Why quality matters as much as quantity with energy transition finance

Energy transition finance needs to be in line with needs and circumstances, and provided in a way that addresses challenges that go beyond just retirement of coal, and toward the easing of burdens of developing countries in the time of climate impacts

Tuesday was Energy Day at COP27. But there was no substantial energy-related news that came out of the UN meeting. Instead, what grabbed headlines were the finance breakthroughs announced in parallel at the G20 meeting in Bali, which are mobilising billions. 

A group of developed countries led by the US and Japan, also including Canada, Denmark, the EU, France, Germany, Italy, Norway, and the UK have committed to a $10 billion investment to reboot and decarbonise Indonesia’s economy through a scheme known as Just Energy Transition Partnerships (JETP). The amount is expected to mobilise another $10 billion worth of private investments, making it the biggest climate finance deal ever struck.

Earlier last week, Indonesia also announced an agreement with the Asian Development Bank (ADB)’s Energy Transition Mechanism, for the retirement of a 660 MW power plant to be refinanced with up to $300 million and decommissioned in up to 15 years, staving off between 25 and 35 years from its lifespan.

With carbon-intensive economies in Asia pursuing clear and aggressive decarbonisation strategies, India’s reaction will be under the spotlight, as the biggest economy that stands to lose, or gain, the most from a disorderly or robust energy transition.

High stakes for India

The coming decades will see India’s infrastructure more than double its size, with an estimated 270 million people adding to its urban population before 2040. A majority of the buildings that will be home to future city dwellers are yet to be built—with a whole lot of metal, cement and other raw materials still to be produced. How much carbon is emitted in this phase of growth matters to the entire planet. But with an annual income per capita of ₹150,000, about $1,800, India cannot afford to slow its development pathway. The country has little option but to situate its low-carbon thrust within the basket of developmental objectives that already confront it. 

And while efforts are in place to make sure that new power and energy needs are met through low-carbon and zero-emission sources, and the energy intensity of the Indian economy has decreased by 1.3% per year over the past 10 years, fresh research by the consultancy firm McKinsey lists the energy sector as the number one source of emissions, with coal taking the industry’s lion share. 

India’s climate pledges make it clear the energy transition is not going to happen without foreign assistance, and so far the conversation has hinged on the amount available, and how they are disbursed, to help meet this objective. But the quality of these funds matter at least as much as the quantity if the energy transition is to happen in a sustainable and just manner, avoiding what experts call ‘maladaptation’—adaptation measures that may ease climate impacts in the short term, but end up creating new problems on the ground. As well as focusing on increasing overall budgets, COP27 is hosting conversations on how to unlock better finance—and equip vulnerable countries to access it.

Ignoring equity elevates maladaptation risks

At the root of maladaptation is an equity problem that goes well beyond a faulty financial architecture. 

Researchers in Chennai and Bangalore have looked at 367 emissions mitigation scenarios plotted by the scientists of the Intergovernmental Panel on Climate Change (IPCC), and found that the potential low-carbon future they design will aggravate today’s inequalities, with developed economies emitting relatively more carbon than their poorer counterparts, and developing countries being forced to choose between carbon-intensive development or no development at all. The study’s authors recommend developing countries “not to use the […] global mitigation pathways as the benchmark […] for negotiations due to the underlying highly unequal regional outcomes on which these scenarios are based.” If the models underpinning global climate action lead to an unequal future, today’s energy transition failures become easier to explain.

In the midst of last April’s record-breaking heatwave, as hundreds of thousands of people switched on fans and ACs at once, power cuts across northern India had to be rolled out to stabilise the stressed electric grid. Without power, villagers could not pump water badly needed for irrigation. Meanwhile, the state was using up the scarce water resources to maintain the solar panels at the Bhadla solar park, stretching for 5,700 hectares in the Jodhpur district.

Across India’s mountainous north, the proliferation of big dams, often planned on outdated environmental assessments, which don’t include projections on how climate change may alter local weather patterns, are contributing to the growing instability of the local terrain. And because the increased likelihood of heatwaves during the warm season may affect water availability, energy supply is also at risk, as was seen starkly in China and Europe this year.

A just energy transition plan takes such risks into account, as well as looking after communities that are dependent on technologies and processes that must be abandoned to curb emissions, such as coal mines. And because much of the existing climate finance is project driven, donor entities, whether it’s individual countries or multilateral development banks, have the responsibility to ensure that these projects are financially and socially sustainable in the long run. 

Quantity doesn’t always ensure quality finance

First, this means preventing vulnerable economies from spiralling into a debt trap—something that research shows is consistently happening. According to Climate Policy Initiative (CPI), a non-profit that analyses global climate finance flows, an average $653 billion per year was mobilised between 2019 and 2020, including domestic and international funds, for projects based in rich countries. Between 2011 and 2021, a total of $4.8 trillion was mobilised as climate finance. While the number might seem massive, CPI estimates the world would need almost as much annually by 2030 to bridge the considerable climate financing gap. While over three-fourths of the money mobilised in 2020 is estimated to have gone toward renewable energy and transport, only 16% was in the form of concessional loans, which are essentially loans given on softer terms of repayment, typically through lower interest rates or flexible repayment periods or a combination of both. Of this total, about 53% was disbursed in 2019-20 as loans with market rate interest, so countries will have to pay back a higher amount than what they received, just as the cost of climate impacts grows higher. Another 31% came in the form of equity, which also typically comes with expectations of high rates of returns.

Flood-battered Pakistan is one such example. The country is already deep in debt, owing the equivalent of $6.7 billion to China, which supported its energy and infrastructural development through the China-Pakistan Economic Corridor (CPEC). Now, after a third of its territory went underwater, reparation costs are only adding to the dues Pakistan has accumulated in an attempt to reform its carbon-dependent energy sector.  

As well as the right type of deals, which analysts say should mostly consist of grants and be additional to what donor countries already allocate for other types of overseas development aid, donors and recipients together should target the right type of projects—initiatives that are scalable and guarantee long-term benefits to the communities they target.

Headlines from this year’s COP27 will be largely dominated by the loss and damage debate, but there are signs that the climate community is waking up to the need for a new finance paradigm. Countries are likely to assess and revisit progress on the Santiago Network for loss and damage, which when implemented should equip developing nations with the technical knowledge needed to access and distribute finance where it’s most needed. 

A transformation on the cards?

And while countries are already starting to pledge support for loss and damage, and all eyes are on the creation of a finance facility for climate reparations by the end of the two weeks, concrete progress on the Just Energy Transition Partnerships (JETP) is already proving as meaningful, promising to ensure faster and transformative impacts for developing economies. This experiment, seen as one of the most promising outcomes of COP26, initially targeted South Africa’s decarbonisation efforts as a pilot that is now set to be replicated in Indonesia, and potentially in India and Vietnam.

While a JETP scheme in India remains just a vague proposition, a potential partnership with Vietnam is already taking shape and may follow Indonesia’s lead, with the Vietnamese environment minister and representatives of the donor countries inching closer to an agreement that would see the country exceed its NDCs.

South Africa is the seventh-largest coal producer and, much like India, its main public power utility is saddled with chronic debt. A portfolio of investments worth $8.5 million, supported by France, Germany, the United Kingdom, the US and the EU, is expected to create as many as 50,000 jobs by greening the country’s power sector and retrofitting its existing building fleet. 

Whether the same model can be replicated in smaller economies such as Pacific Island states remains to be seen, but what these partnerships create is a blueprint for a new form of collaboration between donor and recipient countries. Rather than simply mobilising more money, although this is certainly one of the expected outcomes, the strategic idea is to leverage existing public finance to transform each country’s economy in a way that works for and makes sense to their unique situation. 

If the South African pilot succeeds, it could usher in a new model for global climate finance, one that would be particularly effective for countries struggling with hard-to-abate sectors like India, for which previously successful green investments, such as adding more solar to an unstable grid, won’t cut it going forward.