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Climate finance?

Updated: Aug 31, 2023

The importance of revising climate finance definitions to ensure grids support requisite scale-up in clean energy.

Lack of climate finance for grid infrastructure in developing countries is constraining the supply of clean electricity to where it is needed most, jeopardising energy access and emission reduction goals. In the fourth piece for the Why grids? series, Climate Compatible Growth researchers Steve Pye and Simone Osei-Owusu and TransitionZero's Abhishek Shivakumar outline the challenges in raising finance for transmission lines and how modifications to existing climate finance eligibility criteria would allow International Finance Institutions (IFIs) to invest in grid infrastructure projects that manifestly contribute to the clean energy transition.

Electricity grids are a crucial part of the energy infrastructure needed to meet existing and future electricity demands. Put simply, without a rapid expansion in grids, low carbon electricity generation will never reach its full potential and net-zero emission targets will be missed. This is particularly the case for Emerging Markets and Developing Economies (EMDEs) which in 2019 accounted for the largest share (60%) of total current energy demand growth.

Since 2015, there has been an acceleration of renewable energy generation in EMDEs, driven particularly by private sector investment and government policies that have gradually driven down the cost of renewable technologies.

However, raising finance for transmission lines has been more challenging, because grid assets are more exposed to regulatory uncertainty. Risks may be even greater for cross-border transmission lines, due to a tough combination of poor creditworthiness and complex geopolitical factors. Yet, such interconnectors are often essential to allow countries with limited renewable energy endowments to benefit from clean electricity generated by their neighbours. There is a real concern that the benefits of expanding investment in clean electricity generation may be limited by a lack of a corresponding expansion in grid infrastructure to reach energy consumers.

The use of blended capital is crucial in addressing this need, Necessitating more grid investment from both IFIs and the private sector. Capital from institutions that provide concessional finance, including climate funds, can help reduce the risks for other private sector investors and makes it possible for them to invest in the scaling up of grid infrastructure.

There is a growing willingness among investors and IFIs to provide funding that is focused on clean energy projects and therefore counted as ‘climate finance’. However, because grid projects do not directly reduce emissions (they supply the low carbon electricity rather than generating it), identifying which grid investment projects can be designated as ‘climate finance’ is not straightforward.

As highlighted by the Green Grids Initiative there are currently two main approaches being used by the international community to define eligibility for climate finance: i) the European Union’s Taxonomy, and ii) the IFI’s Common Principles for Climate Mitigation Finance Tracking. Furthermore, other important sources of concessional finance – notably, the Green Climate Fund – do not yet have any approach in place to define the eligibility of transmission investments for climate finance.

In its most recent paper, the Green Grids Initiative takes stock of the experiences of different IFIs and other stakeholders in trying to implement the two established approaches and finds that both sets of criteria risk constraining much-needed grid investment in EMDEs. The paper recommends that IFIs consider specific methodological changes, which could help expand the number of transmission projects deemed eligible for climate finance, while still ensuring rigorous adherence to decarbonization goals. For climate funds which do not yet apply either of the existing approaches, the paper recommends the adoption of new criteria that promote investment in green grids.

Specifically, the paper argues that modern energy system modelling techniques provide a rigorous and readily available means of estimating the carbon emissions reductions that can be attributed to new transmission lines. At the feasibility stage, such models can be used to run scenarios for how entire energy systems respond to the presence or absence of the new line. This makes it possible to estimate, with some confidence, the impact of the investment on enabling renewable electricity generation, altering the flow of electricity through the system, and producing changes to Green House Gas emissions. Alternatively, system models can be used to explore, whether a specific grid infrastructure project contributes to the achievement of specific emission reduction targets. Key to this approach, as with any investment promising certain outcomes, is to monitor the reductions achieved once the project has been initiated.

The paper also proposes incremental changes to existing methodologies. For instance, the EU Taxonomy approach for assessing transmission lines could be usefully amended to consider a country’s planned investments into renewable generation, rather than only focusing on the current carbon intensity of the grid. Therefore, grid investments could be considered ‘green’ based on planned renewable projects that would reduce the carbon intensity of electricity over time. In the case of the Common Principles approach, which does allow partial consideration of future generation plans, climate finance eligibility for grid investments could be extended by putting more weight on the share of planned renewable capacity additions over the next 10 years or so.

In summary, climate finance has the potential to play a more important role as enabler of investments in green grids. But this will only happen if some reasonable amendments can be made to the eligibility criteria. These should be designed to ensure that rapidly growing power systems in low and middle-income countries with vast renewable energy potential do not get overlooked. Credible criteria, and data-informed planning that accurately projects future carbon emission reductions, both have an important role to play. Above all, as IFIs and other climate financiers continue to refine their methodological approaches, they must keep in focus the need to massively scale-up financing in this crucial sector, if energy systems are to be decarbonised and clean energy is to reach the people who need it the most.

This article reflects upon the policy implications of the recent Green Grids Initiative (GGI) Working Paper ‘Mobilising Finance for Grids: Taking Stock of Current Climate Financing Approaches’ by Steve Pye, Simone Osei-Owusu and Abhishek Shivakumar.

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It's evident that without significant investment in electricity grids, the potential of low-carbon electricity generation cannot be fully realized, ultimately hindering progress towards net-zero emission targets. This piece serves as a compelling call to action for International Finance Institutions and policymakers to prioritize investment in grid infrastructure, particularly in Emerging Markets and Developing Economies where energy demand is rapidly increasing.

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