Executive Summary
The event, “Financing the green transition in China: opportunities for local government access to climate finance”, is part of the China Low Carbon Leadership Network 2012-2014 event series jointly organized by the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) and China Carbon Forum (CCF).
It saw the launch of an important new report on opportunities for accessing climate finance by Chinese provincial governments, with a focus on Guangdong. The report, a collaborative project between GIZ and The Climate Group, can be downloaded here:
The speakers on the panel discussion presented a good balance of perspectives, approaching the topic from governmental, academic and think-tank viewpoints. This range of views made for a stimulating Q&A session with the audience. Many stayed on afterward to network and discuss the topic of the evening, providing a valuable forum for interaction and networking between counterparts, especially business, foundations, policy experts and government representatives.
Record of Discussion
The following is an edited synthesis of discussion that took place at the event among panellists (around 60 minutes) and open Q&A with participants (30 minutes). As per convention, individual’s comments are not attributed.
The panel pointed out that there is an accepted wisdom that influences climate change negotiations, that development must take priority, and that we need to adapt to climate change. Climate change, however, is closely linked with other development goals such as air pollution and energy security. So this idea must change, because although the low carbon economy might sound cliché and boring, dealing with climate change is the only acceptable future. China has been working hard to win respect from the international community on climate change. This means that developed countries are increasingly aware of China’s actions on the issue. Although China is the highest emitter in the world, it has also recently brought hope to the world.
China’s hard work can provide a positive impetus for dealing with climate change mitigation and adaptation. China has been making significant efforts to improve energy productivity, energy efficiency as well as expanding renewable energy, recently surpassing the US as the largest investor in renewables. Experts agree, including the recent New Climate Economy report, that a path towards a sound and sustainable future for China is possible, but this requires the transition of the energy system and other parts of the economy to accelarate.
Recently, low carbon pilot and demonstration projects have been a particular theme of Chinese government policy. In March 2011, the 12th Five Year Plan announced comprehensive low carbon economy goals, marking a pinnacle of central government policy on green development so far, including many ambitious goals and compliance requirements. Transitioning to a low-carbon, climate friendly economy is a high priority for the Chinese government, but this requires access to large amounts of new finance, especially for provincial-level governments. In the investment sector, not enough attention has been given to the financial support reguired for the green goals set out in the 12th Five Year Plan. This presents an important challenge in order to realize those goals, and the government realises that more attention must be given to climate finance issues.
If the world is to meet the scientifically-determined target of limiting global warming to 2 degrees, the required capital will be very large. Investment needs to scale up significantly in order to be able to solve the climate change challenge. There are different models for estimating the total budget for both the mitigation and adaptation problems. It is also important to follow the level of investment already made in the climate change sector, although it is difficult to provide accurate numbers. Recently, at the Lima COP, USD 10 billion was pledged by the developed world. Last week, 30 countries gathered in Berlin, pledging another USD 9.3 billion. In Copenhagen, the target was set at USD 100 billion per year by 2020, so we have five years in which to reach a five-fold increase in donations. Where will this money come from? How should climate finance be seen in terms of international law, as well as common but differentiated responsibilities and developed countries’ obligations to developing countries.
In addition to multilateral climate change finance, developing countries should identify capital domestically to invest in climate change solutions, given its close link with economic development. Climate change action has a public good quality, so it is very much dependent on public policy. If there is no adequate policy in place, most people would not be willing to invest, be it governments, enterprises or individuals. This cannot be solved just through charitable donations. The climate change negotiations must ask each country to make global undertakings, and also to create policy incentives. Without this, it is very difficult to make the goals become practical and durable targets.
The Climate Group, in cooperation with partners, has been working on the climate finance issue since 2011. TCG judges that this work has had some influence, judging by the draft Climate Change Law. However, although there has been some progress in central level policy, there is still a long way to go in terms of translating the lessons learned in to practical steps to be taken. As a result, research on how to implement climate change finance at the local/provincial scale was required. Tonight, this event launches a joint report from The Climate Group and GIZ, Analysis of Climate Finance Policies and Innovative Finance Mechanisms in Guangdong – Policy Mapping and Case Studies. This is the first such report on China to focus purely on the provicincial level, and Guangdong was chosen as the focal point for the research. The report represents three months of work.
The report has two sections: the first maps provincial-level climate change policy; the second involves three case studies which aim to reduce the gap between real world actions and conceived targets. A key goal is to leverage resources in order to maximise the scale of climate change finance.
Climate change finance is still at an early stage in China. In Guangdong in particular, both the ADB and the World Bank have been involved in exploring avenues for its development. Guangdong Province has played a leadership role, exploring capacity improvements as well as supply chain structure. Guangdong province is a special case, having advanced quickly in relation to other provinces on climate change, as well as during China’s development and reform process generally. Guangdong has the most ambitious emissions reduction target nationally, as well as the largest ETS in China. Guangdong’s 18% emissions intensity reduction target for 2015 means that the local government has a significant responsibility in relation to emissions reduction. As a result, Guangdong is becoming a leader of low-carbon growth in the country, and provides a good case study for the implementation of climate change finance at the local level.
China has the second largest carbon market behind the European ETS, providing a new channel for climate finance. The carbon market is now a key component of climate change finance in Guangdong. However, government agencies face many challenges overall. Sources of capital include public investment, international funding through channels like the ADB, while the largest is commercial bank loans and green credit. Both market capital and government spending play important roles. The provision of government funds and the stability of public policy are both important in order to boost confidence for private market investment.
All three case studies are relevant to energy efficiency, and they all share some similarities. The first case study focuses on an efficiency power plant (EPP) project developed by ADB. It provides 100 million USD to the Guangdong government to support loans for energy efficiency and renewable energy projects. There are many special aspects to the Guangdong EPP project, including that loans are at interest rates substantially lower than commercial rates, which helps to break many of the bottlenecks for financing of SMEs. It also helps to manage potential risk, as projects may face problems if they were forced to take loans directly from the market. The terms of the loans are for 3-5 years, and the capital is recycled for up to 15 years, meaning that funds could be used up to 5 times. One important question is scalability, and the ability to duplicate to other areas. Among the projects funded, a rooftop solar project at a factory was selected for the case study.
The second case study relates to lorry transportation in Dongguan. The partners are the World Bank and the GEF. This project deals with the low fuel efficiency of truck freight transport in what is a pillar industry for Guangdong, and is a first for China. It utilises a number of advanced technologies to improve efficiency and reduce emissions. The project also utulised an ESCO model for technology provision.
The third project is a commercial LED ESCO project. LED deployment in Guangdong has been increasing rapidly in recent years, encouraged by both national and provinical government policies. This project looks at LED deployment at a factory complex in Zhongshan and the details are shared in the report.
The three projects receive government support, however an entire “ecosystem“ of policy and private sector linkages still requires many elements to be improved upon. To sum up the lessons from these three cases, China has made achievements in developing public policy and boosting public investment, however the outcomes and the industrial capacity are still far from the planned targets.
Guangdong has made progress in low carbon development over the last three years, including data collection and compliation as well as a trial of carbon trading. Of course, local public finance has been a very important element in this process. Guangdong, since 2010, has invested CNY 30 million in low carbon projects, including funding for both basic scientific research as well as practical project implementation. Carbon trading is an avenue which needs further exploration. Guangdong was the first Chinese province to feature auctions for the issuing of emissions credits. CNY 670 million has come from auctioning in Guangdong. In the future, it may also be possible to set up a fund to leverage more capital from the carbon market.
Rather than emissions reduction representing a cost, it should also be a way to make money. The solutions lie in technology, which can help reduce energy consumption and make industrial processes more efficient, or improve agricultural yields by using less fertilizer and pesticides, and reducing costs. There are many existing technologies, but it is often quite hard to commercialise them. There are two key ways to achieve commercialisation: economies of scale and integrating resources. Platforms such as TekoNet aim to provide technology incubation, technology transfer, resource integration, as well as identifying market demand and tailoring solutions to clients.
In Europe, it has been shown that a long-term stable policy framework can help to engage finance contributing to, for example, energy efficience measures in SMEs. Guangdong may be able to learn from this and other examples in order to target sectors until now not engaged in such activities. The ongoing financial reform process in China is stimulating change, for example subsidies for undertaking energy efficiency and other measures. This allows an environmental co-benefit for actions in the private sector which aim to reduce costs and risk in terms of exposure to energy prices. Policies that are being implemented through the banking system are extremely positive. The extent to which they are taken up still needs attention, but there are positive signs.
The Guangdong government’s climate finance contributions include two aspects: First, low interest or no interest loans to help companies under the Guangdong ETS to establish energy efficiency and carbon reduction projects, as well as research and development. Second, encouragement of market mechanisms and involvement with financial institutions. For example, government loans can also attract some private sector contribution, and be structured in a way to encourage companies to pursue clean energy projects. There are many technologies out there that could be scaled up, however, due to lack of funds and financial support, these technologies are not utilised. The government hopes to use of market mechanisms to expand the reach of technologies, including products already the subject of collabration with financial institutions through the carbon market. The Guangdong government is hoping to expand public private partnerships for low carbon development in the province.
Public-private cooperation in the climate change field is becoming popular in China, at the encouragement of the Ministry of Finance. Typically there are two types of such policies: green banks and green funds. Green banks have become successful internationally; the UK Green Investment Bank and banks at the state level in the US are now well-established. However the restrictions for establishing funds are much lower than for establishing banks. Whether from a bank or a fund, public funding can attract additional investment from the private sector. Minimising government investment, while maximising market investment, helps achieve a win-win outcome. A lack of appropriate technologies is no longer an obstacle faced today, but rather how to choose adequate technologies or combination of technologies is crucial. There is significant potential for bringing together capital and technology.
Although the overall picture of financing low-carbon deveopment in China is not clear, and involves a considerable lack of coordination, the silver lining is that we are moving towards the market taking priority. If everything is done through government, the burden falls on the tax payer and there are limits to how much burden can be imposed on individuals, either through taxes or subsidies, or by service charges. China is doing a good job across a range of areas not directly related to low-carbon development, to provide incentives for the private sector to adopt advanced technology. We saw that in solar panels, and now in relation to the LED industry in Guangdong.
The growth of LEDs in Guangdong has been exponential. The impact of this is twofold. Guangdong is supporting this development as it providess local benefits including local industry and jobs. However this has spillover benefits for the rest of the world because it triggers the learning effect where LEDs becoming cheaper for everyone else, a virtuous cycle. This type of development not only benefits the local economy but it also means that the cost of low-carbon development is not being borne by the Chinese taxpayer, but rather by global consumers. So although this development is chaotic and not necessarily integrated, that is the nature of markets, involving experimentation through trial and error. Some things work beautifully, having impacts, while others don’t.
The Guangdong government is looking at avenues for climate finance, and exploring ways to make use of funds efficient. Tradable permits are just one mechanism. Some companies face difficulties in financing, and it is impossible to ask many SMEs to undertake energy efficiency or low-carbon projects on their own. The government is cooperating with banks in order to help SMEs access green finance.
SME finance is a world-wide challenge. It difficult for banks whose interest margin is low on such loans and must still pay for lawyers and staff time within that margin. The income on loans is minimal and often involves high risk. Some projects have long timeframes during which much can change, including policy, technology and the market. It can be hard to guarantee a loan for SMEs. SMEs also have low trading volumes so transaction costs for banks are high. This high risk, high cost, low income situation makes banks reluctant to loan to SMEs. This is especially the case in relation to climate finance, where money is lent for projects in which much of the gains are borne by society rather than the companies.
In order to overcome these obstacles: 1. It is important to understand the value of the energy efficiency that SMEs can achieve. They must also find the best technology in order to optimise the outcome. This is not only a finance problem, but also related to management and policy. 2. Innovative financing models are needed. Commercial banks are more interested in real estate projects or manufacturing than energy efficiency or renewables projects. Although low-carbon investments may be part of a company’s CSR strategy, it may require assessment of its liability and solvency of the project. So we need to design a mechanism which avoids burdening SMEs, allowing them to maximise productivity, while also reducing risk, achieving better corperate governance, and reducing transaction costs. Similar technologies could be bundled into a larger project to be utilised many times. ADB has used a similar approach in China already. Companies not only need loans from banks but also equity finance, so low-carbon equity funds have become important. In this way, returns can be achieved not only directly from the project but also from the capital market. LED lighting is an example of this.
Using finance efficiently is important. This includes leveraging public finance. If government invests money into a green fund, through good project design, incentives can be provided for banks and the private sector to invest money into projects. Financial recycling can then be implemented, maximising efficiency and helping government reach investment goals meeting future targets. This approach has already been used effectively in Guangdong, but could be applied more widely.
Which technologies require support in Guangdong? First, agriculture is both emissions and water intensive, representing a risk to human health. Examples of soil contamination in Hunan have created concerns in the region. Second, environmental protection technology, especially relating to air pollution, water resources and land rehabilitation. Environmental protection also relates to energy and the reduction of fossil fuels. It has been said that if air pollution continues as it is in Beijing, in addtion to APEC, we may need a BPEC and CPEC in order to keep the air clean! Basic human needs of clean air, clean water, safe food and a liveable environment are important. Thirdly, the health sector. The population is ageing, with life expectancy increasing and consequent costs. Climate change will compound these costs.
The characteristics of technologies which government should be incentivising are ones that already have a proven business case, that are ready to be scaled up, that the private sector is poised to take over in order to make the most leverage of the public money. We saw this with wind, and solar still has a way to go. Feed in tariffs can be an effective way to incentivise improvments. Electric vehicles are also worth mentioning. In general, governments need to be careful in the allocation of finance to the private sector in order to avoid undue risk taking, but if it is focussed on technologies that are proven, public money can be used to maximise private profits and public good at the same time.
For other provinces, it is important to remember that Guangdong has a large manufacturing capacity for LEDs and other technologies. On the market side, the government instituted a range of incentives to allow the industry to scale up, representing an important part of the success. However that may not be scaled up in other provinces which do not feature Guangdong’s manufacturing base, meaning the formula doesn’t work in the same way. There has been a mentality in local government that attempts to identify the next technology to “bet” on. Care should be taken in this regard. The recent Climate Group “Cleantech Summit” picked twenty technologies which gave presentations. They include technologies in agriculture, environmental protection (e.g. water treatment), renewable energy and energy efficiency. Funds need some kind of guidance on selection of technologies to fund, but this will up to the fund management itself on a case-by-case basis.
Electricity prices in China are lower than other parts of the world. Experts agree that electricity needs to be priced correctly. China has started on that journey, and although there is still a long way to go, reforming electricity prices is already part of the debate. China currently pays a big price whenever the government decides to create clean air for international meetings, through lost production and transport restrictions. There is a question about the willingness to pay for environmental benefits in this regard. Electricity pricing is important, however if it is the only measure undertaken it may end up benefiting the wrong parts of the economy. There are a broader set of reforms needed, in order to rationalise the operation of markets. This is important so that reforms do not merely increase profits for polluting industries but in fact do provide important incentives and reallocations within industry. Successfully addressing climate change requires a broad set of reforms, including the operation of markets, transparency, the elimination of waste, corruption, etc.
In other parts of the energy sector, prices are higher than other parts of the world, yet pollution is also higher, suggesting that there is significant wastage that requires use of improved technology. Currently, higher energy prices eat up part of the advantage of low labor costs, meaning that the Chinese people are paying an unnecessary cost. Fertilizer is a good example. 70% of fertilizer in rural areas is wasted because for each crop season farmers use fertilizer twice. When it rains, fertilizer is washed in to the water system, wasting energy, farmers money and pollutes the water resources. Not enough attention has been paid to this problem. China needs to learn from other parts of the world and find an efficient, mature technology which could help farmers save money and save significant carbon emissions.
To date, the Guangdong government has not implemented polices for ESCO companies as widely as it could have. There are plans to raise the profile of this avenue in the future, encouraging ‘middle-man’ companies in the energy efficiency sector. This allows the government to mainly provide project support, and identify opportunities for consolidation. The government may cooperate more with banks and other organisations to share the burden in this process.
There is a trend that government support for ESCOs is always too little and too late. Banks do not have much knowledge on energy efficiency, so they are reluctant to give out loans for projects. There have been suggestions, therefore, for government to provide financial leasing to ESCOs. If an ESCO company can prove that energy saved from the equipment will cover the rent of the equipment and interest, the equipment will be provided. ESCO projects usually have a double risk for both parties involved: financial risk and technology risk. A technology guarantee mechanism can also be implemented, by inviting the best technology provider in China to certify the technologies used. Credit rating agencies could also give out credit ratings on ESCO companies. Upfront payment for assets may also help. Estimating how much financial gain a project will provide, there could be a 50% discounted return for upfront payment on such projects. Alliance purchasing of equipment, like a groupon scheme, could also be encouraged. A low price would be provided for a group purchase, with say a 20% reduction in cost. Marginal costs will therefore be reduced for all involved.