate private investments in green infrastructure, governments could rebalance their own policy distortions with a mix of domestic instruments such as feed-in tariffs, direct subsidies, domestic carbon taxes, and other �nancing and �scal incentives, thereby no longer disadvantaging low- emission investments. Additionally, governments could use an array of international �nancing instruments incentives to monetize those bene�ts. The approach presented under the Green Infrastructure Finance framework not only identi�es the �nancial structures that make investments viable, but also ensures that these structures are �rmly grounded on economic principles and, therefore, that actions and contributions of each stakeholder do not create or amplify distortions in the economy. This approach provides a framework for appropriately allocating risks and respon- sibilities and effectively using multiple instruments and tools to make green investments viable. Further, these instruments could be applied in a complementary fashion and commensurately shared among the various parties. For example, in countries where the cost of coal is subsidized, governments could use feed-in tariffs to rebalance the �nancial impact of those policies thereby making low-emission investments no longer disadvan- taged in that context. In addition, green concessional �nance could be used to monetize the value of net GHG emission bene�ts and governments can introduce other instru- ments to monetize the bene�ts of reduction of local negative externalities. The international community and governments need to create a workable, if not optimal, combination of �nancing instruments that can a ract private capital at a least cost to the public. Therefore, the �nancing support structure adopted should address the speci�c reasons that prevent private investments, as well as help understanding speci�- cally what each supporting stakeholder is paying for. This chapter presents a methodology that addresses each of these steps, and in do- ing so guides policy makers towards be er allocating risks and ultimately structuring the �nancing of these transactions while making use of multiple sources of funds. This requires the design of hybrid �nancing arrangements where multiple parties bring in instruments for which they have a comparative advantage and apply to portions of the �nancing gap that are most appropriate. As this approach is similar to a conventional project �nance approach in infrastructure projects, understanding the similarities and differences between private investments in conventional and low-emission infrastruc- ture should help be er understand the methodology. Green Infrastructure Finance: Framework Report 25 Similarities and Differences between Conventional Infrastructure and Low-Emission Investments Low-emission projects can be separated into two categories: (i) capital intensive, infra- structure-like projects; and (ii) less capital intensive, corporate energy efficiency-type projects. Capital intensive, low-emission projects occur predominantly in power generation or in major transportation infrastructure. These include renewable power generation, such as wind energy, solar, hydro or geothermal power plants; and energy efficient transport infrastructure, such as bus rapid transit systems and rail projects. Like all ma- jor infrastructure investments, these capital intensive projects have large �nancing re- quirements and like other major infrastructure investments they are usually �nanced as standalone projects, utilizing “project �nance� structures (see Box 3). In contrast, less capital intensive, energy efficiency-type projects have traditionally been �nanced on- balance sheet, and are �nancially distinct from the more capital intensive, conventional infrastructure investments. Capital Intensive, Low-Emission Investments From a �nancing perspective, low-emission projects have much in common with con- ventional infrastructure projects: ■ Capital intensiveness requiring many years to recover the original invest- ment. Signi�cant upfront capital is required for an asset base that will provide a service over the long-term, typically 20 years or more. To build the asset, both types of projects require long-term �nancing—often arranged on project �- nance, limited recourse basis where the majority of �nancing is typically raised as debt from a syndicate of banks (lenders). Under this �nancing arrangement, satisfying the requirements of the lenders, particularly for allocating risks, is a key consideration in deciding how the project will eventually be structured. ■ Output is typically sold under a long-term contract to an off-taker. The special purpose company (SPC) created by the project sponsors will enter into long- term off-take contracts with a government agency or private company. This contract will set the terms under which the SPC will sell its output. These terms include output speci�cations, price adjustment formulas, as well as the pay- ment terms. Under this type of contract, the SPC that owns the asset is exposed to the buyer breaching the terms of the agreement—for example, by delaying payments (payment risks) or not adjusting the prices according to the formulas set in the contract (regulatory risk). ■ Permi ing risks can be signi�cant. Obtaining environmental permits can be more burdensome for high-emission infrastructure projects. However, both types of projects are exposed to a similar level of permi ing risks as low-emis- sion project confront similar permi ing processes. Securing other investments or construction permits can be more onerous. For example, a wind farm has to acquire the rights to larger areas of land, dictated by the optimum location of the wind resource—this factor alone could make the permi ing risk of wind farms more signi�cant than for coal-�red plants. 26 World Bank Study Box 3: Characteristics of Project Finance Most privately developed green�eld infrastructure projects are �nanced on a project �nance basis. Investors and lenders prefer this �nancing structure because project cash flows and returns can be isolated from those of other investments. Clarity on project cash flows allows investors to identify risks that affect these cash flows and the return on investment, and adopt strategies for managing these risks. Project cash flows are commonly isolated from the bal- ance sheet of a project sponsor by creating an SPC whose only purpose is to build, �nance, and operate the project. The company will use contracts with specialized �rms to transfer and manage speci�c project risks. For instance, engineering, procurement, and construc- tion (EPC) services will often be outsourced to an EPC contractor, while operations and maintenance (O&M) responsibilities are outsourced to an O&M contractor. Figure 3 presents a simpli�ed illustration of the structure that could be used to project �nance a power plant. Figure 3: Project Finance for a Power Plant Off-taker Power Purchase Agreement Equity Special Purpose Lender Investor Shareholders’ Company Loan Agreement Agreement EPC O&M Contract Contract Contractor Operator Source: Authors. This structure gives equity investors and lenders a clearer understanding of the risks to which they are exposed, and the risk-adjusted return that they should expect from their investment. For example, by entering into a �xed-price EPC contract with a contractor, investors will trans- fer the risk of construction cost overruns to the EPC contractor, and could therefore reduce their return requirements—in relation to a structure in which the investors and lenders were directly exposed to this risk. A key bene�t of project �nance is that it provides an effective structure to manage risks, and minimize the cost of risk and the overall cost of the project. However, this bene�t comes at a cost. Creating an SPC and structuring and procuring contracts with specialized �rms have signi�cant transaction costs that are not scaled down if the size of the project is small. This means that smaller projects, with a capital investment of less than US$10 million, could �nd that project �nance is not cost-bene�t justi�ed. Source: Authors. Green Infrastructure Finance: Framework Report 27 Many of aforementioned features, however, are more pronounced in case of low- emission projects, making them less a ractive than conventional ones. Moreover, dis- tinct characteristics of low-emission projects negatively affect all three key factors of project viability (revenues, costs, and discount rate), making it even more difficult to a ract investments. These characteristics include: ■ Capital costs are higher: Low-emission projects have higher upfront capi- tal costs, and higher lifecycle costs than their high-emission alternatives. This means that low-emission projects: (i) need to raise more upfront �nance per unit of capacity; (ii) need to pay more interest during construction, which further increases upfront capital requirements; (iii) pay more interest overall; (iv) re- quire larger debt service reserve accounts as debt payments are higher; (v) incur higher upfront and commitment fees; and (vi) produce output at a higher price than high-emission alternatives—making it less competitive. ■ Revenues are lower: Low-emission projects produce less output per unit of capacity than high-emission alternatives. The output of low-emission proj- ects—for example, wind farms or solar plants—depends on natural sources of energy that are largely unpredictable. This means that the actual output of low- emission projects per unit of capacity installed is less than their conventional alternatives. Moreover, unpredictable variations in cash flow means that debt service coverage ratio may not be met as easily, making debt harder to raise, or requiring a lower debt to equity ratio—which could increase the cost of capital of the project. ■ Demanded returns are higher: Low-emission projects have higher perceived risks than conventional infrastructure projects. The perceived risks can lead in- vestors to demand higher returns, or can even become a complete barrier to investment when the risks exceed the levels that investors are willing to accept. Risk perceptions for low-emission projects are higher because the technologies used are often new to many countries, and there is limited experience in the country in investing, using, and maintaining these technologies. These cost, revenue, and return characteristics are intrinsic properties of the low- emission projects and while technology development and penetration can positively af- fect them in the long-term, in the short-term they should be considered static. Often, however, an investment pro�le of the low-emission project is further disadvantaged by the actions taken by government that favor tradition projects and disincentivize low- emission investments: ■ Policy and price distortions: Low-emission projects can often be disadvan- taged compared with conventional alternatives by fuel subsidies and other price distortions. Such distortions include subsidies, tax incentives, and trade restrictions. For example, coal power is subsidized in Vietnam due to coal ex- port restrictions that are placed on coal produced domestically. This, in turn, lowers the price of coal, reducing the fuel cost for coal power plant operators. These distortions often result in decreasing the revenue flows and increasing cost outlays for low-emission projects. Examples of additional risks of low-emission investments are shown in Table 1. 28 World Bank Study Table 1: Additional Risks of Low-Emission Investments Risks that are the same, but cost Risks that are perceived to be high, Risks that are higher low-emission projects more but may not be • Resource availability • Transactions tend to be smaller • There is a limited secondary market • Non-traditional project developers • Existing assets that are replaced • Market unfamiliarity with investment lack track records may still have residual value that is class creates an irrational risk • New or emerging technologies greater than their salvage value aversion • Inexperienced local contractors • Non-investment grade off-takers • Regulatory risk from regulatory or �scal support instruments Source: Authors. While low-emission projects possess these additional challenges, they also generate GHG emission and local pollution abatement bene�ts when compared to a conventional infrastructure projects. As a result, low-emission projects can create substantial interest to monetize these bene�ts, and use the generated revenue to offset some of the factors that make low-emission projects more difficult to �nance. For example, the international community could “pay� the SPC for every tonne of GHG abated. This payment can be in many forms of �nancial support that have an implicit subsidy, such as an upfront grant or concessional loans or feed-in tariffs. Table 2 illustrates the similarities and differences using a hypothetical coal-�red power plant and a wind farm. The shaded cells indicate the differences between projects. Table 2: Technical and Financial Factors for Coal and Wind Energy Investments Coal-�red Power Plant Wind Farm Power Plant Technical and Financial Factors Capacity 100 MW 100 MW Capital Cost US$130 million US$160 million Off-take Contract 20 year PPA 20 year PPA Capacity Factor 95% 35% Cost of Fuel Coal—US$60/tonne Wind—zero Financing Project Finance: 70% Debt, 30% Equity Project Finance: 70% Debt, 30% Equity Key risks and their importance Permitting (environmental) High Medium/High Construction Medium/High High Variability of Output Low High Uncertainty in Sources and Prices High Low of Fuel Operation & Maintenance Medium High Price Regulation High High Off-taker Payment High High Source: Authors. Green Infrastructure Finance: Framework Report 29 Less Capital Intensive, Corporate Energy Ef�ciency-Type Projects While most green infrastructure investments confront similar constraints to �nancing, the extent of the barriers and �nance challenges for different technologies differs mark- edly (as McKinsey & Co. illustrated in GHG marginal abatement cost curve). Energy efficiency (EE) projects, such as street lighting, retro�t of buildings, new investments and replacements of energy-using plants, and machinery and equipment generate nega- tive costs or positive returns and are typically considered �nancially viable with short payback periods. Yet, investment levels in these projects, particularly in replacement projects, could be improved considerably. First, the �nancial viability of EE investments is signi�cantly affected by the number and extent of distortions in an economy that favor traditional technologies. Subsidies for fossil fuels or politically set tariffs that do not recover appropriate costs include, notably, urban transport as well as water supply and sanitation. Such distortions affect purchase decisions for both new and replacement investments. Second, unlike the more capital intensive projects, EE projects are typically �nanced on the strength of the entity’s balance sheet, whether it is a corporate entity, a municipal government, some other public enterprise or joint stock company. Hence, the a ractive- ness of the investment may only play a secondary role in terms of access to �nancing. The �nancing may be denied because of the entity’s poor overall condition despite the cost savings generated by the proposed investments. Third, speci�cally for replacement energy efficiency investments, the difference be- tween the depreciated value and the salvage value of an existing asset that would be replaced must be fully incorporated in the evaluation analysis as a deduction from the cash flow bene�ts of the new investment. For example, all costs associated with salvag- ing an existing, less efficient generator would have to be deducted from the bene�ts of the new investment. This problem is accentuated, for example, in a street lighting case, which would typically require the replacement of all the lamps in given lighting section, regardless of whether the lamps have signi�cant differences in their remaining useful lives. Moreover, if proponents gain very li le from tax incentives, such as accelerated de- preciation, the incentives to replace existing assets, while they are still in operational condition, are signi�cantly reduced. While the current stock of �xed assets in developing countries is arguably lower than in developed ones, pointing to a strategy of greening an economy through growth rather than EE replacements, EE replacements should none- theless be an essential component of a government’s green growth agenda. Fourth, even if an EE investment, replacement or otherwise, produces a positive rate of return that exceeds the entity’s hurdle rate, the sponsor may still decide against it for a number of reasons. For example, given that an entity typically has very well de�ned �- nancing limits which guide it in formulating its investment plans, alternative investment options besides the EE project may be more a ractive because of: (i) strategic or business considerations (for example, expanding markets and production rather than improving efficiency; (ii) other investment choices offering higher rates of return than the EE project against the entity’s �nancing limits; or (iii) the calculation of the bene�t stream of the en- tity’s other investments may be more reliable than those of the EE project (for example, calculating the bene�t stream of improving the efficiency in buildings versus an outright investment in equipment for expanding production: see Figure 4). 30 World Bank Study Figure 4: Energy Ef�ciency Projects May Be Less Attractive than Core Business Projects Source: Authors. Moreover, EE investments, like their more capital intensive counterparts, confront a series of other challenges such as capital market gaps, information or knowledge gaps, and con�dence gaps. Capital Market Gaps Capital market imperfections or market failures are substantial obstacles in �nancing green infrastructure investments, particularly EE projects. In perfectly functioning capi- tal markets, rational investors will deploy capital to all investments that are �nancially viable—investments that deliver returns consistent with their risk pro�le. There are three key reasons, however, why capital markets could fail to deploy capital to low- emission investments: ■ Lack of �nancial instruments. Many of the EE and RE investments suffer from the unavailability of certain �nancial instruments. For example, EE projects of- ten rely on ability of project sponsors to raise debt �nancing. However, lenders may not be willing to provide such loans as EE projects do not generate addi- tional sources of revenue and, normally, do not offer collateralized assets. Simi- larly, RE projects require securing a long-term commercial debt with a tenor commensurate with the life of the project. However, this long-term debt �nanc- ing instrument can simply not exist in emerging �nancial markets. ■ Information problems. Energy efficiency investments are a good example of low-emission projects that suffer from information problems. Because the mar- ket for EE investments is nascent, project sponsors or �nanciers need to invest money and resources to perform adequate due diligence of opportunities— Green Infrastructure Finance: Framework Report 31 thereby increasing the initial cost of sourcing information that eventually deters investor interest. ■ Coordination problems. The nascent energy efficiency market in East Asia also suffers from coordination problems due to the lack of investors actively looking for, and investing in, projects, as well as the lack of project developers. When there are few buyers and sellers in a market it becomes difficult and costly to coordinate transactions because of a lack of market support structures that have been set up for efficient transactions. Box 4 provides an example of the existence of a capital market gap in a low-emission project in Southeast Asia. Box 4: Capital Market Gap for South East Asia Biomass Plant A 17.5 MW power plant project, located in Southeast Asia, will use agricultural biomass to generate power. The plant will require a capital investment of US$61.2 million, which the sponsor plans to �nance 70 percent with debt and 30 percent with equity. The sponsor has already secured debt from a local bank. Ninety percent of the debt is guaranteed by an export- import bank. The sponsor has also secured the electricity off-take agreements as well as the feedstock supply agreements. The sponsor has been unable to attract private equity to close the �nancing of the plant. The question arises why investors have not been interested in this project. A capital market gap can partially provide an explanation. The sponsor is a new company established by a group of industry experts yet does not have an operating history that is easily veri�able. As a result, equity investors would need to invest more time and money undertaking the due diligence of this investment than for other invest- ments that could yield similar returns. This constitutes an information problem. Further, this is the �rst biomass project in that country, and one of only a few in Southeast Asia. This represents a coordination problem, as there are very few participants in the bio- mass industry in the region. The equity investor has therefore limited options for sourcing the expertise needed to support its investment decision. Source: Authors. Understanding the Financial Viability Gap—A Wind Farm Case The following example illustrates the problem of understanding the viability gap. Using the same wind farm and coal-�red plant parameters presented in Table 2, the wind farm project has a present value of revenues of US$60 million, and present value of lifecycle costsA of US$170 million—a viability gap of US$110 million. Figure 5 illustrates and ex- plains the factors that constitute the �nancial viability gap for the project. This �nancial viability gap for the Wind Farm case shown above can be explained by examining how low-emission projects differ from conventional projects. Besides higher upfront capital and lifecycle costs for low-emission projects compared to high-emission alternatives, the key differences include: ■ Low-emission projects have a lower output per unit of capacity compared with conventional generation projects. This is caused by the intermi ent char- acteristic of natural resources such as the wind and sun. For example, a produc- 32 World Bank Study Figure 5: Explaining the Financial Viability Gap for a Wind Farm Source: Authors. tive wind farm typically has a capacity factor of 35 percent, much lower than a typical coal power plant capacity factor of 95 percent. This has two implications that reduce the value of energy generated by a wind farm. First, because the wind farm is unable to operate as constantly as a coal power plant it will not generate as much energy revenues. Second, a wind farm needs to be supported by a reliable and dispatchable generation capacity that can provide power sys- tem stability when the wind drops. If a wind farm had a 95 percent capacity fac- tor, it could earn US$200 million more in revenues over the project lifetime (see Figure 5, the tall bar on the left labeled “High Output Per Unit of Capacity�). ■ Public policy distortions, such as subsidies, tax incentives, or trade restrictions, can disadvantage low-emission projects compared with conventional projects. Such distortions can decrease the competitiveness of low-emission projects, par- tially neutralizing the key advantage of renewable energy sources—zero fuel cost.B In Figure 5, the impact of this policy distortion is depicted as foregone revenue (hatched portion on the bar on the left) caused by subsidized resourc- es—in this example the foregone revenue has a present value of US$34 million. ■ Finally, the characteristics of low-emission projects lead investors to perceive them as riskier than conventional alternatives. Coal �red power plants are well understood and �nanciers are be er equipped to assess and manage their risks. Wind farms are new and still perceived as risky in much of East Asia. The apparent greater risk means that investors demand a higher return. If it is assumed that an investor expects a project-level return of 14 percent when investing in a wind farm, and 10 percent when investing in a coal power plant, the present value of the additional risk premium is US$33 million.C This cost is depicted as the lighter portion on the bar on the right of Figure 5. Green Infrastructure Finance: Framework Report 33 As indicated above, the key reasons why low-emission projects do not a ract capi- tal include the existence of capital market gaps and �nancial viability gaps. To obtain �nancing for projects, one or both of these gaps need to be addressed. The goal of green �nance can be viewed as addressing these gaps, and encouraging private capital by in- creasing the a ractiveness of low-emission investments. How green �nance can achieve this is explained in the next section. Making Green Infrastructure Finance Work to Close the Viability Gap Green �nance can be used in two ways to close the capital market and �nancial viability gaps: ■ First, by rebalancing policy distortions that cause some low-emission invest- ments to be �nancially not viable; ■ Second, by monetizing the bene�ts that low-emission investments create by re- ducing GHG emissions and local air pollution reduction. Green �nance helps to reduce and ultimately close the �nancial gap of low-emission projects by providing an economic rationale for the actions of each stakeholder and, therefore, minimizes the chances of creating inadvertent distortion. Rebalancing Policy Distortions As mentioned earlier, policy distortions that favor only conventional infrastructure proj- ects can place low-emission projects at a �nancial disadvantage, leading to under-invest- ment. Policy distortions, such as subsidies, tax incentives, and export restrictions, keep the price of conventional energy below its true economic cost. For example, in Indonesia retail electricity rates are highly subsidized—set at around 60 percent of the true cost of electricity generation. Likewise, in Vietnam, coal export restrictions reduce the cost of coal power generation by reducing the domestic price of coal. Such distortions are often harmful because they lead to increased energy use, the inefficient use of resources, and, consequently, to higher GHG emissions. To encourage investments in low-emission projects there is a need to balance the policy distortions. The optimum solution would be to phase out such distortions, but this may be politically difficult. Instead, national governments could rebalance the dis- tortions favoring conventional energy with a subsidy to low-emission projects. This would neutralize the distortions and ensure conventional and low-emission projects are treated more equally. If a government subsidizes energy consumption by 6 cents per kWh, it might choose to be consistent and also to subsidize, through various instru- ments, energy efficiency projects by 6 cents for each kWh saved. Monetizing Reductions in GHG Emissions and Local Air Pollution It is generally accepted that GHG emissions cause global harm. However, the harm is rarely accounted for in �nancial costs or revenues. For instance, in developing coun- tries such emissions are often not subject to carbon taxes or cap-and-trade schemes that would a ach a �nancial cost to the emissions. This creates an opportunity for �nancial instruments that in essence can pay low-emission projects for their GHG abatement, and therefore the bene�t they create through emissions reduction. A well-known example of such an instrument is the CDM. 34 World Bank Study In addition to GHG emissions, there also exists the opportunity to monetize local negative externalities, such as local air pollution, that is reduced as a co-bene�t of low- emission projects. For example, a coal power plant may emit harmful nitrous oxide and sulfur dioxide that cause acid rain and other environmental damage. A low-emission project such as a wind farm would not have such emissions, but its environmental ben- e�ts are not yet monetized. Examples of Filling Viability Gaps The following cases illustrate the opportunities for rebalancing policy distortions, mon- etizing GHG emissions, and monetizing local air pollution. The 100 MW wind farm outlined previously has an estimated viability gap of US$110 million. This gap could be closed by rebalancing policy distortions, and monetizing the economic bene�ts from avoided GHG emissions and local air pollution (see Figure 6). The present value of the policy distortion is US$34 million. The economic bene�ts from the avoided cost of GHG emissions are US$102 million. In this case, �nancial support valued slightly higher than the GHG abatement bene�ts alone would be enough to close the wind farms viability gap of US$110 million. Other non-monetized bene�ts can also be signi�cant for some projects, such as ur- ban transit. Figure 7 illustrates a Bus Rapid Transit (BRT) project for a second tier East Asian city with a viability gap of US$165 million. Monetizing the economic bene�ts of air pollution (US$35 million) and GHG emissions (US$25 million) does not close the via- bility gap. However, other non-monetized bene�ts that mitigate local externalities, such as reduced congestion, reduction in accidents, and productivity bene�ts total US$150 million in value. If certain portion of these bene�ts could be monetized through national or local government �nancing, the viability gap could be closed. Figure 6: Filling the Viability Gap with Public Bene�ts: Wind Farm Case Source: Authors. Green Infrastructure Finance: Framework Report 35 Figure 7: Filling the Viability Gap with Public Bene�ts: Bus Rapid Transit Case Source: Authors. Combining Instruments for Effective Financing Solution The international community and national governments should �nd a practical combi- nation of �nancing instruments that, with minimum use of public funds, would collec- tively close the gap and a ract private capital. Therefore, the �nancing support structure adopted should address the speci�c reasons that are preventing private capital from flowing to low-emission investments, but do so at least cost to the international com- munity or government. This section addresses these issues by analyzing two important points. Firstly, by reviewing the role that the international community and governments (stakeholders) could have in supporting the �nancing of low-emission projects; and secondly, by de- scribing the types of policies and instruments that these stakeholders can use to �nan- cially support low GHG emissions projects. Finally, examples of such projects show how these policies and instruments can be used in practice. The Roles of Various Stakeholders The literature and international consensus is clear—funding for low-emission invest- ments must come largely from the private sector, but the international community and national governments should collaborate and demonstrate leadership to solve this chal- lenge. The capital market gap and �nancial viability gap analysis above has shown that private sector �nance will only be forthcoming if low-emission projects are made �nan- cially a ractive or if the market gaps or imperfections that are preventing �nancially viable projects from being �nanced are resolved. A key role for national governments and the international community, therefore, is to use their �nancial resources and policy powers to help in closing these gaps. 36 World Bank Study A clear and appropriate allocation of responsibilities between the international com- munity and national governments is important to ensure gaps are closed and private �- nance is a racted. Therefore, the international community should lead where payments for GHG emissions reductions are needed to close the gap, while national governments should lead on interventions related to national policy. For projects that are not �nancially viable, monetizing GHG emissions reduction could close the viability gap, allowing private investors to deploy capital and achieve required returns. For other projects that are �nancially viable, but where the market has failed to invest, monetizing GHG emissions reductions could provide the necessary en- couragement to private investors to deploy their capital. Given that GHG emissions are a global problem, the international community is well placed to contribute. Low-emission projects will also bene�t from rebalancing measures taken to offset the effects of policy distortions, and to reward them for reducing local air pollution. These measures contribute to closing the capital market and viability gaps, and can be justi�ed solely with reference to the creation of local bene�ts. Therefore, there is a strong case for national governments to make the greatest contribution in these areas. Contribution of the International Community The international community has created a number of funding mechanisms for green investments. Speci�cally, the World Bank Group manages a wide range of windows that could be used to introduce tools and instruments that improve �nancial viability. Major windows include: ■ Climate Investment Funds (CIF)—a US$6.4 billion facility that draws on the expertise of several MDBs to help developing countries pilot low-emission and climate-resilient development. CIF consists of two funds: • Clean Technology Fund (CTF)—aims to promote the demonstration, de- ployment, and transfer of low-carbon technologies through public and pri- vate sector investments. CTF provides support in the power sector, transport sector, and for energy efficiency projects; • Strategic Climate Fund (SCF)—targets three separate programs to channel �nancing for climate change mitigation and adaptation investments. The programs include the Forest Investment Program, the Pilot Program for Cli- mate Resilience, and the Program for Scaling-Up Renewable Energy in Low Income Countries. These funds are of course in addition to the non-climate speci�c windows of the World Bank Group including IBRD lending to middle-income countries, IDA conces- sional �nance to low-income countries, IFC �nance of private companies in developing countries, as well as guarantees offered by MIGA, the IFC and the World Bank Partial Risk and Partial Credit Guarantee products. Other notable climate �nance modalities include: ■ Clean Development Mechanism (CDM)—allows an Annex-I country with an emission-reduction commitment under the Kyoto Protocol to implement an emission-reduction project in developing countries. Such projects can earn Green Infrastructure Finance: Framework Report 37 saleable certi�ed emission reduction credits, each equivalent to one tonne of CO2, which can be counted towards meeting Kyoto targets. The CDM is the �rst global environmental investment and credit scheme of its kind. ■ Global Environment Facility (GEF)—provides grants to developing countries and those with economies in transition for projects related to biodiversity, cli- mate change, international waters, land degradation, the ozone layer, and or- ganic pollutants. To date it has allocated US$9.2 billion, supplemented by more than US$40 billion in co-�nancing over 2,700 projects in more than 165 coun- tries.30 ■ Policy-oriented private equity fund-of-funds such as the Global Energy Ef- �ciency and Renewable Energy Fund (GEEREF)—GEEREF provides global risk capital through private equity investments for energy efficiency and renewable energy projects in developing countries. In addition, individual country donors provide support through bilateral mecha- nisms such as direct grants and bilateral assistance. Some development agencies will provide grant assistance, some offer concessional loans, and technical assistance on sustainable energy policy. However, coordinating the wide variety of these different mechanisms in a complementary fashion and for maximum effect remains a challenge as many of these operate independently, applying their own operational guidelines. Contribution of National Governments Some national governments do provide funding to reduce GHG emissions. For example, the government of the Philippines is in the �nal stages of implementing feed-in tariffs for renewable energy.31 This policy will increase energy costs in the Philippines, but will also help a ract private �nancing to renewable energy projects, and so reduce GHG emissions. In 2001, Thailand approved a feed-in tariff policy through their very small power producer program for renewable energy.32 In 2010 alone, Thailand’s renewable energy program unlocked US$700 million in low-emission investments.33 However, it is more common for national governments to provide subsidies that bene�t conventional projects, inadvertently disadvantaging low-emission projects. For example, Vietnam’s coal export restrictions disadvantage renewable energy projects. National governments should progressively unwind policies that provide disincentives for investors to deploy capital into low-emission investments but, while these policies persist, governments should provide equivalent �nancial support to low-emission proj- ects to bring the investment conditions to parity. Green Infrastructure Finance Policies and Instruments A wide and diverse range of policies and instruments is available to the international community and governments to close the market and viability gaps that prevent low- emission projects from being �nanced by private investors. Most of them improve the viability of low-emission projects through targeting speci�c component of project viabil- ity (revenues, costs, and cost of capital). Table 3 lists some of the most important policies and instruments, along with the key advantages and disadvantages. 38 World Bank Study Table 3: Public Sector Policies and Instruments Instrument Advantages Disadvantages Revenue Policies and Instruments Clean Development • Pays directly for the desired result (GHG • Dif�cult to coordinate with other �nancing Future uncertainty Mechanism abatement) • Bene�t is received after the project is already in operation • Designed to pay up to the lesser of the viability and as such does not address the initial �nancing challenge gap and the value of the emissions reduction • Costly for project sponsors to use • Established scheme • Relies on a burdensome regulatory framework for • Links directly to developed country carbon monitoring, reporting and veri�cation markets Feed-in Tariffs • Typically tailored to the viability gap of • Hard to calculate appropriate value; known to often pay particular technologies more than the value of the GHG abated, or the viability gap, • Pays directly for renewable power or both • Highest price certainty to investors • Provides cash flow once the project is in operation; does not • Simple to administer fully address the initial �nancing challenge • Tariffs need to be periodically reviewed and adjusted • Can be dif�cult to raise �nance against Renewable Portfolio • Can help lower the total cost of that • The exact cost impacts of an RPS cannot be known with Standards (RPS) development certainty in advance • If enforced can meet RE targets • Can be dif�cult to design and implement • RPS imposes relatively low administrative • An RPS is not necessarily suited to supporting diversity burdens and direct administrative costs on among renewable technologies, although an RPS can be those responsible for overseeing the policy designed to do so through the use of resource tiers and credit multipliers Other Carbon Payment • Pays directly for the desired result (GHG • Needs to be created Schemes abatement) • Unproven • Can be designed better than CDM in order to facilitate use in �nance-raising, and lower costs Cost Policies and Instruments Capital Grants and • Simple • Because it is paid up front, there is a risk that the project Financial Incentives on • Can be targeted precisely to close viability gap does not ultimately deliver the desired results (although Imports • Quick in raising capital by forming part of the good design can greatly reduce this risk. The Government capital structure and reducing the amount of of India Viability Gap Fund for PPPs is a good example, equity and debt �nancing required particularly the way it integrated the grant funding into the senior debt disbursements). Tax Credits and Other • Can offer a politically acceptable way to • The foregone tax revenue may have a real �scal cost, but Tax Incentives provide a subsidy in some countries may not be accounted for in budgeting process, reducing the ef�ciency of public expenditure decisions • It may be hard to raise �nance against tax credits and bene�ts only come downstream • Only pays out if a project is successful enough to generate revenues and/or pro�ts. Many RE project do not generate accounting pro�ts for many years in operation Cost of Capital Policies and Instruments Concessional Loans • Traditional approach • Limited impact; may not fully cover the �nancing gap • Helps provide �nance directly at lower cost • Degree of concessionality is unclear, and so is dif�cult to of capital target Risk-Sharing Facilities • Allows the entity offering the facility to directly • Dif�cult to target to particular levels of GHG abatement target what it believes may be excessive risk • Unfamiliar, and so may appear complex and dif�cult to perceptions implement Tax Equity Swaps • Allows tax credits to be used more effectively • Creates complexity and risk for investors compared to more by making them fungible between investors straightforward instruments such as capital grants • Brings in equity contributions from companies • Like tax credits, may have real �scal cost and, therefore, seeking to bene�t from tax offsets can distort public expenditure decisions Direct Equity • Provides risk-bearing capital. Equity is the • IFIs have relatively high transaction costs, meaning they can Investments by IFIs cornerstone of the �nancial structure, and can only do larger deals economically mobilize other �nance • Investment by IFIs can provide accreditation which attracts other investors and �nancing Equity Investments • Creates highly incentivized investors • The most expensive form of capital. Demands high returns through Private Equity • Delivery through fund managers can assist in and has high transaction costs, and as such requires other Funds project origination and knowledge transfer forms of support to close the �nancial viability gap Source: Authors. Green Infrastructure Finance: Framework Report 39 Financing Structures Green �nance can enhance the viability of project-�nanced low-emission investments by targeting the characteristics that distinguish them from high-emission projects. Figure 8 illustrates (in the gray boxes) how some of the green �nance instruments listed in Table 3 can be used to enhance project �nance structure. This illustration represents a low- emission power generation investment—for example a wind farm—that will be �nanced using project �nance. Figure 8: Green Finance Interventions in a Project Finance Structure Feed-in Tariff Off-taker Power Purchase Upfront Grants Agreement Concessional debt Equity Special Purpose Lender Investor Shareholders’ Company Loan Agreement Agreement EPC O&M Contract Contract Development Guarantees Equity Contractor Operator Source: Authors. Some of the green �nance interventions, designed to increase the �nancial a rac- tiveness of renewable energy projects, could be applied as follows: ■ Feed-in tariffs (FiT) or other public sector instruments could be used to rebal- ance policy distortions that disadvantage low-emission projects. For example, if the price of coal is subsidized through export restrictions, the FiT could be set at a level that offsets the subsidy on coal. The difference between the value of established FiT and value of short-run marginal cost of a coal-�red plant repre- sents an explicit grant payment to renewable energy project. The present value of all these incremental payments reflects the total value of subsidy provided by the introduction of the FiT. ■ Upfront grants or concessional loans that could be used to reduce the upfront capital investment or the cost of �nancing the investment if providing a FiT to rebalance the subsidy on coal is not sufficient to make the project �nancially vi- able. A concessional loan could be offered by one of the green �nance facilities supported by the international community—for example the CTF. The conces- sional loan will have an implicit grant if compared to commercial sources of debt, as outlined in Box 1 in chapter 2. It would be economically justi�ed for 40 World Bank Study CTF to provide a concessional loan that has an implicit grant value equal to or less than the value of the reduction in GHG. ■ Additional concessional loans. If the combination of a FiT and implicit grant in the concessional loan is still not sufficient to make the project �nancially viable, it would be economically justi�ed for the government to provide an additional concessional loan with an implicit grant equal to or less than the value of the local negative externalities avoided with the development of the project. If the discussed interventions do not help achieve �nancial viability of the project or investors are still reluctant to deploy capital due to concerns about technology or resource availability risks, the international community could extend the support even further and provide a guarantee to cover some of these risks, or could provide equity or concessional loans to signal that this project is a sound investment. The guarantee and concessional debt have an implicit associated subsidy. The intervention of the interna- tional community will be justi�ed on the grounds of emission abatement bene�ts if this implied subsidy is equal to or less than the value of the GHG emissions reduction. If the joint application of all these policies or instruments fails to make the proj- ect �nancially viable then the project may need to be re-considered or other sources of monetizable bene�ts need to be determined to support the project fully. In some cases, interventions of international community may go beyond emission reduction bene�ts if there are other (preferably monetizable) bene�ts or if these particular interventions help achieve necessary economies of scale or create sufficient impetus for the technology so that the �nancial viability gap can become bridgeable. Policy Support at Least Cost It is useful to be aware of the array of policies and instruments available to the interna- tional community and national governments to support low-emission projects, and the maximum level of support that is economically justi�ed for each. These policies and instruments, however, have a cost and a rational policy maker would certainly want to examine how these costs could be minimized and how these stakeholders can obtain the largest return on their investment. Furthermore, while the calculation of the �nancial vi- ability gap is based on certain assumptions, the “actual� viability gap—the amount that investors will calculate as the gap—might be different. This leads to the question: How can the actual gap and the corresponding amount of �nancial support from stakeholders be set in practice? One possible approach is to set the level of �nancial support through a competitive process. If the project is being tendered by the government, the project could be awarded to the sponsor that requires the least present value of government intervention. The in- tervention could be an explicit support, such as a subsidy or grant; or implicit, such as a concessional loan or guarantee. This approach would reveal the least amount of support that is needed to get the project privately �nanced. This competitive process approach may not always be possible—for example, when the project is not being tendered by the government. Building energy-efficiency projects are a good example, as these are unlikely to be procured by the government. In this case, competition could be introduced at the stage in which the support (explicit or implicit) is being considered by the sponsor of the project. If there is an opportunity to compare two or more projects, the support could be given to the project that delivers the lowest Green Infrastructure Finance: Framework Report 41 abatement cost. However, if there is no opportunity to compare projects, the grant ad- ministrator could set a ceiling grant per unit of bene�t (for example, dollars per tonne of CO2 avoided) and award these grants to all projects that fall within that ceiling. Examples on the types of green �nance �nancial structures that could be used to support wind, geothermal, and energy efficiency projects are presented below. Examples of Green Finance Financial Structures Green Finance for a Wind Energy Project The wind energy project, previously described in this chapter, is an ideal case to illustrate the complexity of the �nancing challenge for low-emission projects, as well as to under- score the reasons why certain instruments are more important than others—a conclusion of the stocktaking report. As was presented earlier, the 100 MW project has a cost of capi- tal of 14 percent, resulting in a negative net present value, or Figure 9: Example of Wind Energy Project a viability gap of US$110 mil- lion (see also Figure 9). One reason why the proj- ect is not �nancially viable is because the price of coal is subsidized. In this case, the subsidy reduces the short run marginal cost of a coal-�red plant by 1.7 cents per kWh (from 4.7 cents to 3.0 cents per kWh), which in turn, reduces Source: Authors. the avoided cost to the off- taker, and ultimately the price that the off-taker would pay to the sponsor of the wind farm. In order to rebalance this distortion, a government has a number of options including deploying the FiT instru- ment—the instrument that has already been introduced by many governments in the EAP region to support clean energy projects. In this case, the distortion can be corrected with a FiT of 4.7 cents per kWh—the rate that brings the price of electricity in-line with the avoided cost of a non-subsidized coal-�red plant. The rate also reduces the �nancial viability gap of the project by US$34 million.D Although widely utilized, this tool has often been adopted without considering the avoided cost of the energy displaced. Box 5 presents a good example in the Philippines. Once the policy distortions are corrected, the remaining gap can be closed through instruments that monetize the bene�ts of the project’s global externality bene�ts (which are estimated at US$102 million within this illustration) or local air pollution reduction (not shown in this example). In this case, a CTF concessional loan could be utilized in order to reduce the cost of capital, such that the US$76 million (US$110–US$34 million) remaining gap is closed. Table 4 shows an example of possible �nancing structure through this arrangement. The FiT and the CTF loan are combined in order to close the �nancial viability gap of US$110 million, and thereby a ract the investments. However, the CTF loan would car- ry a heavy burden in this structure, with a US$100 million or 62.5 percent contribution to 42 World Bank Study Box 5: Feed-in Tariffs The feed-in tariff (FiT) is a premium rate paid for electricity fed back to the grid from a renew- able energy generation plant. Many countries set FiT at a level that reflects the true cost of the renewable generation plant that is displacing conventional generation sources. For example, the government of the Philippines has announced its intention to set FiTs. For wind farms, the government intends to set a FiT of 24.3 cents per kWh. This tariff reflects the government’s estimate of the true cost of a privately �nanced wind farm in the Philippines. The true cost of a privately �nanced wind farm varies depending on the location of the farm, grid conditions, and other factors. In favorable cases it may be signi�cantly lower, requiring lower FiT to bring the project to �nancial viability. However, in any circumstances this level is substan- tially higher than 4.7 cents per kWh—the avoided cost of a non-subsidized coal-�red plant. Setting the FiT at such a high level may support a private �nance structure, but also creates strong opposition—as has been the case in the Philippines—from consumer groups. This op- position—as it might be case in the Philippines—can block the adoption of these policies and therefore the development of privately �nanced renewable energy projects that are bankable. Source: Authors. Table 4: Financial Structure for Wind Energy Project—Needed CTF Support Financial Instrument Amount Maturity Grace Period Cost of Capital Subsidy Feed-in Tariff 4.7 cents/kWh — — — US$34 million Concessional Loan US$100 million 20 years 5 years 0.9% US$76 million Sponsor’s Equity US$18 million — — 22% — Commercial Debt US$42 million 20 years — 11% — Total US$160 million US$110 million Source: Authors. the overall �nancing. While this �nancing is a possible solution, it is not a good leverage of limited public funds as it mobilizes only US$0.60 of private capital for every US$1 of CTF funds. Moreover, this structure, while technically feasible, presents other challenges as CTF funding rules seek a high leveraging factor and is usually capped at around 25 per- cent of the total �nancing requirement, allowing for no more than US$40 million of CTF loan. This constraint leaves an unfunded viability gap of US$45 million. In most cases, this project would not proceed. The above discussion illustrates the �nancing dilemma confronting these projects. Governments can set FiT tariffs that exceed the avoided costs, and face political criticism from consumers and other key stakeholders. However, increasing the amount of concession- al �nancing is constrained by other factors. Notably, both are not optimum policy choices. Another difficulty that arises from applying the FiT solution is that FiT payments do not help satisfy initial capital funding requirements. The FiT revenue provides its contribution over the operational phase of the project, instead of an upfront payment, when the capital is most needed. As many low-emission projects are signi�cantly up- front loaded, raising upfront capital may at times become a substantial constraint. Green Infrastructure Finance: Framework Report 43 To overcome this constraint, the subsidy component of the FiT (1.7 cents per kWh) could be securitized as an upfront grant. The funds provided by the securitization facil- ity will get repaid over the life of PPA agreement by diverting the subsidy portion of the FiT revenue from the wind farm operator to the securitization facility. Perhaps the most feasible approach is for the securitization facility to be sponsored by domestic government or international donor. Then, subsidy portion of future FiT revenue payments can be securitized at a lower discount rate, resulting in an upfront grant of as high as US$64 million (Table 5) and leverage of the CTF funds of US$1.71 of commercial capital per US$1 of CTF money. The CTF leverage could be further enhanced by offering a guarantee on the com- mercial loan with the objective of lowering the cost of borrowing, in this case from 11 percent to 7 percent. This would mobilize about US$2.1 of commercial capital for each US$1 of CTF funding (excluding the cost of the guarantee, see Table 5). Table 5: Alternative Financial Structure for Wind Energy Project Financing scenarios FiT subsidy paid FiT subsidy FiT subsidy securitized Parameters over useful life securitized plus loan guarantee Source of capital Sponsors’ equity US$18 million US$11 million US$13 million Commercial debt US$42 million US$26 million US$30 million Concessional loan US$100 million US$59 million US$52 million Upfront value of FiT subsidy US$0 million US$64 million US$64 million Leverage by CTF loan 1 : 0.60 1 : 1.71 1 : 2.10 Source: Authors. If securitization facility were to be established by private �nanciers, the size of the upfront grant would only reach US$34 million and would not increase the leveraging factor for CTF money. Moreover, the project would experience difficulties in meeting its debt service obligations, rendering this �nancial solution to be not viable. Green Finance for a Figure 10: Example of Geothermal Project Geothermal Project A 150 MW geothermal project has a capital cost of US$543 million. Adding operation and maintenance costs gives a present value of total costs of US$714 million, while the present value of the project revenue is US$588 million. This leaves a �nancial viabil- ity gap with a present value of Source: Authors. US$126 million (Figure 10). 44 World Bank Study Avoided GHG emissions are valued at US$188 million; bene�ts from reduced local air pollution total US$45 million. In this case, the viability gap can be bridged in several different ways. For example, a government can provide subsidies to fully cover local pollution reduction bene�ts, while the international community can provide the required residual amount against the value of abated global externalities. However, given the scarce resources of many governments of developing countries, it may be more practical for the international com- munity to provide the maximum amount justi�ed on the grounds of the net GHG abate- ment bene�ts. Thus, a concessional loan with an implicit grant of US$126 million could be used as the instrument to close the gap fully. To achieve this level of concessionality, the loan would need to have a 30-year repayment period, a 10-year grace period, and an interest rate of 2.5 percent, as shown in Table 6. Table 6: Financial Structure for Geothermal Energy Project Financial Instrument Amount Maturity Grace Period Cost of Capital Implicit Subsidya Concessional Loan US$138 million 30 years 10 years 2.5% US$126 million Commercial Debt US$240 million 15 years — 11% — Sponsor’s Equity US$165 million — — 22% — Total US$543 million US$126 million Source: Authors. a. The implicit subsidy was calculated based on the 14 percent cost of capital and a 30 year timeframe. The grant equivalent value of the concessional loan equals the US$126 million vi- ability gap. Private �nance of US$165 million in equity, and US$240 million in commer- cial debt, completes the US$543 million project �nancing. Therefore, US$138 million of concessional �nance leverages private �nance of US$405 million. Building Energy Ef�ciency Project This �nal example illustrates another CTF instrument—a risk sharing facility—that could also be used to mobilize private �nance (Figure 11). This energy efficiency example will require an investment of US$2.4 million to re- duce the energy consumption of a building by 1,560 MWh over a 15-year period. Given the commercial electricity Figure 11: Example of Energy Ef�ciency Project tariff is 25 cents per kWh, the annual energy savings would amount to US$400,000. With the cost of capital of the equity �nanced deal of 20 percent, the present value of the project’s revenue from energy savings amounts to US$1.8 million. The viability gap is therefore US$600,000. The developer of the project would prefer to reduce the Source: Authors. Green Infrastructure Finance: Framework Report 45 cost of capital by bringing debt into the project, but prospective commercial lenders perceive the risks to be too high. The avoided cost of GHG emissions is calculated to be US$400,000—not sufficient to close the viability gap, if it could be monetized. However, the energy efficiency project will avoid local air pollution costs of US$300,000 over the useful life. Therefore, if both the GHG emissions and the air pollution savings could be monetized, then this would be sufficient to close the viability gap. One possible approach is to blend a CTF risk-sharing facility (to cover the GHG emission reduction portion) with an IBRD loan (to cover lo- cal pollution reduction portion). Together, these can reduce the cost of capital, thereby making the project pro�table. The present value of the support of US$600,000 needed could be achieved by pro- viding a US$250,000 IBRD loanE and a risk-sharing facility to cover 70 percent of the commercial debt in the project. The risk-sharing facility assumes that the project cost of capital would reduce from 20 percent to 12 percent with the introduction of debt. The assumed terms and implicit subsidy of these instruments are provided in Table 7, indi- cating their grant equivalent values. The grant equivalent value of the IBRD concessional loan and risk sharing facility equals the US$600,000 viability gap. Along with the US$960,000 in sponsor’s equity, the project is able to raise sufficient �nancing. Table 7: Financial Structure for Building Energy Ef�ciency Project Financial Instrument Amount Maturity Grace Period Cost of Capital Implicit Subsidya Risk Sharing Facility US$1.20 million 15 years — 10% US$0.4 million IBRD Loan US$0.25 million 20 years 5 years 5% US$0.2 million Sponsor’s Equity US$0.96 million — — 20% — Total US$2.41 million US$0.6 million Source: Authors. a. The implicit subsidy was calculated based on the 20 percent cost of capital. Notes A Lifecycle costs include capital cost, operating cost, maintenance cost, salvage value at the end of ownership or useful life and all other recurring and one-time costs associated with the full life span of the system. B In this example it is assumed that subsidized coal prices are approximately 60 percent of the ex- port price, creating an implicit subsidy to local coal-�red power generation C This is the present value of the additional revenue that the wind plant must earn over its life to provide the higher return that investors demand from a wind farm. D The value of US$34 million reflects present value of additional revenues resulted by the increase of a tariff from the short run marginal cost of a coal-�red plant to the established FiT rate. This is not the present value of total future FiT revenues. E IBRD can only lend to governments, so in practice these funds would have to be lent to gov- ernment, and then on-lent, possibly through a government-owned �nancial intermediary, to the project company. For simplicity, we assume that on-lending is on the same terms as the IBRD loan to the government. CHAPTER 4 Assessment of Green Investment Climate in EAP Countries The Role of Country Assessment Methodology G overnments can play a pivotal role in promoting investments in climate friendly technologies by adopting a wide range of interventions. Many EAP countries have proposed policies, programs, legislation, institutions, �scal and �nancial interventions, and other measures designed to promote green growth of their economies through im- proving the investment climate.A The investment climate for environmentally friendly activities, along with the set of abovementioned measures, is termed here as the “green investment climate.� A country’s ability to alter its investment climate differs according to the level of sophistication of its �nancial markets. A well-developed �nancial market offers a wide range of instruments through which governments can design their intervention strate- gies in order to shape their investment climate. While in many cases the effort and the scale of public sector interventions is signi�cant, the measures are often implemented in a piecemeal fashion without an overarching framework. Research indicates34 that such a comprehensive framework has not been developed yet. A number of a empts have been made to classify the broad array of possible public interventions and create a coherent approach to how to select the most appropriate ones. Thus, many international organizations, including the United Nations Economic and Social Commission for Asia and Paci�c (UNESCAP) Green Growth,35 Office of Chief Economist of the World Bank,36 Organisation for Economic Co-operation and Develop- ment (OECD),37 United Nations Environment Programme (UNEP),38 London School of Economics (LSE),39 and others, have conducted work in this area. Nevertheless, these a empts have not resulted in a practical, comprehensive, and adaptable to speci�c coun- try conditions framework that is aimed at promoting green investments. If such a framework were to be developed, it should be flexible and adaptive to the status and trends of the current investment climate of a given country. Therefore, both an overall evaluation and a detailed assessment of a country’s green investment climate must be performed in order to develop a framework capable of bridging in opportuni- ties to create more green investments and thereby reducing the �nancial viability gap for opportunities that already exist. The overall evaluation of the green investment climate of countries provides general understanding of a ractiveness, prevailing trends, strengths, and other aspects affecting 46 Green Infrastructure Finance: Framework Report 47 the ability of the country to alter green investment climate. The following section con- tains an overview of the green investment climate of a number of EAP countries, includ- ing China, Indonesia, Malaysia, the Philippines, the Republic of Korea, and Vietnam. Evaluation of Overall Green Investment Climate in EAP Countries Annual growth of �nancial investments in clean energy in 2010 surpassed 30 percent,40 with China registering the fastest growth rate among the EAP countries as well as at the global level. As a result, China occupies a predominant position among the EAP countries. For instance, the share of gross domestic product (GDP) invested by China in 2009 is �ve times higher than the United States,41 reaching US$54.4 billion in 2010 (see Table 8). Table 8: Key Clean Energy Indicators in EAP Countries Clean energy investments in 2010a GDP per unit of energy use Energy use per Country (2005 PPP$/kg oil eq.) capita (kg oil eq.) (US$ million) as share of GDP in % China 3.4 1,484 54,400 1.091 Indonesia 4.1 849 247 0.046 Korea, Rep. of 5.5 4,586 356 0.043 Malaysia 4.7 2,733 n.a. n.a. Philippines 7.1 451 200b 0.124 Vietnam 3.7 655 200b 0.206 Source: Authors’ calculations based on data from The Li le Green Data Book, The World Bank, 2011;42 Who’s Winning the Clean Energy Race?, The PEW Charitable Trust, 2011;43 Global Trends in Sustainable Energy Investment 2010: Analysis of Trends and Issues in the Financing, UNEP and Bloomberg, 2010.44 a. The �gures include only private investments. b. The �gures are rounded and approximate. Investments in clean energy are driven by energy security, in addition to the global effort to curb climate change and create employment. Measured along these three di- mensions, China’s 12th Five-Year Plan RE targets are among the world’s most ambitious. The Chinese government aims to increase the renewable energy share to 15 percent by 2020, mainly through investments in key sectors such as wind, biomass and solar pho- tovoltaic (PV).45 To achieve this, China has established FiTs, tax subsidies and other sub- sidy schemes for wind, rooftop, and building integrated PV along with other renewable energy projects. During 2008–09, China’s National Development and Reform Commi ee (NDRC) approved a US$218 billion green stimulus package that accounted for almost half of the global expenditures for �scal interventions.46 Due to China’s commitment to a lower carbon–intensive growth path, the share of coal in China’s energy mix is expected to fall to 63 percent from its current level of 70 percent.47 China’s experience offers interesting green development prospects which could be adopted by the other EAP countries with similar characteristics in order to promote their own sustainable growth pa erns. The Chinese experience in promoting energy efficiency utilizing GEF funds sum- marizes the potentials for leveraging private �nancing. Table 9 illustrates the scope for leverage using different combinations of �nancing instruments. 48 World Bank Study Table 9: Financial Products and Their Use Leverage Donor leverage Financial product Potential for use (IFC: local FI) Donor role (donor to FI) Trade �nance Addresses trade in EE/RE 1:1.3 None/potentially a N/A equipment subsidy Long-term credit line Asset liability matching and 1:1.3 Interest or capital N/A liquidity for projects with longer subsidy paybacks Pari-passu risk Addresses risk perception > 1:2 First loss or subsidy > 1:5 sharing facilities (soft) and exposure barriers (funded/unfunded) Subordinated risk Addresses �nancing gaps, risk > 1:3 First loss or subsidy > 1:15 sharing facilities appetite (funded or unfunded) Source: Adapted from Scaling up Climate Finance in the Private Sector, IFC, 2011.48 Similarly, the Republic of Korea made solar and wind two key sectors of its green development plan. In 2010, the Korea’s total investments in clean energy climbed to US$356 million, almost doubling its total renewable energy capacity from the 2009 lev- el.49 In 2009–12, the Korea plans to inject US$59.9 billion in its economy as part of its stimulus package. FiTs and tax exemption for dividends are among the incentives pro- vided by the Korean government to foster green energy.50 While Korea has declared its in- tention of becoming the world’s seventh-largest green power by 2020, the achievement of this goal may be adversely affected by strong overseas energy dependence (see Table 10). Table 10: Energy Consumption and Imports for the Republic of Korea: 2000–07 Category Units 2000 2001 2002 2003 2004 2005 2006 2007 Primary Energy Consumption Growth % 6.4 2.9 5.2 3.1 2.4 3.8 2.1 1.3 Overseas Dependency % 97.2 97.3 97.1 96.9 96.7 96.6 96.5 96.6 Source: KEMCO, Korea Energy Management Corporation.51 Such dependence could negatively influence the country’s balance of payments and compromise the achievement of the country’s development targets. Therefore, a sound green investment plan is required to mitigate energy dependence-related risks and al- low the Korea to achieve its green objectives. Indonesia and Malaysia have also adopted green stimulus plans, even though the magnitude of their impacts is lower than China and Korea’s interventions. In 2010, In- donesia’s private investments amounted to US$247 million with geothermal energy the main recipient of such spending. One of Indonesia’s key energy targets is the increase of geothermal power through preferential tariffs (such as FiT) and the abolishment of im- port duties. Ultimately, Indonesia aims to source 15 percent of all electricity from clean energy. Indonesia’s energy use per capita is, however, lower than Malaysia (see Table 8), which in turn is high in terms of energy intensity. This is potentially symptomatic of Malaysia’s inefficient commitment towards energy conservation measures. The Philippines lacks strategic policies and has set no speci�c objectives for GHG re- duction. However, the country bene�ts from an abundance of geothermal energy which Green Infrastructure Finance: Framework Report 49 suggests that a comprehensive framework to promote green investments should be de- signed on the speci�c available resources of a given country. Vietnam ranks last among the EAP countries considered for this analysis. The data on �nancial instruments and market-based mechanisms for Vietnam are scarce, but the country’s energy balance shows that Vietnam is heavily dependent on oil imports to meet its energy needs. Hence, Vietnam is exposed to high energy risks52 and can clearly bene�t from instituting changes in order to promote more clean energy investments. Detailed Assessment of Country Green Investment Climate The overall evaluation of a country’s green investment climate should be complemented by a detailed assessment of its four main components: (i) policies and legislation; (ii) �nancial and economic instruments; (iii) programs and institutions; and (iv) regulatory environment (see Figure 12). Each of these components consists of a number of elements (see the Appendix for a more detailed discussion). Figure 12: A Breakdown of the Elements of Green Investment Climate Source: Authors. ■ Policies and legislation are evaluated as they provide the context to establish �nancial and economic instruments, along with speci�c programs and institu- tions. ■ Financial and economic instruments are closely examined as they foster the implementation of the abovementioned policies and laws. Such instruments in- teract with programs and institutions through a variety of channels including market signals, and promote certain activities including investments in research and development. ■ Programs and institutions often involve different ministries and levels of gov- ernment, thereby increasing the overall complexity of a country’s green invest- ment climate. Such determinants are investigated as they facilitate the adoption of green investments in order to demonstrate viability and reduce excessive perception of risk. 50 World Bank Study ■ The regulatory environment is analyzed in order to evaluate the system re- sponsiveness in providing adequate feedback and corrective measures aiding proper functioning of a country’s green investment climate. To provide EAP countries with a point of reference for their green investment cli- mates and to allow them to set realistic expectations for what can be accomplished in the short-, medium- and long-term, the information on the four components of the green investment climate is aggregated and then used to develop a country benchmark. Benchmarking Green Investment Climate Countries are adopting pro-green policies at increasing rates and are developing �nanc- ing schemes and instruments for funding clean investments within their boundaries. Countries with well-developed capital markets and sophisticated tax policies can es- tablish a wide array of both public and private �nancing options. Governments of these countries are not only focusing on improving the global and domestic environments, but are also recognizing a highly signi�cant opportunity for developing and deploying as well as exporting their green technologies in order to foster industrial growth along with its related income and employment bene�ts.B, 53 For developing countries, the options for national interventions are signi�cantly fewer. Not only do these countries have limited capacity to compete in the area of tech- nology, but their own public funding is constrained by budgetary limitations and com- peting commitments to other important initiatives such as, health, education, and other basic services, such as water supply and sanitation. Moreover, local capital markets and �nancial institutions of poorer economies are still not adequately developed, and lack the capacity to develop sophisticated instruments and to mobilize long-term �nance. Consequently, many developing countries rely heavily on donor support through a number of international �nancing mechanisms such as carbon markets through CDM, the clean investment funds, as well as direct grants. Nonetheless, governments need to contribute to closing the �nancing gap, especially in policies that distort prices and dis- advantage green investments in their own economies. Therefore, it is essential that countries, especially those with inadequate gover- nance, are guided by a proper benchmark through (i) establishing a monitoring, report- ing, and veri�cation (MRV) system, and (ii) utilizing the data to establish an index of green investment �nance climate that would be helpful for investors. These steps will allow policy makers to set more realistic goals for the short term as well as to undertake appropriate actions facilitating progress in the medium and long term. Country assess- ments and benchmarking are needed to determine these expectations as well as to shape the policy dialogue and actions that can reasonably be taken in order to expand the total portfolio of green projects in the medium and longer term. The results of the benchmarking provide an understanding of the strengths and weaknesses of the green investment climate in any country as well as the ability to assess both the potential and limits for improvements, especially in the short to medium term. These results should also help international donors and funding institutions understand be er how and to what extent to deploy their existing instruments and programs. Green Infrastructure Finance: Framework Report 51 Notes A The investment climate refers to the economic and market conditions that influence decisions to invest. A sound investment climate provides private �rms with opportunities and incentives to invest and is key to sustaining growth. A vibrant private sector creates jobs, provides the necessary goods and services to improve living standards, and contributes taxes to fund health, education, and other public goods. However, all too often potential private sector contributions to develop- ment are constrained by unjusti�ed risks, costs, and barriers to competition. B Sorrell and Sijm (2003) note the potential for an “early mover advantage,� by which strong, early renewables support could spur the development of viable industries with signi�cant export po- tential. They �nd that such a strategy enabled German �rms to capture much of the world’s wind energy market. CHAPTER 5 Conclusion and Next Steps T he report has presented a green infrastructure �nance framework that can be used to stimulate greater flow of funds for green investments in EAP countries. It is pri- marily oriented toward promoting private investments, but can also serve to accelerate public-private partnerships as well as purely public engagements. The framework consists of two complementary components: 1. Analytical methodology that will assist policy makers in deriving the �nancial viability gap of green investments, understanding what comprises the gap, and explaining the causes of this gap in terms of global and local externalities, price distortions and risk premiums; 2. Country assessment framework that will allow a be er understanding of a country’s investment climate in general and green investments climate speci�- cally. The following bene�ts can be derived by the implementation of this framework: ■ The evaluation and explanation of the gap can determine rapidly whether an investment can be justi�ed on the grounds of climate change (net GHG emis- sion abatement) bene�ts and to be er understand how price distortions in an economy impact the viability of these investments. ■ The estimation of what constitutes the viability gap provides a guideline for which portions of the viability gap should be targeted, although the framework does not supply strict prescriptions in this regard. ■ Apportioning the viability gap to various stakeholders will determine more ac- curately the mix of instruments that can be used to close the gap. This can com- bine international �nancing mechanisms with government instruments such as feed-in tariff, direct subsidies, and �scal incentives. The methodology also provides guidance to use these instruments for maximum effect and at least cost to governments. ■ The framework will also identify actions that governments can take to improve the various elements of their investment climate and thus increase the scope for �nancing a greater number of investments with the implementation of those actions. ■ The framework provides a sound basis for the identi�cation of those green in- vestments that can already be �nanced and implemented, given the country’s current conditions and ongoing international programs. This approach can fur- ther determine the investment projects that are not currently viable but can be made viable in the short term through blending �nancial instruments. 52 Green Infrastructure Finance: Framework Report 53 ■ Lastly, nonviable projects that require substantive change in the investment en- vironment can also be identi�ed along with the corresponding set of required policy interventions. Overall, the framework will allow policy makers to evalu- ate the projects and develop a strategic green infrastructure �nance plan. This process is illustrated in Figure 13, where the intention is to proceed with the piloting of the framework in selected EAP countries. Figure 13: Process for Pilot Implementation of the Green Infrastructure Finance Framework Source: Authors. Throughout the EAP region and worldwide, the implementation of the Green Infra- structure Finance framework can bene�t from further work in the following relevant areas: ■ Innovative �nancing schemes. This report discusses a number of new schemes, including a viability gap facility, and guarantees or surety to reduce the equity portion of the �nancing plan. Many innovative schemes that have also been introduced for PPPs, such as hybrid �nancing schemes, can also be utilized for green investments. While carbon markets improve and ultimately stabilize, there is a need to identify other ways to mobilize international donor support through the identi�cation of innovative solutions and new approaches for �- nancing and implementing green investments. This may mean identifying new ways of blending different �nancing instruments, international donor support, and approaches to close the �nancial viability gap or creating more innovative mechanisms in areas that contain the main de�ciencies (see Box 6). 54 World Bank Study Box 6: Mechanism to Subscribe Emission Subsidy Costs In a highly uncertain environment where the price of carbon is fluctuating widely, an alterna- tive approach in evaluating an “appropriate value� for the externality costs is to obtain the ratio of the capital subsidy required to implement a given clean investment over the quantity of carbon it proposes to reduce. This would provide a benchmark for the relative attractive- ness of a given clean project. Clean projects can then be ranked according to the amount of GHG emissions saved per one dollar of subsidy (Emission Subsidy Cost) from the highest cost to the lowest. Then, the subsidies of these projects could be offered for subscription by international donors in a voluntary market through a “market maker� mechanism. Through this mechanism, donors would contribute to closing the funding gap by subscribing to a por- tion or the entire subsidy required to make the project �nancially attractive. Ultimately, the discretion of the donors would determine which projects they would �nancially support and the criteria used to evaluate the projects may differ between donors. For the projects of a signi�cant size of the �nancing gap, where a single donor may not be willing to or capable of carrying the entire �nancing burden and investment risk, a syndication process may be established. Since this scheme proposes to attract upfront �nancing, the regulatory approach would be based on compliance through the posting of security such as a perfor- mance bond. Unlike the CDM system, in-country participating regulatory agencies could be certi�ed to carry out this function and audited by themselves for compliance. Source: Authors. ■ Benchmarking systems: A credible benchmarking system would allow govern- ments to assess their own progress in improving their investment climate with an emphasis on low-emission project-related issues. ■ Public-private sector cooperation: Developing a framework for improved col- laboration between public and private sectors could greatly bene�t green in- frastructure �nancing mechanisms. This might occur through the development of a practitioners’ network that would focus on knowledge exchange and on building working relationships. ■ Technical assistance and coordination between stakeholders from different country: Coordinated work between stakeholders from different countries will allow policy makers, �nancial institutions, investors, and developers secure a common understanding of the opportunities and challenges of green infrastruc- ture �nance. Accordingly, an experts’ panel sponsored by APEC Senior Finance Ministry officials has recommended the establishment of a Green Finance Insti- tute, recognizing that the capacity building requirements are substantial.54 ■ MRV systems: As more tradable permit schemes are developed, emerging country governments should consider establishing a cost efficient system of monitoring and veri�cation in order to access the potential �nancial bene�ts that these schemes can offer in terms of �nancial support. For example, the To- kyo Emission Trading Scheme (Tokyo ETS) allows for the issuance of green cer- ti�cates by projects conducted in other countries. Japanese manufacturers that are seeking opportunities in developing countries can export their technologies at discounts in exchange for sellable veri�ed tradable permits. Such a scheme, which would be highly bene�cial to both importer and exporters, can only be Green Infrastructure Finance: Framework Report 55 achieved under the auspices of a reliable MRV system that generates compara- ble data across countries. Establishing a credible MRV system will require vari- ous models/country case studies of national and sectoral MRV systems. It will also need a thorough analysis of organizational structure, mandates, budgets, human resources, and technical skills. The methodologies currently available for quantifying energy use and CO2 emissions from various sources covering the supply-side and the end-use sectors will need to be evaluated. APPENDIX Green Investment Climate Matrix T here are a number of determinants of a country’s investment climate. Such determi- nants also have a strong impact on the risks perceived by private investors and the returns they anticipate from their investments. Several a empts have been made to iden- tify the main determinants of a country’s green investment climate and develop a struc- tured approach to assess the efficiency and applicability of public sector interventions in different country and project contexts. This work presents a comprehensive matrix developed by the authors that serves this purpose. Although more research is needed to identify all variables influencing private investments on green-related projects, desk- research has shown that such variables can be grouped into (i) policies and legislation, (ii) �nancial and economic instruments, (iii) programs and institutions, and (iv) regula- tory environment. A graphic breakdown of the subsections of green investment climate is presented in Table 11. 56 Table 11: Green Investment Climate Matrix Policies Financial and economic instruments Programs and institutions Regulatory environment Financial Market-based Procedures and Regulatory Policies, targets, and legislation Fiscal incentives measures mechanisms Programs Institutions mechanisms agencies Financial Speci�c programs Speci�cations, Policies, speci�c legislation and instruments, Markets that have that have been standards and Institutions information availability-related initiatives Incentives typically schemes been created to implemented to Institutions involved veri�able indicators responsible for that have been introduced to implement enacted to reduce and subsidy value and trade promote green in a country’s for regulating green the regulatory policy objectives tax liabilities arrangements carbon investments speci�c programs investments environment • Policies, • Environmental • Tax credits • Feed-in tariffs • Cap and trade • Voluntary • Institutions • Standard • Regulatory objectives and laws • Tax deductions • Life-line tariffs programs programs speci�cations agencies targets • Liability rules • Tax deferrals • Government • Baseline and • R&D programs • Corrective action ensuring Green Infrastructure Finance: Framework Report • Information • Tax-equity swaps loans credit programs • Capacity building plans for ensuring compliance with availability such • Tax holidays • Guarantees • Offset schemes programs compliance with regulation as eco-labeling, • Loss carry • Credit lines • Tradable white • Eco-industrial regulation reporting forward • Equity funds certi�cate parks • Emission requirements, • Reduction of • Venture capital schemes • Smart growth monitoring, energy auditing levies ( income • Grants • Tradable green zones reporting and and best practice or VAT) • Bonds certi�cate • Waste exchange veri�cation guidelines • Accelerated • Mezzanine schemes • Green Public depreciation Procurement • Subsidies • International organizations’ programs • Local institutions’ programs • Net metering Source: Authors. 57 References 1. 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Retrieved on 10/20/2011 from h p://aimp.apec.org/Documents/2010/MM/FMM/10_fmm_006.pdf ECO-AUDIT Environmental Bene�ts Statement The World Bank is commi ed to preserving In 2010, the printing of endangered forests and natural resources. this book on recycled paper The Office of the Publisher has chosen to saved the following: print World Bank Studies and Working • 11 trees* Papers on recycled paper with 30 percent • 3 million Btu of total postconsumer �ber in accordance with the energy recommended standards for paper usage • 1,045 lb. of net greenhouse set by the Green Press Initiative, a non- gases pro�t program supporting publishers in • 5,035 gal. of waste water using �ber that is not sourced from endan- • 306 lb. of solid waste gered forests. For more information, visit www.greenpressinitiative.org. * 40 feet in height and 6–8 inches in diameter G reen Infrastructure Finance: Framework Report is part of the World Bank Studies series. These papers are published to communicate the results of the Bank’s ongoing research and to stimulate public discussion. This report builds on the conclusions of the Green Infrastructure Finance: Leading Initiatives and Research report and lays out a simple and elegant way in which scarce public �nancing can leverage market interest in “greening� infrastructure, particularly in the East Asia and Paci�c Region. The framework introduced in the report bridges ideas and concepts between environmen- tal economics and project �nance practices and consists largely of an analytical methodology for determining the �nancial viability gap of low-emission projects, as well as an approach for assessing and strengthening the green investment climate in a given country environment. The authors argue that the solution to the �nancing challenge of low-emission investments lies in understanding the causes of a given project’s �nancial viability gap, and then investigating how speci�c actions—including concessional �nancing, strategic subsidies, and other public policy interventions and reforms—can be deployed in a complementary fashion to close the gap. The approach provides suggestions for appropriately allocating risks and responsibilities to various stakeholders for �nancing portions of the �nancial viability gap and recommends using multiple instruments and tools to make green investments viable. Governments, for example, could rebalance their own policy distortions with a mix of domestic instruments such as feed-in tariffs, direct subsidies, domestic carbon taxes, and other �nancing and �scal incentives. The international community could contribute international instruments for monetizing the global externality bene�ts of green investments through concessional �nancing and direct grants. Such an approach results in hybrid �nancing structures designed to maximize the leveraging effect of public interventions. World Bank Studies are available individually or on standing order. This World Bank Studies series is also available online through the World Bank e-library (www.worldbank.org/elibrary). ISBN 978-0-8213-9527-1 SKU 19527