How can we close the green infrastructure gap?

Look ahead interviews the leading authorities on trends, challenges and opportunities in innovation. Today, we interview Christopher Kaminker, economist/project manager of long-term investment in the Environment Directorate at the Organisation for Economic Co-operation and Development (OECD). Here, we discuss his views on how investment can flow to projects and build a more sustainable, low-carbon and climate-resilient economy. Disclaimer: The views expressed and arguments employed herein are solely those of the interviewee and do not necessarily reflect the official views of the OECD or its member countries.

Mr Kaminker, what would you say is the size of the global green infrastructure gap today? 

In 2010 world governments agreed to limit the increase in global temperature to two degrees Celsius (2 °C) above pre-industrial levels to avoid the worst impacts of climate change. Roughly $310bn flowed to clean energy last year ($170bn to asset finance). The IEA suggests incremental investment needs to be $1trn, so there’s a shortfall of $700bn per year if we are to have an 80 percent chance of maintaining the 2 °C limit.

Scaling up and shifting the financing is most pressing in high-growth, developing economies investing heavily in coal-fired power generation, such as China, India, Indonesia, South Africa and Brazil.

What are the main reasons behind this $700bn gap? 

Policy uncertainty is one major issue but at the OECD we have been examining the supply and demand for green infrastructure finance and investment where there are clear mismatches. In OECD countries, on average, roughly 1/3 of investment is financed by the public sector and 2/3 by the private sector. The latter is split between corporate and financial sources —globally around half each, although there will be key differences at the country level and in debt or equity provision. In developing countries the “quasi-public sector” and state banks play a much larger role representing over 2/3rds of infrastructure finance.

For the public sector, the global financial crisis has made it harder for governments to budget for infrastructure investment. This is ironic given the low interest rate environment and that green infrastructure projects increase productivity, put people to work and come with a host of other co-benefits for health, fiscal and energy security objectives.

On the corporate side, utilities are having a hard time and losing market cap; their equity valuations are falling. Utilities in Europe lost 500bn euros of market capitalisation over the past few years; they have less capacity to invest and are less able to raise debt or equity.

As for the financial sector, the composition of bank asset financing has changed. We’re seeing fewer long-tenor loans (over seven years) which creates re-financing risk. Infrastructure really needs 10-15 year loans. The volume of loans, too, has changed because of financial turbulence and deleveraging.

Last but not least, there’s the impact of financial regulations. There are concerns, for example, that Basel III which has important financial stability objectives is causing banks to reassess whether infrastructure lending is as attractive as it used to be, even though infrastructure has one of the lowest default rates and highest recovery rates. So far, however, these concerns have been based on stylized facts and anecdotal evidence rather than empirical evaluation due in part to a lack of consistent and comprehensive data .

What are some barriers to closing the gap for green infrastructure in particular?

Let’s examine institutional investors, which manage $93trn in the OECD as of 2013. Pension funds manage around $25trn in the OECD: our latest survey showed that direct infrastructure investment —not to be confused with indirect investment, such as owning shares in a company— accounted for only 1% of asset allocation of funds in 2013. For green infrastructure, it’s much less than that.

We’ve come up with four reasons:

1. The existence of energy and climate policies that favour investment in brown over green infrastructure such as insufficient pricing of carbon, the presence of fossil fuel subsidies, or both.
2. A lack of stable regulatory environments; discouraging long-term investments.
3. An overall lack of transparent support policies—such as well-designed, cost-effective, support—to help immature green technologies achieve competitiveness. Or regulatory policies with unintended consequences, such as investment restrictions and accounting, reporting and reward cycle issues that tend to encourage short-termism.
4. A dearth of suitable infrastructure financial vehicles coupled with a shortage of objective information, data and skills to assess transactions and underlying risks.

How can technology and innovation help reduce the infrastructure gap?

Solving for the infrastructure gap is less about quick-win technological innovation and more about long-term costs declining. Given the scale of the infrastructure gap, it is clear that we are not talking about single, silver bullet breakthroughs. More work needs to be done to ensure that advances in transmission and storage technologies keep up with the energy production side, for example. But the cost of some of these new technologies is falling fast.  The cost of solar photovoltaic modules has fallen by 79% since 2009 and 99% since 1977, for example. And this process is continuing.

Financial innovation is also important if it’s done in a prudent way with judicious oversight. By our count, almost twenty public “green infrastructure investment banks” recently have been created to mobilise and “leverage” private capital. In policy-stable environments, we’ve also seen ‘Yieldcos’, forms of listed infrastructure funds that could drive costs down, starting to flourish. [Ed. Note: A Yieldco, which pays in dividends, has assets tied to long-term and predictable power purchase agreements, separating out volatile assets.]

Finally, there’s been an explosion in the market for green bonds which have potential to close the gap. In 2011, we came up with a figure for the whole outstanding market of $16bn. In 2014, $37bn of green “labelled” bonds were issued and analysts are forecasting issuance doubling in 2015 to $80bn.

This article is published in collaboration with GE LookAhead. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Holly Hickman is a writer at GE Look Ahead

Image: Rows of solar panels face skywards. REUTERS/Rebekah Kebede.