approaches to low carbon energy and development

Bridging Paper 3 4

Approaches to Low Carbon Energyand Development

Bridging Concepts and Practice for Low CarbonClimate Resilient DevelopmentMatthew Lockwood and Catherine Cameron

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2The IDS–DFID Learning Hub aims to improveknowledge and information flows between DFIDpractitioners and experts in the field of low carbonclimate resilient development. It is a new approachthat combines practitioner learning networks,knowledge management capacity and reflectivelearning processes with bespoke research and analysis.The Hub has four interconnected ‘learning cycles’(Approaches to planning for climate change; tacklingpoverty in a changing climate; low carbon energy anddevelopment; and difficult environments). Each cyclehosts a learning event which are safe, supportedspaces for DFID staff who work on climate change anddevelopment to share individual learning and skills;engage experts in dialogue; develop new ways ofthinking and working together; identify where there areknowledge and learning gaps and contribute to the co-creation of a common knowledge base around ‘lowcarbon climate resilient development’. All the learningcycles are linked through various inputs and outputsthat create an ongoing flow of knowledge and will leadto the development of theories of change for LowCarbon Climate Resilient Development.

This is the third Bridging Paper from the Hub’s thirdlearning cycle; low carbon energy and development.

Authors’ affiliations:Matthew Lockwood is a ResearchFellow and Climate Change TeamLeader at IDS.

Catherine Cameron is a Director ofAgulhas: Applied Knowledge

Acknowledgements:Thanks go to all DFID, DECC and FCOstaff who participated in the LearningHub event in Jakarta in October 2011:Michael Anderson, John Barrett, RituBhardwaj, Greg Briffa, Stuart Bruce,Paul Chambers, Mark George, LornaHall, Gustya Indriani, Joanne Manda,Kirsty Mason, Udit Mathur, Shan Mitra,Paul Mullard, Sarah Resouly, MatthiasRhein, Arum Sari, Nicole Stewart,Jenny Yates and to Shiva Susarla ofReEx Capital for his insights and toMelissa Tipping of AusAid. Thanks alsogo to the IDS Learning Hub staff team,Fran Seballos, Blane Harvey andPatricia Curmi and to event facilitatorCarl Jackson (WKG) for their support,feedback and organisation throughoutthe Learning Cycle.

Edited by: Dee Scholey

Designed by: The Ethical GraphicDesign Company Ltd

© 2012 Learning Hub, Brighton: IDS

The Learning Hub

This material has been funded by UKAid from theDepartment for International Development, howeverthe views expressed do not officially reflect thedepartment’s policies.

ContentsUnderstanding the political economy

Deploying climate finance

Working with the private sector andleveraging private finance6.1 Working with SMEs in small-scale low carbon energy6.2 Leveraging private sector finance

Critical dimensions of low carbon energy and development

Approaches to Low Carbon Energy and Development: Bridging Paper 3 2012

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TablesTable 1 The contribution of energy to the MDGsTable 2 Illustrative categorisation of LCD interventionsTable 3 Matching type of leveraging tool to type of risk and context

BoxesBox 1 Win-wins – mini-grids and power from agricultural wasteBox 2 The marginal abatement cost curveBox 3 Power sector reform in Madhya PradeshBox 4 Climate Innovation CentresBox 5 The political economy of low carbon development in IndonesiaBox 6 Fuel subsidy reform in GhanaBox 7 The Bangladesh Climate Change Resilience FundBox 8 Low carbon energy for the poor – success storiesBox 9 Supporting innovation in business models for small-scale low carbonenergy in rural IndiaBox 10 CP3

FiguresFigure 1 Fossil fuel subsidies – by economy and as a share of GDP, 2008

Introduction

The challenges2.1 The energy access challenge2.2 Small-scale low carbon energy2.3 Decarbonising grid electricity2.4 Fossil fuel subsidies

Approaching low carbon development3.1 Identifying priorities3.2 Balancing emissions reduction and poverty reduction3.3. Aiming for transformational change

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4ADB Asian Development BankAECF Africa Enterprise

Challenge FundCCS carbon capture and storageCDC UK Government

Development FinanceInstitution

CIC Climate Innovation CentreCOP Conference of the PartiesCP3 Climate Public Private

PartnershipDANIDA Danish International

Development AgencyDECC Department of Energy and

Climate ChangeDRC Democratic Republic of

the CongoEU ETS European Union

Emissions Trading SchemeFCO Foreign and

Commonwealth OfficeGACC Global Alliance for Clean

CookstovesGERES Groupe Energies

Renouvelables,Environnement etSolidarités

GoB Government ofBangladesh

GVEP Global Village EnergyPartnership

GW gigawattIFC International Finance

CorporationKfW Kreditanstalt für

Wiederaufbau (GermanDevelopment Bank)

LCD Low carbon developmentLED Light Emitting DiodeLIC Low-income countryMAC Marginal abatement cost

MDB Multilateral DevelopmentBank

MDG Millennium DevelopmentGoal

MDTF multi-donor trust fundMIC Middle-income countryMIGA Multilateral Investment

Guarantee AgencyMtCO2e Metric Tonne Carbon

Dioxide EquivalentNGO Non-governmental

organisationNORAD Norwegian Agency for

Development CooperationONGC Oil and Natural Gas

CorporationOPIC Overseas Private Investment

Corporation (USGovernment DevelopmentFinance Institution)

PAT Perform, Achieve and TradePV PhotovoltaicR&D Research and DevelopmentRBF Results-based financingREACT Renewable Energy and

Adaptation to ClimateTechnologies

SME Small and medium-sizedenterprises

SREP Scaling up RenewableEnergy Programme

SSA sub-Saharan AfricaT&D Transmission and

DistributionTWh terawatt hourUKCCU UK Climate Change UnitUNEP United Nations

Environment ProgrammeUNFCCC United Nations

Framework Convention onClimate Change

Acronyms

5IntroductionThe third cycle of the Learning Hub aimed tobring together theory and practice on lowcarbon development (LCD). LCD is increasinglyon the development agenda, not only for fastgrowing emerging economies where there issome urgency about getting onto lower carbondevelopment trajectories (Hepburn and Ward2010), but also for the least developed countries(see for example, Bowen and Fankhauser 2011).

There are an increasing number of frameworksfor low carbon development, low carbon growthand green growth being put forward (Pye et al.2010; World Bank 2010; Crawford 2010). Therehas been a recent surge of interest in ‘greengrowth’, with statements and reports from theOECD (2009), the UN1, and the UNEP (2011) aswell as numerous specific national or regionalinitiatives (for example, in Denmark, NewZealand and South East Asia), an ongoing greengrowth project in the World Bank, and mostimportantly, individual country strategies thatappear to have real ownership.2

However, despite the growth in analyticalframeworks and strategy documents, lowcarbon development is still a relatively new areafor donors and developing countrygovernments. Resources for low carbondevelopment programming or policyengagement are growing, and there is thepotential for leveraging even larger amounts ofprivate finance, but there is also a need to learnwhat works and what doesn’t, in which contexts.Donors are typically trying to strike the rightbalance across three dimensions:

First, a low carbon development agendaimplies some kind of balance between twoobjectives: poverty reduction and carbonabatement. For the UK government inparticular, both global poverty reductionand global carbon emissions reduction arecross-government goals, which should bejointly owned by all departments.

Second, a related challenge emphasised byparticipants in the Learning Hub event inJakarta, is getting the balance right inprogramming in any particular countrybetween attention to factors that arespecific to mitigating carbon emissions,and attention to weaknesses in underlyinginstitutions, policies and practices.

Third, limited resources and the fact thatemissions come from many sourcesmeans that choices need to be madeabout where to focus effort. There areimperatives to reduce poverty and carbonemissions quickly, and discrete projectscan deliver significant results. However,ultimately the low carbon developmentagenda is about putting the wholeeconomy on a different growth path, andthis transformation requires majorpolitical and policy changes. A balancemust be struck between these objectives,levels of ambition and timescales overwhich such changes occur.

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Technical frameworks and advice forsupporting low carbon development areincreasingly available, based partly on growingexperience in developed countries. However,during the Learning Hub event the emergingexperience of participants highlighted severalareas where technical frameworks are notenough to guide decision-making:

n As the deadline for reaching the MDGsdraws nearer, there is often a pressure ondonors to produce immediate results, asnoted above. But at the same time, someof the big opportunities for low carbondevelopment involve longer-term policyengagement and an indirect chain topoverty reduction impacts, dependent oncomplementary changes. A strongerempirical evidence base and indicators ofsuccess will help to strike the balancebetween the two imperatives.

n A good understanding of the country-specific political economy and relevantnarratives about poverty reduction andeconomic growth co-benefits reallymatters for low carbon developmentprogramming.

n There is already an excessive proliferationof vertical funds in climate finance, anddonors should guard against becomingdependent on these. Whereprogramming goes through themultilateral development banks (themain public actors on low carbon energy,for example), it is important tounderstand as much as possible aboutwhat they do and hold them to account.

n Private finance will have to play a majorrole in delivering low carboninfrastructure (and potentially haltingdeforestation). Donors need to develop adetailed practical understanding of therole of private finance in low carbonenergy investments, how best to leverageit and how to work in partnership withdifferent private sector actors.

The low carbon development learning cycle heldthe potential to cover a wide range of areas,including low carbon energy, deforestation, lowcarbon agriculture, cities, and transport.However, in the Learning Hub event in Jakarta,the discussion and contributions focusedheavily on low carbon energy. This outputreflects that focus.

This paper bridges the concepts and review ofthe state-of-play set out in the backgroundpaper for the learning event, with the learningoutcomes from the third cycle. In the nextsection it lays out some of the core challengesfor getting developing countries onto a growthand development path in which energy comesfrom low carbon or renewable sources.

It then goes on to review experience andlessons in the areas mentioned above insections three to six:

n how to aim for transformation of energysystems and manage risk;

n why political economy matters and whatto do about it;

n the trade-offs in working through verticalfunds and with the MDBs, and how tohandle them, and;

n how to leverage private finance.

Section seven concludes by setting out thecritical dimensions of low carbon developmentprogramming and policy engagement thatemerged through the dialogue between DFID,DECC and FCO practitioners, advisers and theauthors.

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1 www.greengrowth.org/index.asp (accessed 26 February 2012).2 Generally, there seems to be interest from developing country

governments in the green growth concept, which places emphasison new economic opportunities and other co-benefits of a lowcarbon growth path rather than on abatement, and also includes abroader set of sustainability concerns (see section 3.3). Greengrowth strategies take as their starting point the growth ambitionsof countries and seek to find low carbon or less resource-intensivepaths to that growth. They seek general growth policies that canbe amended to produce the growth path with lower emissions. Intheory, this approach may well either avoid or minimise the short-term costs of low carbon and resource-efficient investment, whilestill yielding as many, if not higher benefits over a longertimescale. Green growth seems to be an important driver in Chinaand in many other Asian countries, who are not just investing inlow carbon technologies such as wind, LED lighting, solar PV andelectric vehicles, but are also seeking to shift the sectoral balanceof growth towards services, investing in rail as well as roads, andinvesting in schemes such as car-sharing schemes.

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7The challenge of low carbon energy indeveloping countries is two-fold. First, there isan urgent need to expand access to modernforms of energy to poor people. Although thereis no specific MDG for energy, there are anumber of ways in which access to modern

forms of energy is essential or important forachieving the MDGs (Table 1). Second, there isthe need to ensure that this energy comes fromlow carbon sources, typically in politicalcontexts in which emissions reduction is not apriority aim.

Table 1 The contribution of energy to the MDGs

MDG Energy’s contribution1 Poverty and hunger Lighting for activities when it is dark, powering factories, transporting

goods and materials, pumping drinking water and cooking (energy is required to cook 95% of staple foods for human nutrition).

2 Education Lighting for schools and home study, energy for computers in schools.

3 Gender equality Reduces time spent by women and children (especially girls) cooking and collecting firewood, water, and goods from markets.

4 Child health Reduces smoke from cooking (indoor air pollution contributes to 36% of all acute respiratory infections in children), computers to raise awareness.

5 Maternal health Reduces smoke from cooking, lighting for care after dark, refrigerating vaccines, sterilising equipment, transport to health centres, computers to raise awareness.

6 HIV/Aids and diseases Lighting for care after dark, refrigerating vaccines, sterilising equipment, transport to health centres, computers for medical training.

7 Environmental Reduces number of trees cut down for fuel, reduces emissions from sustainability burning fuel.

Source: Modi et al. (2005).

It is critical then, to ensure that climate change interventions contribute toreinforcing the pathways of poverty reduction and to helping people get out of oravoid pathways of poverty reproduction. Newsham et al. (2011: 5).

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2.1 The energy accesschallengeThe energy access problem (that is, bothaccess to electricity and to modern forms ofenergy for cooking and heating) is huge andurgent. It is estimated that:

n 20 per cent of the world’s population –around 1.4 billion people – still lackaccess to electricity (IEA 2010b).

n Three billion people cook on coal andtraditional biomass (such as wood andmanure) (IEA 2010b).

n Universal access to electricity will requirean additional 950 TWh of generation ayear by 2030 across the developing world(IEA 2009). In sub-Saharan Africa, this willrequire a ten-fold increase in generatingcapacity (Bazilian et al. 2011a).

The nature of the challenge varies by regionand country. Access is particularly low in sub-Saharan Africa (less than 30 per cent ofhouseholds in 2005, even fewer if South Africa,where 75 per cent have access, is excluded),compared with South Asia (65 per cent) andLatin America (~60 per cent) (Eberhard et al.2011). South Asian grid access in 2009 was stilljust over 50 per cent in rural areas, and in Indiaover 400 million people are without access.3

Universal access to modern energy is nowincreasingly high on the international agenda:

n 2012 will be the UN’s International Yearof Sustainable Energy for All

n The UN Advisory Group on Energy andClimate Change has called for a goal ofuniversal energy access by 2030

n The UNDP’s Human DevelopmentReport 2011 calls for Universal Access toEnergy focusing on ‘clean’ energy.

Access is expected to be reached through twodifferent routes: the extension of grid electricitygenerated in large-scale power plants and off-grid, small-scale, ‘decentralised’ electricity. TheIEA estimates that off-grid expansion will play amajor role in meeting universal access in sub-Saharan Africa and India by 2030, with 60–65per cent of new generation occurring either inmini-grids or in standalone systems (IEA2010a). A decentralised electricity supply ismost attractive in remote or sparsely settledareas where grid infrastructure is an expensiveoption. Deichmann et al. (2011) emphasise thatit is difficult to make generalisations becausespatial factors vary so much between countries.However, even where grid electricity may be thecheaper option, there are nevertheless reasonswhy decentralised technologies are used andare preferable from a longer-term perspective,to avoid high carbon lock-in (Unruh 2000; Vogt-Schilb and Hallegatte 2011; Strand 2010).

The two routes raise different sorts of issuesand policy challenges. They also typicallyinvolve different kinds of actors. Low carbonenergy programmes and investmentsespecially need an understanding of privatesector investors and firms. But the privatesector covers a wide range of scales. Typicaldelivery agents for cookstoves or householdsolar PV kits are social enterprises and SMEs.By contrast, grid electricity usually involvesmajor infrastructure investments with a 40+year lifetime made by major utilities andinstitutional investors. SMEs will tend to bemore hampered by high transaction costs andlack of access to capital, while larger lowcarbon energy investors will be much moreconcerned with the credibility and stability ofpolicy frameworks, risk and the cost of capital.

There is a need to examine how lowcarbon resilient development canmitigate the negative impacts ofclimate change and addresschallenges to poverty reductionthrough extending the penetration ofand affordability of access to resilientgateway systems (power, water,communications and transport).Hedger et al. (2011:8).


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2.2 Small-scale lowcarbon energyIn sparsely populated rural areas or whereconventional power sectors are badly managed,small-scale, decentralised energy solutions canbe the most viable – and least cost – option,particularly for lighting and cooking. In terms oftechnologies, small-scale solar, wind, micro-hydro and biomass gasification are perceived tohave the most potential to support basic accessin developing countries (See Box 6, section 6.1).

Improved cookstoves are also very important fortransforming efficiency. The sector has recentlybeen re-energised, partly because of the climateissue and the possibility of carbon finance (atleast in theory) and the involvement of somemajor corporates, including Shell, BoschSiemens, Phillips and BP. At the same time, tworecent initiatives have increased momentum:the Global Alliance for Clean Cookstoves(GACC) and the government of India’s re-launched programme on improved cookstoves.A new wave of producers, coming through inthe last 5–10 years, appears to be moresuccessful than previous generations, althoughsome are still at the pilot stage.

Small-scale low carbon energy products also havedevelopmental co-benefits. The best documentedare the health benefits from reduced indoor airpollution due to improved cookstoves,particularly benefiting women and girls (WHO2011). Potential outcomes from access toelectricity include improved educationaloutcomes, increased micro-enterpriseproductivity, and transformations in mobilephone use (see, for example, Energising

Development (2010); Khandker et al. 2009a,2009b).4 Solar pumps are also a big potentialwin-win technology.5 However, the evidence basefor the impacts of modern energy provision ondevelopmental outcomes in most areas remainsthin. It is an area where more research is needed.

It is also important to recognise the limits tosome small-scale technologies, and that thereare, in effect, degrees of energy access. Thus, asolar PV home kit with a peak output of a few10s up to 100 watts will provide power forlighting, TV or mobile charging, but this is quitedifferent from the power demands of activitiessuch as agro-processing which are likely to havemuch greater transformation potential throughincreasing income and diversifying rurallivelihood opportunities. Such loads will requirea much larger supply, for example providedthrough a mini-grid from small-scale hydro orbiomass gasification.

Common delivery organisations for small-scalerenewables are SMEs or social enterprises,sometimes working in partnership with an NGO(this model seems more prevalent in South Asiathan in Africa). They face several barriers,especially in scaling up:

n Business model: Some enterprises havedeveloped successful business models,involving sales purchased on credit, withmicro-finance provided by the retailer or apartner NGO, to overcome the relativelyhigh upfront cost of renewable and lowcarbon technologies.6 However, othersneed support in working out a viable wayto deliver products.

n Finance: Another key barrier to scaling upis difficulty in accessing working capital.Many small enterprises are working incountries with weak local financial sectors,and find it difficult to access capital to buyproducts in bulk, or make largerinvestments. Transaction costs, low marketprices for carbon and conventional projectrisk have all been barriers to a greater rolefor carbon finance. Signs of progress areemerging through new programmaticcarbon finance and innovative lendingvehicles (see www.energyincommon.organd Box 8 in section 6.1).

Decentralised and renewablemethods of energy production withless geographic exposure offer amore resilient system of achievingbasic electrification for many places;the adaptive capacity of householdswould be increased too.Hedger et al. (2011:20).

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n Technology: Although technology costsare falling and overall economic returnscan be good, renewable energy stilltypically involves a high upfront capitalcost. Where costs have come down, as inthe case in recent years for solar lightingor solar home systems,7 product qualitycan also sometimes be a problem, whichthreatens growing markets by erodingconsumer confidence. Standards areoften lacking or not enforced. This wasone motivation for the establishment ofthe Lighting Africa initiative(www.lightingafrica.org), which placesemphasis on quality assurancemechanisms. Another key issue is design.Getting improved cookstove design rightfor a mass market has been a perennial‘valley of death’ challenge, with manyinitiatives failing to provide productswhich actually displace traditionalpractices (Rai and McDonald 2009; WorldBank 2011a).

n Policy: Policy and regulation is typicallyunsupportive. Many countries havesupport policies for grid connectedrenewables but no support to standalonetechnologies. Renewable power sourcesare sometimes competing with fossil fuelalternatives that enjoy subsidies – that is,kerosene for lighting, and diesel forgenerators – although against this, highoil prices are currently working in favourof small-scale renewables.

n Markets: High information costs areanother barrier. Policymakers andconsumers are often unaware oftechnologies, their prices and availability.Under-developed supply chains regularlyact as a brake on market expansion. Thewider environment for SMEs, includingmacro-economic stability, currencystability, infrastructure, skills andtraining, or even property rights, may alsopresent barriers in some countries.

The most difficult part of the small-scale lowcarbon energy agenda is also the part with thebiggest potential for win-win effects – mini-grids based on renewable energy, andespecially technologies using agricultural wastesuch as crop residues that also generate extrarevenue streams for farmers. Examples of co-benefits for poverty reduction throughdiversifying livelihoods and income generationopportunities are detailed in Box 1. Suchprojects produce more power and are morecontrollable than solar PV, but are far morecomplex than selling products, requiring ahigher degree of technological expertise andmanagement. There has been mixedexperience with this more complex technologyand there is uncertainty about potential forsustained expansion due to the challenges ofremote operations, maintenance andinvestment. This matters because of the keyrole that mini-grids are expected to play in thefuture. The longer-term challenge for donors isto build on the success of areas like solar PV tosupport the development of mini-grids.

Mini-grids are systems that userenewable energy, and serve one ormore communities, but operateindependently of the national orregional grid.

3 See www.iea.org/weo/electricity.asp (accessed 26 February 2012).4 See also NORAD’s project on the impact of electricity on gender

relations at www.norad.no/en/thematic-areas/energy/gender-in-energy (accessed 26 February 2012). 500 million people worldwidehave a mobile phone but no access to the electricity grid. Accordingto Safaricom, Africa’s largest mobile provider, the largest problemthey face is that such users leave their phone switched off much ofthe time. A handset typically costs $0.10 to charge, many times whata grid consumer pays. Small solar and kinetic chargers (hand crankor other mechanical devices) can provide electrical charge to mobilehandsets and/or small lights.

5 See www.sciencedaily.com/releases/2010/01/100104151923.htm(accessed 26 February 2012) for a study of their impact in Benin.

6 New links are also emerging, with some companies finding ways tomerge energy, payment systems and other sector operations,reducing costs further. Examples: www.grundfoslifelink.com(accessed 26 February 2012) and www.gsma.com/green-power-for-mobile/ (accessed 2nd March).

7 The price of crystalline silicon solar PV modules has fallen from over$3.5 per watt in 2007 to $1.5 per watt in 2011 (a fall of over 15 percent a year) (Financial Times, 5 September 2011). This fall is partlydue to a decrease in the supply of silicon, but also oversupply ofpanels as Chinese firms entered the global market.

8 See www.guardian.co.uk/environment/2011/jul/14/india-coal-rush(accessed 26 February 2012).

9 See http://pdf.wri.org/powering_up_executive_summary.pdf(accessed 26 February 2012).

10 India has just started a Perform, Achieve and Trade (PAT) scheme,designed to enable the aluminum, cement, paper, and textilesindustries, power plants and railways, to save some 19 GW of energyand reduce emissions by 98 MtCO2 a year.

11 Regulation is most effective when well-designed to avoid perverseincentives, not politically difficult and when enforcement costs arelow, as with the case of the phase-out of incandescent light-bulbs,which is now increasingly common in the developing world.

12 See http://industrytracker.wordpress.com/2010/08/26/td-losses-in-india-aggravate-the-power-problem/ (accessed 26 February 2012).

13 China is to pilot an emissions trading scheme that will include thepower sector in five regions, but the other countries currently haveno carbon price.


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2.3 Decarbonising gridelectricityThe other aspect of the low carbon energy anddevelopment challenge lies in the rapidexpansion of high carbon energy capacity,especially in the Asian emerging economies andin South Africa. In contrast, sub-Saharan Africa(outside of South Africa) could see a significantincrease in electricity generation and provisionwith relatively little increase in carbon emissions,as 93 per cent of its hydro-power resourceremains unexploited (Eberhard et al. 2008).

The main and urgent issue here is heavydependence on coal for power generation. Overhalf of total Indian electricity demand is metfrom coal. In China, reliance on coal for powergeneration is even greater, at 95 per cent in 2009.The IEA’s 2009 reference scenario, reflectingcurrent policy, involves an additional 1,500 Mtoe

(Million tonnes of oil equivalent) of coal beingconsumed across Asia by 2030, largely in powergeneration (IEA 2009). According to recentreports, in 2010 India approved plans for 173coal-fired power stations, expected to provide anextra 80–100 gigawatts (GW) of capacity8. In themid-2000s, China was completing 70–80 GW ofnew coal plants a year, but this has now fallen toaround 30 GW expected to be completed thisyear (NETL 2011). Because large-scale powerstations are very long-lived investments (withlifetimes of 40–50 years for a typical coal plant),lock-in to a high carbon economy poses a majorchallenge (Unruh 2000, 2006).

Historically, in both Africa and South Asia,provision of energy by state-owned companies hasbeen skewed towards wealthier households and tourban areas, and often subsidised at the expenseof other pro-poor spending. In some Indian states,for example, up to 50 per cent of spending went toelectricity subsidies in the mid-2000s (Joseph

Box 1 Win-wins – mini-grids and power from agricultural wasteHusk Power Systems – Bihar is one of the most poorly-served states in India when it comes toelectricity. Husk Power is connecting remote villages in Bihar to a clean, reliable electricitysupply, which provides better light, harnesses a widespread waste product and costs less thanalternatives. Husk Power’s 65 plants gasify rice husks and other biomass waste to supplyelectricity to around 180,000 people and, by replacing kerosene, they cut greenhouse emissionsby over 8,000 tonnes of CO2 a year. The company is growing rapidly, aiming for over 2,000 plantsin operation by the end of 2014.

Abellon Clean Energy – In Gujarat, one of India’s most industrialised states, factories spew outblack smoke and farmers burn their crop waste to clear the land, thus further polluting the air.Three years ago the founders of Abellon Clean Energy saw the opportunity to tackle both of theseproblems, by replacing the coal and lignite used in factories with a fuel made from the farmers’crop waste. They now have a thriving business which gives 8,500 local farmers a small incomefor the use of their crop residues such as cotton stalks and cumin stems. Along with sawdustfrom nearby saw-mills, these residues are made into pellets and sold to local industries.Poornakumba, an NGO set up by Abellon, works with local university experts to train and advisefarmers on more sustainable farming, and coordinates the collection of crop residues. Abelloncurrently produces around 65,000 tonnes of pellets per year for large industrial customers andprovides over 215 local jobs. These pellets not only save around 110,000 tonnes of CO2 per year,but produce less dust and smoke so factory workers find them easier to handle, as well asproviding a safer and healthier working environment. The company aims to treble sales in Indiaover the next five years, and to expand into international markets.

Source: www.ashdenawards.org/international_2011.

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2010: 504). A lack of incentives, weak capacityand politically driven pricing meant that theseutilities lacked the finance and ability to expandcapacity, increase the efficiency of transmissionand distribution (T&D) and improve reliability ofsupply (see, for example, Eberhard 2008). Manycommercial and industrial companies haveresponded to this situation by investing in theirown ‘captive’ power, which may also feed backinto the grid. This is often high carbon, eithersmall coal plant or diesel powered generators.

The differences between countries and regionsmean that policy challenges also differ (see alsoAEA Technologies 2011). In rapidly growingcountries using a large amount of low-cost coalfor power generation (for example, China, India,Indonesia, South Africa, and to some extent,Vietnam), the challenge is to minimiseemissions from existing power plants andurgently find affordable low carbon alternativesfor investment in new capacity. There are anumber of different types of response, all ofwhich are likely to be necessary:

n Improve end-use efficiency in electricityuse. There are a range of possibleresponses, including support to an energyservices market,9 revolving funds, ‘whitecertificate’ (energy efficiency) tradingschemes,10 market transformationschemes with energy labelling andaspirational targets, or regulation11. Netenergy and carbon savings, especially inthe commercial and industrial sectors,may be smaller than expected because ofthe rebound effect – improvements inenergy efficiency, especially in industrialand commercial sectors, makes anactivity cheaper, freeing up resourceswhich will be spent either on more of thesame activity or on another activity whichalso uses energy (since almost allactivities do) (Sorrell 2007).

n Increase efficiency in generation,transmission and distribution. There isconsiderable potential for efficiencyimprovements in many South Asiancountries, especially India. The efficiencyof India’s coal-fired generating plants isparticularly low by world standards, atabout 25 per cent (IEA 2010b), – which

partly reflects the fact that India’s coalsupply is not well suited to high efficiencyultra super critical coal plant technology –and although they have improvedsomewhat since the mid-2000s,transmission and distribution losses arestill almost 30 per cent, way aboveinternational standards.12

n Invest in alternative, low carbongeneration technologies, includingrenewables.

n Develop carbon capture and storage (CCS)as a further option for these countries.

Power sector reform may be a route to some ofthese outcomes. In both Africa and South Asia,there is a long history of power sector reform,which has been only partially implemented inmost cases (Besant-Jones 2006). There hasbeen some unbundling of the power sector inmost countries, but state-owned utilities stilldominate in most, co-existing withindependent power producers. However, incountries and regions with rapid economic,and especially industrial growth, sharpincreases in power demand is driving a newwave of reforms (see section 4).

In sub-Saharan Africa (excluding South Africa)and some South Asian countries like Nepal,the small scale of electricity generation, and itsrelatively low carbon intensity, means there islittle existing high carbon plant to beconcerned about (SSA contributes only 1.5 percent of global energy-related emissions (AEATechnologies 2011), and the priority isexpansion of low carbon generation at anacceptable cost. One possibility is hydro-power,but large-scale schemes are controversial,because of the dangers of producing methane,displacement of people, and the risk thatclimate change may affect rainfall and riverflow patterns (see for example, Urban et al.2011), so a sustainable expansion would haveto be carefully thought through. There isrenewed interest in hydro-power in somecountries, including Ethiopia, Ghana, Sudanand the DRC, with increasing involvement ofChinese companies, but institutional andcoordination problems remain significantfactors, and some plans for large-scaleinvestments may not be realised.


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2.4 Fossil fuel subsidiesThe policy challenge is heightened by the absenceof a carbon price in most countries,13 and thisabsence means that public finance has a crucialrole in supporting low carbon energy investments.

In some middle-income countries there is negative

carbon pricing, in the form of fossil fuel subsidies(see Figure 1). Globally, energy subsidies stood at$558 billion in 2008, almost all in non-OECDcountries. Much of the expenditure isconcentrated in Iran and Russia, but some otheremerging economies also have significantsubsidies, especially for oil and electricity in China,India, Indonesia, and for electricity in South Africa.

The literature on fossil fuel subsidies shows thatin most cases they are not pro-poor. The IEAestimates that of $22.5 billion spent by India onfossil fuel subsidies in 2010, less than $2 billionbenefited the poorest 20 per cent of thepopulation. Ratios for Indonesia, Thailand,Pakistan and South Africa were similar, and onlyslightly better for China (IEA 2011: 40). Themajority of the benefit is captured by wealthierhouseholds and subsidies take up fiscalresources that could be spent on pro-poorpublic services. At the Jakarta learning event,UKCCU in Indonesia estimated that in 2011Indonesia will spend $21 billion on energysubsidies. This is more than the combinedgovernment budget for health, education, socialsecurity and defence. It is estimated that 40 percent of the subsidy goes to the 10 per cent

richest households, and 90 per cent goes to thericher half of the population. In some Indianstates in the mid-2000s, as much as 50 per centof the state budget went on subsidies to (largelycoal-fired) electricity (Joseph 2010). Reform ofsuch subsidies is discussed in section four.

The combination of challenges explored above –increasing energy access, whether on-grid or off-grid, while ensuring that energy is produced in alow carbon way, and at the same time tacklingpolitically difficult issues such as fossil fuelreform – demands a response that involvescareful analysis and planning, political awarenessand effective and efficient use of finance. The restof this paper looks at some of the issues involvedin making that response work.

For footnotes for this chapter see page 10.

Figure 1 Fossil fuel subsidies – by economy and as a share ofGDP, 2008

0 5 10 15 20 25 30 35

0%

5%

10%

15%

20%

25%

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Iran

Rus

sia

Saud

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Indi

a

Chi

na

Egyp

t

Vene

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nesi

a

Arg

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a

Iraq

Uzb

ekis

tan

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E

Paki

stan

Ukr

aine

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a

Kuw

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Ang

ola

Col

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Sri L

anka

Peru

Bru

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Kore

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idy

as a

per

cen

tage

of G

DP

Subs

idy

(bill

ion

US$

)

coal

gas

oil

% of GDP

Global subsidized consumption of fossil fuels amounted to US$ 557 billion in 2008.Of the countries surveyed this represents 2.1% of GDP (PPP) on averageSource: IEA (2008). www.iea.org/files/energy_subsidies_slides.pdf

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At the outset it is important to acknowledge thatgetting developing countries onto a low carbondevelopment path is a new challenge – unlikemore established areas such as the delivery ofhealth or education outcomes. A frequentstatement in discussions at the Jakarta eventwas: ‘We don’t know what we are doing’. At thesame time, however, the ‘development’ elementof LCD is crucial. In some settings, low carbondevelopment will be difficult not so muchbecause of factors that are specific to mitigatingcarbon emissions, but because basicinstitutions, policies and practices are so weakthat any kind of development is difficult.

This section explores the inter-related issues forthinking about low carbon developmentidentified in the introduction. It reviews thechallenge of balancing multiple objectives,transforming economic growth paths andlinking these challenges to what is needed fordelivery – understanding political economy,getting public finance delivery right, andleveraging private finance.

3.1 Identifying prioritiesThe most basic low carbon development issuefacing policymakers is where to place limitedresources in addressing an economy-wideproblem. A widely used tool for analysis in thisapproach is the marginal abatement cost (MAC)curve (see Box 2). For example, the UK Climate

Change Committee makes frequent use of botheconomy-wide and sectoral MAC curves in itsreports on how to meet the UK’s carbonbudgets. A number of MAC curves for emergingeconomies were developed by McKinsey in therun-up to the 2009 Copenhagen COP summit.14

The content and shape of the MAC curve willdepend partly on whether a country has a lot offorest cover, but also on the sectoral pattern ofemissions, which is related to the stage ofdevelopment a country is at. Lower-incomecountries use relatively little energy, and typicallyabout half of their emissions tend to come fromagriculture (or forests if relevant). By contrast, infast growing diversifying middle-incomecountries, especially if dependent on fossil fuelsfor electricity generation and industrial energy, amuch higher proportion of emissions andabatement opportunities (~70–80 per cent) comefrom the energy, industry and transport sectors.

MAC curves are a very useful starting point forguiding strategy, but there are several reasons whythey may over- or under-state potential abatementand abatement costs. Typically they do not includepolicy costs, and experience from the developedworld shows that these may be significant (Helm2009). They do not always reflect hidden costs ortransaction costs, especially for apparently cheapoptions like energy efficiency measures (Ekins etal. 2011). Energy efficiency also suffers from therebound effect (Sorrell 2007), so that energyefficiency measures may produce smaller than

Approaching low carbondevelopment

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anticipated overall energy and carbon savings(although they do lower the energy and carbonintensity of growth, and make industries morecompetitive, especially energy intensive ones). Onthe other hand, experience from existing policieswhere MAC curves have been used to indicate astarting point for abatement measures, includingthe EU ETS and the UK’s Climate ChangeAgreements, has shown that cost-effectivepotential can be higher than initially thought.There are also reasons why more expensiveabatement measures sometimes make sense,especially where a longer time perspective isbeing taken, because doing what is cheapest firstmay lock an economy into higher carbon optionslater (Vogt-Schilb and Hallegatte 2011).

In addition, decisions about where to focuseffort has to take into account a range of other

factors, including: what is politically feasible;what will bring in investment from other donors,civil society organisations and the privatesector; and what can be funded throughinstitutional routes that deliver quick results andhave low fiduciary risk. Each of these is exploredin detail in sections 4 to 6.

3.2 Balancing emissionsreduction and povertyreductionThe low carbon development agenda implies somekind of balance between two objectives: povertyreduction and carbon abatement. In the case of theUK, both poverty reduction and global carbon

High costpower sector

abatement

SoilCellulose ethanol

0 5 10 15 20 25 30

40 3/t

Water heating Forestation

Nuclear

Fuel efficient vehiclesLighting systems

Fuel efficient commercial vehicles

Negative abatementmarginal cost

Abatement marginalcost below 340/t

Abatement marginalcost above 340/t

Abatement potentialGt CO2 / year in 2030

Marginal cost of abatement – examples3/t CO2

100

50

0

-50

-100

-150

Captture & storage,coal retrofitInsulation improvements

Solar

Wind

Industrialmotor

systems

Biodiesel

Box 2 The marginal abatement cost curve

The MAC curve lines up all the types of abatement opportunity in the economy or in a sector, inorder of their net costs over some defined lifetime (see figure below for the global MAC curve).The metric for prioritising policies and projects under this approach is the cost of abatement, in$/tCO2. This abatement cost is the additional cost of undertaking the measure relative to businessas usual. For energy measures, this means that the cost is sensitive to fossil fuel prices. Anincrease in oil, gas and coal prices will shift down the abatement costs of energy measures,including energy efficiency.

Source: Vattenfall (2007)

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emissions reduction are cross-government goals,jointly owned by all departments.

It is important to acknowledge that there aresome real short-term trade-offs between theseobjectives in some cases – for example, afterincreasing the end-use efficiency of electricity,the cheapest way of extending access toelectricity to many poor households in SouthAfrica is currently still likely to be via high carboncoal-fired power generation in the absence ofcarbon pricing to address externalities andtechnology policies to bring down costs ofalternatives, such as renewable energy. Thesealternatives will be lower carbon, but because oftheir high financial cost fewer poor people willbe served by electricity as a result of choosingthem. In some cases, notably growing biofuelsand investment in large-scale hydro-electricschemes, there may also be direct negativeimpacts on some poor people, throughdisplacement from land (see, for example,Matondi et al. 2011; World Bank 2011b).

However, there are also many potential win-winopportunities (see section 2.2). These willinclude some low carbon energy interventionsin rural areas where providing conventional gridelectricity is costly or where there are strong co-benefits other than carbon emissions, includingproviding improved cookstoves, solar PVlighting, solar irrigation pumps, and energyfrom agricultural waste (AEA Technologies2011). Some of these interventions will alsoprovide benefits specifically for women andgirls, as detailed in Table 1 on the MDGs.

Such interventions can provide both emissionsreductions and direct poverty reductionbenefits, but the effects, especially onemissions may also be small, since poor

people, almost by definition, use very littleenergy. By comparison, interventions with amuch bigger carbon impact, such as improvingenergy efficiency in the industrial sector, mayalso lead to reduced poverty through greatercompetitiveness and employment creation, butonly indirectly, and these effects may be hard toquantify or will have a large error margin.

Similarly, investing in grid-connected15 renewableenergy is still, in most cases, an expensive way toreduce emissions and expand energy access, butit will contribute to bringing down the costs oflonger-term options for emissions reduction. Itshould also help countries gain familiarity with,and even build industrial and innovative capacityin, technologies that will be needed for a futurelow carbon path. However, benefits for poorpeople will be indirect and again have a widerange of uncertainty.

The point that the poverty benefits of some lowcarbon development policies or investmentsare indirect and dependent on complementarypolicies or measures, implies that there ismore than one kind of ‘win-win’, and it isuseful to think about interventions in this way(see Table 2 for an illustrative categorisation).

This way of thinking also focuses attention onthe complementary policies or project designfeatures needed. One example given in theLearning Hub LCD event was investments incity-level projects that combined recycling withenergy-from-waste. Such projects may removethe livelihoods of people scavenging on wastesites, so it is important to provide new andbetter alternatives, such as secure employmentsorting recyclables. Another example would bethe explicit linking of efficiency savings inpower sector reform projects to specific pro-poor spending programmes (Box 3).

However, it is also important to recognise thatconventional power sector reform is notspecifically aimed at mitigating carbonemissions, and that, while it can lead toemissions reductions, it does not always do so. Arecent review by the World Bank of experience ofreform across 19 countries and three Indianstates, for example, finds that partial unbundlingof generation, transmission and distribution, has

We must still bear in mind that thenew impetus for making growth low-carbon is not automatically going tobe pro-poor. It should take intoaccount questions of equity and leavesufficient space for material and non-material aspects of well-being.Newsham et al. (2011:26).


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Table 2 Illustrative categorisation of LCD interventions

Lifetime Mitigation Potential net Route How far do Win-win?additional potential benefit to povertycosts poor reduction

benefits rely on complementary policies?

Industrial andNegative– Large in + large in Indirect, via High – Indirectcommercial low MICs long run competitiveness inclusivenessenergy and growth of growth policyefficiency

REDD Low Large in +/- large in Direct, via access High – climate Indirect/rainforest long run rights to forest system trade-offnations resources; indirect,

via mitigation

Biofuels Low ?? +/- small Direct via incomes Direct/–medium or land rights trade-off

Improved Low Small + medium Direct, via fuel Low Directcookstoves costs, health

effects

Small-scale Low– Small– + medium Direct, via Low Directrenewable medium medium –large increasedenergy productivity,

education, health effects

Large-scale Medium– Medium– +/0 medium Indirect, via High – climate Indirect/renewable high large –large mitigation, but system trade-offenergy direct if grid

expansion

Power sector Low Medium– + medium Indirect – via High – pro-poor Indirectreform large –large fiscal effects fiscal decisions

Urban waste- Low Small– +/- small Indirect – via High – pro-poor Indirectto-energy medium fiscal decisions fiscal decisions

and mitigation and climate system

Urban mass Low Small– +/0 small Direct – via travel Low Direct?transport medium costs and health

impacts

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led to higher carbon emissions, as has theintroduction of private ownership in generation(ESMAP/PPIAF 2011). In the Indian context thiscan be easily understood; in the absence ofeffective carbon pricing, coal-fired powergeneration remains the most competitiveinvestment for independent power producers.One possible response is to make cleanerinvestments attractive to independent powerproducers. Green Africa Power is a newmultilateral mechanism being developed tomobilise private investment for the construction ofpower plants in Africa based on renewable energy.The facility is to be a not-for-profit company thatbuys electricity produced by independent powerproducers for a price that reflects real costs, whichis then resold to African national utilities.

3.3. Aiming fortransformational changeOne strong theme that came out of the LearningHub LCD event was the recognition that gettingcountries onto a low carbon development pathwill require transformation. While transformationis an ill-defined term – for low carbondevelopment transformation can be characterisedin terms of catalysing large-scale change that ispermanent, rather than incremental changes –some characterise it as the next ‘industrialrevolution’ (Stern 2011). This perspectiverecognises that development is path-dependent,and that many countries are characterised by‘carbon lock-in’ (Unruh 2000, 2006) – aninterlocking set of institutions in energy,transport, industry and the built environmentdriven by economies of scale, technological

complementarity and network effects.

Escaping carbon lock-in requires not only newtechnologies, but also multiple inter-relatedinstitutional changes, including functioningcarbon pricing, decarbonised power generationand low carbon public transport, all driven byclear government policy showing strong politicalcommitment, giving confidence to investors,and based on strong public support.

Achieving transformational change is closelytied up with understanding, working within andchanging the political economy of climate policyin a country (see section 4).

A central challenge is making the case forchange – that is, getting political leadersinterested in LCD in the first place. Climatechange as a political driver suffers from thelimitation that its worst effects are distant intime, whereas many solutions (for example,renewable energy technologies) typically notonly have higher costs but higher upfront costs.Making the case may often involve usingmessages that resonate better withpolicymakers and politicians (because they givehigher priority to them), such as improvingenergy security, competitiveness, reducingpressure on budgets (for example, by reducingfossil fuel subsidies) or creating jobs.

Box 3 Power sector reform in Madhya PradeshOne at least partially successful example of power sector reform is Madhya Pradesh (ADB 2011).Despite a reduction in the provision of free electricity in the state, reform over the course of the lastdecade has produced some desirable outcomes. Investment by the state-owned utility more thandoubled capacity from 4 GW to 8.35 GW between 2002 and 2009, with another 4.5 GW of independentpower producers’ capacity expected to become available by 2013, all of which has improved reliability ofsupply. Transmission losses halved, and although distribution losses were still high by the end of theperiod, they had reduced. Carbon savings from these reduced losses are estimated to be around 1MtCO2e/yr. Reduced subsidies from improved efficiency freed up £30 million a year for other purposes.

Adaptation can also be – and mightalso need to be – thought of in termsof transformation of the system, notof maintaining its resilience.Newsham et al. (2011:17).


19

Many governments will be more open toframings (such as ‘green growth’) thatemphasise these benefits rather than placingthe attention on international emissionsreductions targets. This was the case shared byDFID from Vietnam where ‘low carbondevelopment’ was associated by the Vietnamesegovernment with international targets but‘green growth’ was associated with industrialopportunities. As well as changing the message,it may also help to change the messenger. Oneof the UK’s most effective interventions in high-level influencing in India was also very low cost– organising a visit from Lord Turner, chair ofthe UK’s Climate Change Committee, provideda credible voice who could share, in detail, theexperience of how the UK has approacheddecarbonisation. Business leaders can also beimportant messengers in a way that traditionaldonors cannot. International businesses with acommitment to slowing deforestation, such asUnilever, have made a difference to awarenessand actions in countries like Indonesia.

Demonstration can also be a powerful instigatorof transformational change, and in many casesDFID country offices are attempting both to learn-by-doing and to demonstrate the benefits of lowcarbon alternatives – for example, the UK ClimateChange Unit in Indonesia wants to catalyse theexpansion of geothermal energy throughdemonstration by backing a particular project.Decentralised energy technologies in particularhold out the prospect of the democratisation ofenergy and the breaking of parastatal control,somewhat like the way in which mobile phonestransformed communication by working aroundcentralised control of landlines.

Transformation will also require innovation.There is a strong case for increasing support tolow carbon innovation, both globally and withindeveloping countries, especially in technologiesof particular use in poor countries. Innovationgenerally is undersupplied by the private sector,because even with intellectual propertyprotection, such as patents, the social benefitsof innovation exceed the private benefits (Jaffeet al. 2004).16 Similar, but even more seriousmarket failures apply to the process by whichexisting technologies are learned about andadopted in developing countries (Rodrik 2004).

Innovation can be quite a complex process (Grubb2004; Foxon 2004) involving social entrepreneurs,companies, government, public, researchinstitutes and others in a ‘national innovationsystem’, which generates and determinesdomestic capacity and the skill base for innovationand learning in a country. Support to innovationinvolves thinking about the whole innovationprocess and the national innovation system. Acommon problem is that the phase of the processwith highest risk for companies is not the R&Dphase, or the scale-up of a tested technology in anestablished market, but the so-called ‘valley ofdeath’ in between, moving from demonstrationphase through early commercialisation. It is herethat overall costs can rise sharply but where thereis as yet little or no market experience. This canalso be the stage where it is hardest to obtainprivate finance. This problem applies to lowcarbon innovation as well.17

For most developing countries, the key issue is howlocal innovation can be supported – that is, adoptionand adaptation of existing technologies to localcontexts, but also innovation in areas that areimportant for poor people and where the privatesector in developed countries will not be active. Amechanistic ‘technology transfer’ approach is nothelpful – the processes involved in learning to adapttechnologies for local use share many of thecharacteristics of the innovation process describedabove (Watson et al 2010). Policy is better directedtowards strengthening this capacity than towardssupporting the importation of particular technologies.Current policy ideas for low carbon technologydevelopment include the idea of a network oftechnology or innovation centres (Box 4).18

Many people in the donor community recognise thetransformational challenge at the heart of lowcarbon development, but are also underconsiderable pressure to deliver attributable resultswithin a short timeframe, especially as the deadlinefor the MDGs approaches. Under thesecircumstances, investing in capacity building andpolicy engagement with a potentially transformativebut indirect chain to impacts involves a risk. Thistends to drive investment in projects with directresults (or spending on capital-intensive projects),rather than work for institutional, governance orpolicy change (which may involve relatively littlespend). It can also drive staff in bilateral agencies to

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route spending via the MDBs, who often have largeinfrastructure projects worked up and ready to go.

In this context, a key message from the Hublearning event was the importance of seeingclimate funding as a means to an end – a concernto spend and achieve immediate results shouldnot crowd out long-term and riskier approaches.The approach of the UK is that it is right to takerisks if the expected payoff is large, and if there issome evidence about likely success and thenature of risks. In other words, taking risks isnecessary for learning, and in a new area like lowcarbon development learning is necessary.

However, this approach also points to the need forbetter evidence on the results chains for potentiallytransformative projects, and better indicators ofwhat transformation, including in capacity, lookslike. Transformative projects like power sectorreform can have a huge impact. For example, in thecase of Madhya Pradesh (see Box 3), carbonsavings from transmission and distribution lossesare estimated to be around 1 MtCO2 a year,equivalent to five million solar lanterns replacingkerosene, and some £30 million a year was releasedfor potential pro-poor spending. More evidenceabout such numbers, and the complementarypolicies that actually lead to pro-poor, low carbonoutcomes, will be needed to support the case fortaking risks in transformational investments.

A transformational approach to low carbondevelopment also raises the issue of whetherconventional measures of development and

especially economic growth are fit for purpose inan era when environmental limits (especially thoseof climate change and biodiversity loss) areincreasingly under pressure. There is goodtheoretical thinking and practical work onindicators of genuine investment and growth thattake such pressures into account (see for example,Dasgupta 2004, 2007), but most donors have notyet fully integrated them into their thinking.

Finally, the transformational approach to lowcarbon development requires thinking and actingbeyond the conventional development agenda. TheUK has been innovating with the creation of cross-governmental Climate Change Units in India, Braziland Indonesia, involving departments of energy,climate change, international development andforeign policy, which have been successful inbringing these agendas together. The UK’s newInternational Climate Fund also involves cross-government decision-making on investments.

Box 4 Climate Innovation CentresAt the Cancun COP in 2010, the UNFCCC agreed to a Technology Mechanism with plans for a ClimateTechnology Centre and Network. These plans were fleshed out at the Durban COP in December 2011.In parallel, a number of actors, including the Indian government, DFID, infoDev, UNEP, the EnergyCentre Netherlands and the Carbon Trust, have been developing different models for ClimateInnovation Centres (CIC). These centres may include adaptation and wider sustainable technologies,as well as low carbon technologies, according to local demands. The CIC concept is being piloted inIndia, Ethiopia and Kenya (where it is being backed with $9m by DANIDA). Support will likely be forthe demonstration, diffusion and pre-commercial deployment of technologies with the private sectorat its centre. CICs may also act as information hubs, and create a marketplace for investors. A keyissue currently being negotiated is where the CICs will sit, and how far they will be independent of (orat arms’ length from) government control. In Kenya, the private sector is wary of the potential forcorruption and misallocation of CIC resources if there is too much government control.

14 See www.mckinsey.com/en/Client_Service/Sustainability/Latest_thinking/Costcurves.aspx (accessed 26 February 2012).

15 Off-grid renewable energy, especially in areas that could not crediblybe served by the grid, is different, as additional cost against the basecase (for example, kerosene lamps) is lower and because a newservice is being offered.

16 The Stern Review gives figures of private returns to R&D of 20–30 percent, compared with social returns of around 50 per cent andrecommends a doubling in global public R&D on low carbontechnology. Studies of US data suggest that the social return to R&Dby firms is between two and three-and-a-half times higher than theprivate return (Margolis and Kammen 1999; Bloom et al. 2005).

17 See BERR/BIS/DEFRA (2007).18 Other mechanisms being piloted and adopted include innovation

prizes and challenge funds (including the REACT fund in East Africa).Prizes seem to work well, both globally (for example, X PrizeFoundation’s successful commercial air space prize which launchedVirgin Galactic) and locally. The Global Village Energy Partnershiphas been running competitions in Latin America and East Africa fornew small-scale low carbon energy technology ideas (DFIDCaribbean is funding a window for Caribbean entrepreneurs).Winning these prizes can raise the profile of the entrepreneurs (aswith the Ashden Awards) but can also offer other support to scalingup, including capital, training or business model development.

Understanding thepolitical economy

421

Having a good understanding of the politicaleconomy in a country was the most frequentlycited prerequisite for low carbon developmentprogramming and policy engagement at theLearning Cycle 3 event (see Box 5 for theexample of Indonesia). Political economyencompasses not only actors and interests(including material and political interests) butalso the ideas or ideologies that legitimiseactions and policies (Tanner and Allouche2011). It also involves thinking about howcoalitions can be formed to produce change,and how the political settlement within acountry’s elite will affect the likelihood of pro-poor outcomes.19

There are a number of reasons why such anunderstanding is important for LCD. The first,as noted in section 3 above is that it is neededto guide engagement with political elites. Insome cases, key decision-makers in nationalgovernments are already keen to take action onclimate change, and especially in moving to alow carbon development path. But as a recentstudy of climate finance in the Asia-Pacificregion noted, ‘it is arguable for some countriesin the region, [that] were it not for theinternational focus on climate change...it isunlikely that climate change would feature yet asan issue’, and that ‘the lack of any real domesticpolitical salience means that policydevelopment, coordination and implementationmay be constrained’ (OECD 2010). Similarconclusions apply to some African countries

(OECD 2011). There is also a risk that climatefinance will appear as an opportunity forunproductive rent-seeking.

A second example is the politics of fossil fuelsubsidy reform; a big issue for a number ofcountries, including India, Indonesia andNigeria. Where they are significant, fossil fuelsubsidies are the single biggest inhibitor ofinvestment in energy efficiency. Because evenbasic goods are transported, removal ofsubsidies will increase almost all prices, but thebenefits of most subsidies are heavily skewed towealthier groups. It is precisely because of thisthat reform is difficult. However, high fossil fuelprices are also putting pressure on subsidypolicies, as spending balloons; in India, forexample the government is reported to beconsidering requiring ONGC, the largest crudeoil supplier in the country to cover more of thesubsidy to relieve pressure on state budgets.20

A political economy approach toplanning will be a key component inensuring transformative change.Hedger et al. (2011:24).

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Box 5 The political economy of low carbon development in Indonesia

The Indonesian government accepts in principle that climate change poses a risk to thesuccessful development of the country, and has set a target for reductions in emissions by 2020 of41 per cent from a business-as-usual growth path. However, at the same time, economic growthstill dominates the agenda, with the aim of achieving a growth rate of 7 per cent per year by 2014.The growth rate target will not be sacrificed – both targets will have to be met at the same time.

However, the political economy of Indonesia presents some severe challenges to achieving suchan outcome. There are large fossil fuel subsidies largely going to a politically important middleclass, and some strong vested interests. Rent-seeking is ubiquitous and observers estimate thaton average, it makes up 30–40 per cent of project costs – higher than other places in Asia.

In the power sector there is a single dominant company, and limited opportunities for externalinvestors. The Indonesian economy is based on natural resource extraction, and high returns inexisting sectors (of 25–40+ per cent within 3–5 years) means competition for finance is severe.Long-term projects (and thinking) do not survive easily.

Indonesia is the third largest forest nation in the world, and also has peat forests that are amassive store of carbon but are vulnerable to fires and land use change. The governance problemsare huge – politicians use access to rainforest as patronage, and there is a lack of clear land tenure.There are also big gaps between high-level rhetoric and the ability to deliver, which in Indonesia isoften quite decentralised. An example is the statement by Indonesia’s president in 2011 that hewould spend the rest of his term ensuring that the country’s tropical rainforest is protected.However, given the nature of decentralisation in Indonesia, and the fact that local politicianscontrol licences to develop forest tracts, this statement may well not lead to much real change onthe ground. Change needs to happen simultaneously from the bottom up and at the centre.

A recent study for the Global Subsidies Initiativesuggests four key points for reformers:

i. Powerful interests that benefit, have to becompensated, or reform has to beinoculated from their opposition.

ii. Transparency about cost and purpose ofsubsidy usually aids reform.

iii. If subsidies are unavoidable, better designcan often reduce negative impacts.

iv. Having better administrative tools (toreplace broad spectrum subsidies as ablunt instrument) aid reform (Victor 2009).

One example of reform, at least temporarilysuccessful, comes from Ghana (see Box 6).Another is India, where fossil fuel subsidies area huge issue, and where some reduction insubsidies was introduced several years ago, withattempts to offset impacts on poorer peoplethrough cash transfers. Parity with subsidies forfossil fuel energy has also been an important

strategy by the Ministry for New and RenewableEnergy, in getting support for both on-grid andoff-grid renewable generation.

A third example is power sector reform. Indiaagain provides an important example of howpolitical economy is important forunderstanding policy change. Power sectorreform in India has been difficult because largegroups of politically important consumers –better-off farmers in rural areas – have longreceived heavily subsidised or free electricity.Despite some cross-subsidisation from higherprices for industry, this situation has led notonly to heavy fiscal pressures on state budgetsbut also a lack of resources for investment and,consequently, high transmission anddistribution losses and unreliable power supply.The government has responded by a hybridstrategy, allowing businesses to invest in theirown ‘captive’ capacity, which can also feed backinto the grid and provide extra supply to the


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Box 6 Fuel subsidy reform in Ghana

In the early 2000s, two attempts to phase out liquid fuel subsidies failed in the face of popularopposition. However, as global oil prices continued to rise, fiscal pressure from subsidies alsotightened. In 2004, Ghana was spending around 3 per cent of GDP – well in excess of healthspending – on subsidising fuels and maintaining the state-owned refinery. In 2005, thegovernment embarked on a new round of reform. However, this time it built a political strategy. Apoverty and social impact analysis was undertaken to reveal the extent to which wealthierGhanaians benefited from the existing subsidy structure, and the results were used in debates onthe issue. Comparisons with neighbouring countries were published in the press. There werediscussions with trade union leaders. A number of steps were taken to compensate poorerhouseholds, including eliminating school fees, capping bus fares, and more resources for ruralhealth care and electrification. A cross-subsidy for kerosene was maintained. This round of reformwas more successful, in that there were no street protests. However, as global prices spiked in2007 and 2008, the government froze prices, and after elections in 2008, the policy was reversed.

Source: Laan et al. (2010: 11–14).

network (Joseph 2010). However, the rapidgrowth of industry in India in recent years, andthe continuing fiscal pressures also mean thatthere is greater willingness for morefundamental reform to improve performance.

Yet another important area for OECD donors isunderstanding the political economy of the roleof China in the energy sector. In both Asia andAfrica, Chinese companies (both state-ownedand privately owned) and China as a donor playan increasingly large role in infrastructure. Thiscan be both in high carbon infrastructure (forexample, coal-fired power generation inVietnam) and low carbon infrastructure (forexample, large-scale hydro in Ethiopia orgeothermal in Kenya). These Chinese actors usedifferent tools and have a different approachfrom the MDBs, and their investments andrelationships are often highly politicised. Chinacan also move fast – offering to close decisionson infrastructure projects within months asopposed to years (often because environmentaland social impact assessments are notundertaken). Their loan offers can lookattractive, but countries may subsequently payhigher rates through power purchaseagreements. There may be a role for moretraditional donors here in helping developingcountry governments ensure that impactassessments are done – one example shared byparticipants came from the DRC where DFID

assisted the government in undertakingenvironmental impact assessments of Chinese-financed road building projects – or in supplyingtechnical capacity on power purchaseagreements, for example.

There are a range of other areas where a goodunderstanding of political economy is importantfor low carbon development, from assessingrisks of corruption at project cost level, tounderstanding gaps between statements at thetop and delivery on the ground, (see Box 4) andunderstanding energy investments in contextswhere members of the elite ‘straddle’ bothpolitics and business, so policy and personalinterests may become entwined.21

The political economy of low carbondevelopment is important, not only for theeffective delivery of public climate finance, butalso for understanding how the private sector,and especially investors, assess risk. We nowturn to these two issues in turn.

19 For some case studies see the IDS Bulletin special issue on thepolitical economy of climate change (42.3, May 2011). For asummary of DFID research on political economy seewww.dfid.gov.uk/Documents/CABI/Politics%20of%20Poverty%20Feature%20-%20June%202010%20(2).pdf (accessed 2nd March 2012).For more detail on the political economy of African institutions seehttp://institutions-africa.org/ (accessed 26 February 2012).

20 See www.businessweek.com/news/2011-09-20/india-said-to-consider-doubling-ongc-s-fuel-subsidy-bill.html (accessed 26February 2012).

21 For example, there is comment in Kenya that the prime minister’senthusiasm for mitigation policies is linked to family businessinterests in renewable energy.

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Deploying climatefinance

5The likely absence of a carbon pricing signal todrive lower carbon investments in mostdeveloping countries in the next few yearsmeans that official climate finance for lowcarbon development has a crucial role to play,both in itself and for leveraging private finance(see section 6).

A range of estimates for the financingrequirements for low carbon development exist.The High Level Advisory Group on ClimateChange Financing projects an annual financingrequirement of $100 billion by 2020, of whichabout half would be needed for mitigation. The2010 World Development Report estimates thatmitigation in developing countries could cost$140–170 billion a year between now and 2020(World Bank 2010, ch. 6). The IEA estimatesthat the additional clean energy investmentrequired for developing and emerging countriesto achieve the 2°C target will be almost $200billion by 2020 (IEA 2009). In addition,estimates of the investment costs of providinguniversal energy access range from $48 billion–150 billion annually between now and 2020 (IEA2011; Bazilian et al. 2011a).

By comparison, pledges under the range ofcurrent global climate change funds totalaround $35 billion. Pledges for fast-startfinancing for the period 2010–12 stand at about$29 billion.22 Public finance for renewables indeveloping countries has risen sharply in thelast five years, but in 2009 was still less than

$6bn.23 Thus while public finance will beimportant, it cannot come close to meeting allneeds. It is widely recognised that privatefinance flows for investment in low carbondevelopment are essential, especially for lowcarbon energy (see section 6).

Within public finance for low carbondevelopment, there are a set of inter-relateddelivery issues that are particularly relevant forbilateral donors. Public climate finance is stillbeing delivered largely within the context ofofficial aid frameworks, so the principles of theParis Declaration on aid effectiveness –ownership by recipients; alignment to recipientpriorities and institutions; harmonisation(between donors); managing for results (forpoor people) and mutual accountability – wouldbe expected to be important.

However, the recent final report of theEvaluation of the Paris Declaration found thatclimate finance flows ‘will create many of thesame challenges as have other forms of aid –perhaps even more – and yet there is very littlecoherent thinking or planning about adaptingand applying lessons and good practices ineffective aid to these new financing flows’(Wood et al. 2011). Recent OECD-fundedreviews of climate financing in five countries inthe Asia-Pacific region and six African countriesfound problems in a number of the ParisDeclaration themes (OECD 2010, 2011):


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n In some, but not all countries, there islittle ownership of climate change as anissue, and so financing is largely supplydriven, rather than demand led. Nocountry had a dedicated forum fordialogue on climate financing involvingdonors, government, civil society, and theprivate sector. There may be lessons tolearn here from the Poverty ReductionStrategy Paper experience, which at itsbest did help to build ownership.

n In Africa, responses to climate changeonly become coherent when politicallyimportant ministries become engaged.Which ministries these are varies, but inmany circumstances climate finance mayflow to environment ministries, which areoften politically marginal. Effective use ofclimate finance requires a combination ofelements – overall vision and policy, actionplans, targets and budgets, functioninginstitutional arrangements and amechanism of accountability, that wasfound nowhere in Africa. This weakcountry capacity means it is hard tointegrate climate finance into localbudgets. Where capacity is stronger andfiduciary risk is lower, ‘direct access’arrangements, such as routing financethrough a national development bank,would offer more alignment (similarly todirect budget support), but there is limitedexperience with this approach.

n There was role confusion in governmentsas to who oversees climate funding.Mechanisms for donor coordination atcountry level existed but were notfunctioning fully. A particular concern isthat the overall picture of financial andinvestment flows to developing countriesis already complex, with a high risk of

fragmentation and increasingadministrative and institutionalrequirements (Atteridge et al. 2009). Publicsources are at risk of adding to thatcomplexity – it is estimated that within fiveyears there may be as many as 100 specialclimate change funds (OECD 2010).

The OECD reviews of climate finance cited abovemade a number of recommendations tointernational funders. Many of these are familiarfrom long-standing discussions of the aidrelationship, including: fitting disbursementcycles to recipients’ budget processes; usingdomestic reporting systems where possible,simplifying and streamlining where not;delivering funding according to schedule; havingformal agreements to harmonise funding; anddelegating to local offices if at all possible.Others are more specific to climate finance –mapping, publishing and updating informationon all climate finance for each country;establishing pooled funding mechanisms, suchas country-level multi-donor trust funds(MDTFs) for climate change finance (see Box 7),and starting from the recipients’ priorities. At theglobal level, the recommendation is to clarify thedefinitions of what is climate change finance andhow to ‘earmark’ it; to work harder at ensuringthere is a clear division of labour betweeninstitutions at the global level; and to rationalisefunding channels, ideally into singlemechanisms for each region.

However, while some of the Paris Declarationprinciples are clearly important for deliveringclimate finance, a simple, mechanicalapplication is unlikely to work. One issue is thatmany recipient governments are strongly of theview that climate finance should take the formof mandatory flows under a UN agreement, andshould not be considered part of the aidarchitecture at all. Another is that, whilecoordination is desirable, a degree ofcompetition between climate finance providersmay also be a good thing.

At the same time, the experience with some ofthe mechanisms suggested by the ParisDeclaration agenda, such as MDTFs, shows thechallenges involved.

But PRSPs were established beforeclimate change entered into themindset of national financial plannersand the lack of connection betweenthem and NAPAs has been criticised.Hedger et al. (2011:22).

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The Bangladesh example throws up a moregeneral dilemma for bilateral donors – how farshould they channel financing for low carbondevelopment through the multilateraldevelopment banks (MDBs), especially in theform of sector specific vertical funds, and howmuch should they programme bilaterally?24

MDTFs were originally conceived of as atransitional mechanism to bridge from projectfinance to direct budget support, and efforts tomake them work better should not beabandoned.

The advantages of working through MDBsinclude being able to contribute to making bigopportunities happen, having access tospecialist expertise, and to people already beingfamiliar with low carbon investments. Where abilateral is small in comparison with otherdonors (for example, DFID in Vietnam), workingthrough a multilateral offers the prospect ofmore influence and access. However, suchfunds can also be slow to spend, attribution ofimpact is diluted, and any one bilateral will haveless influence over how the money is spent oncethe basic decision is taken.

One alternative is for bilaterals to learn-by-doingthemselves, developing their expertise andcapacity in parallel, and learning how to channelfinance directly to new partners, especially in theprivate sector. Some countries will have their

own bilateral development investment agencies(for example, in the case of the UK, the CDC)that may be a useful alternative partner. Amiddle ground would be for bilaterals tocontinue funding low carbon programmesthrough the MDBs, but continue closeengagement throughout programme life, andseek to hold the MDBs to greater account.

Each of these routes has risks, but all should beconsidered within the context of a given countryprogramme. This is also an argument fordiversifying channels of funding. As oneparticipant in the Jakarta event put it: ‘if we onlyuse one channel – if we fail we fail big’. One keyfactor in any particular case will be the politicaleconomy of the relationships betweengovernment, civil society, the private sector and donors.

Box 7 The Bangladesh Climate Change Resilience Fund

One response to donor fragmentation has been the country-level multi-donor trust fund (MDTF)– intended to coordinate donor and government decision-making, building on existingframeworks to produce greater coherence, a reduction in reporting burdens and increasedtransparency and accountability. They cover a wide range of issues. DFID has played a leadingrole in setting up two climate MDTFs in Indonesia and Bangladesh. In Bangladesh, theexperience so far has been mixed – it has taken time to get government ownership, and therehas been some controversy over the role of the World Bank, who administer the Fund. There arealso some features of the Bangladesh Climate Change Resilience Fund (and indeed other GoBfunds) that do not work well for low carbon development finance in particular – it is heavilyadaptation focused, has no engagement with the private sector, and makes it difficult toprogramme relatively small projects, such as small-scale renewable energy in the early phase ofscale-up. This is driving DFID financing in other directions, including the bilateral programmeand regional (for example, ADB) routes.

Sources: http://mdtf.undp.org/overview/funds; Alam et al. (2011); DFID Bangladesh (2011).

22 See www.wri.org (last updated May 11th 2011).23 The World Bank Group (including IFC and MIGA), partly through

SREP, had a five-fold increase in 2009 with $1.38bn committed tonew renewables, although fossil fuel lending jumped in 2010 andnow far exceeds renewable and energy efficiency lending.

24 See Isenman and Shakow (2010) for a wider discussion.

Working with the privatesector and leveragingprivate finance

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The private sector, both within developingcountries and globally, plays a key role in lowcarbon development. Private firms, especially smalland medium-sized enterprises (SMEs) are playingan increasing role alongside NGOs in providingaccess to electricity in rural areas, via smaller scalerenewable technologies, and to improvedcookstoves that reduce wood and charcoal use.

At the same time, private finance will be neededfor larger scale investments in clean energy. Lowcarbon private finance flows are alreadysubstantial, especially in low carbon energyinvestment (Liebreich 2011). New investment inrenewable energy globally in 2009 was $162billion, quickly catching up with investment infossil fuel-based capacity at around $215 billion.However, a large proportion of investment isgoing to just two countries – China and the USA– with $47 billion and $21 billion in asset financein clean energy investment in 2010 respectively.By comparison, even other emerging economiesare lagging behind, including Brazil with $7billion, India with $3.2 billion and Mexico with$2.3 billion. Relative to estimated needs, eitherfor low carbon energy or for wider energy access,flows to most developing countries are still verysmall, so a key policy issue is how large flows ofprivate finance for low carbon investments can beleveraged through smaller flows of public finance.These roles mean that understanding of, and

engagement with, the private sector in theseareas is becoming important for donors. This isa relatively new experience, and so, again, thereis much learning to be done, including therecognition that the private sector is nothomogenous and different firms have differentpriorities, especially in relation to policy.

6.1 Working with SMEsin small-scale lowcarbon energyThere are a range of barriers facing firms andorganisations in the small-scale low carbonenergy sector. A basic one is the lack of businessmodels. Although there are some successstories (see Box 8), very often the private sectoris not interested in understanding consumerwillingness to adopt low carbon goods andservices, and do not have an awareness of lowcarbon opportunities in rural areas.

In particular, there are in reality very few scalablebusiness models. This is partly a matter ofaccess to capital but with low levels ofimmediate demand for electricity and limitedwillingness to pay, there is a more basic problemof commercial viability. Achieving scale is

important just in terms of energy access goals,but it is often also seen as helping to bringcosts down. However, for technologies usingbiomass, including crop residues, there are alsoconcerns that scale-up will increase biomassprices and so raise costs as projects multiply.

Donors are responding by experimenting withdifferent kinds of support to business modeldevelopment, partly with the aim ofencouraging more market entry and greatercompetition. This approach is based on thepremise of a certain level of entrepreneurship,which may not be present everywhere. InIndonesia for example, where much economicactivity is about extracting rents from naturalresources, innovation is often lacking.Experiments include establishing partnershipsbetween private sector firms and CSOs, payingfor market analysis showing poor peoples’willingness to pay,25 developing micro-creditoptions, and an element of reward for businessmodels that can deliver (see Box 9 for aprogramme in India that combines some ofthese elements). The REACT (climate change)window in the Africa Enterprise Challenge Fund(AECF) offers grants and loans as co-financefor new business models in Burundi, Kenya,Rwanda, Tanzania and Uganda. REACT is openfor business ideas in renewable energy,adaptive climate technologies (small-scaleirrigation, drought resistant crops, etc.) andalso for applications from financial institutionsthat wish to expand their lending in theseareas. Multi-donor funded GVEP Internationaland the Dutch Rural Energy Foundation havepiloted a new credit model in Uganda,supporting a solar hire-purchase scheme.

A second major barrier to scaling up is accessto finance. In many countries, the bankingsector is weak, and where it is stronger, banksare unfamiliar with the sector and risks areperceived to be high. This means that whilelarge firms (such as India’s Tata) can offersolar PV products at scale because they canaccess capital, SMEs cannot.

Accessing finance for small-scale energy forscaling up through donors and NGOs hastherefore played a critical role. These haveprovided start-up funds, helped lower

transaction costs for SMEs trying to accesscarbon finance, and provided scale-upinvestment to drive innovation and mitigaterisk.26 A particularly interesting concept here ismicro-equity (as opposed to micro-credit),where donors might take a stake in anenterprise. This not only directly providescapital to projects that can have multiplebenefits for poor households, but also de-risksproject finance by sending a signal to otherpotential investors that the investment isrelatively safe because a public body has takena share. Risk can be lowered further by donorsmaking their equity stake subordinate toothers’ (that is, first in, last out).

However, a key issue that donors are stillwrestling with, across all interventions in lowcarbon finance, is how to avoid giving excessivesubsidy or risk mitigation to the private sector.

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Box 8 Low carbon energy forthe poor – success storiesIn India, Grameen Shakti is on track todeliver five million solar systems and fivemillion improved stoves by 2015 (seewww.gshakit.org ). In Africa, if barriers aretackled, solar portable lighting could reach 8per cent penetration of off-grid consumersby 2015. GERES in Cambodia has producedand sold 1 million improved stoves with a22 per cent cut in fuel wood consumptionper stove. Toyola Energy in Ghana has soldover 150,000 improved charcoal stoves,(see www.ashdenawards.org/winners/toyola11). Christian Aid has partnered withsocial enterprise d.light (seewww.dlightdesign.com/home_global.php)on microfinance to bring solar lighting torural India. d.light reports serving over onemillion customers in 40 countries.

In addition to co-benefits through reducedpollution, improved health, andelectrification of homes, these markets offernon-traditional livelihood opportunities,particularly useful for women, where theyhave been trained, for example, as so-called‘barefoot engineers’.


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An important issue relating to both businessmodels and finance is the viability of mini-grids.Mini-grids are systems that serve one or morecommunities but which operate independentlyof the national or regional grid. Such grids,typically attached to technologies such as adiesel generator, a micro-hydro scheme or aStirling engine using gasified biomass, offermuch larger amounts of controllable power thana solar PV home kit, and will be needed forapplications such as agricultural crop processingwhich are needed for the diversification of ruraleconomies, an essential element of mostsuccessful poverty reduction strategies increating higher productivity employment.

However, mini-grids and associated powersources require a greater degree oftechnological expertise and management, aswell as higher capital costs. They ultimately alsoneed a higher level of demand for electricity.There has been mixed experience with this morecomplex technology and there is uncertaintyabout potential for sustained expansion due tothe challenges of remote operations,

maintenance and investment. This uncertaintymatters because of the key role that mini-gridsare expected to play in the future. In its results-based financing (RBF) pilot programme, DFIDmay include some micro-hydro mini-gridschemes, which should help donors learn more.

DFID is intending to pilot a RBF approach inRwanda for the delivery of solar lanterns, micro-hydro in mini-grids and institutional biogas.

Finally, it is particularly important to assesswhat is working for the scaling up of improvedcookstoves, because they are an obviouspotential win-win intervention. A previousgeneration of improved cookstoves initiativesfared badly, because there was too muchemphasis on technical design, often takingplace in labs, and not enough on behaviouralaspects, desirability and affordability. The sectorhas been re-energised, partly because of theclimate issue and the possibility of carbonfinance (at least in theory) and the involvementof some major corporates, including Shell,Bosch Siemens, Phillips and BP. At the same

Box 9 Supporting innovation in business models for small-scalelow carbon energy in rural India

DFID India is starting to explore two different ways to support the development of viable businessmodels for off-grid renewable energy provision. One is through grants for product and businessinnovations. The grants are made to civil society organisations to develop partnerships betweenprivate sector firms, communities and government, and may be used for activities such ascapacity building, training, research and community mobilisation. The aims are to help buildsupply chains, demonstrate commercially viable business models, and generate evidence toinfluence policy and regulation.

The second approach is ‘results-based financing’, or RBF. This model, which DFID is also tryingto develop in several other countries, pays SMEs or other delivery agents for reaching a set ofagreed outcomes. The idea of this approach is to incentivise the scaling up of viable businessmodels, flexibility and innovation. It also aims to maximise value for money through a reverseauction mechanism. RBF allows a targeting of business models on poorer areas. However, giventhat the firms involved have to carry the cost of financing the product or service, a complementaryelement involves ensuring that they can also access upfront financing cheaply.

RBF is an innovative approach for DFID. It raises the challenge of how to design a programmethat is new and risky, and therefore ideally has points for evaluation, learning and adjustment,before moving on to the next stage. Details of the proposed India programme are yet to befinalised and agreed with the Indian government.

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time, two recent initiatives have increasedmomentum: the Global Alliance for CleanCookstoves (GACC) and the government ofIndia’s re-launched programme on improvedcookstoves. A new wave of producers, comingthrough in the last 5–10 years, appears to bemore successful (see examples in Box 8),although some are still at a pilot stage.According to studies by GVEP and the WorldBank, experience points to a number of factorscritical to scaling up the use of cookstoves (Raiand Macdonald 2009; World Bank 2011a):

n Getting the product right for the specificmarket, with user involvement in design,is important.

n Donor support has been important forsupporting large-scale commercialisation,although different actors should be awareof all actions in the market and avoidundermining each other.

n Small-scale renewable energy funds offera good model for supporting cookstoves.

n Social entrepreneurs are able to reach thepoorest, often using links to micro-finance.

6.2 Leveraging privatesector financeThe issue of finance for low carbon energy goesbeyond provision of off-grid low carbon energyproducts through SMEs and CSOs, and appliesmore widely to expanding power grids in a lowcarbon way, and helping industry make thetransition to a low carbon development path.

A basic problem is that in many countries,including all LICs, the financial sector is thin andunderdeveloped. Even good projects find it hardto obtain loans, and equity is even harder. Manyprojects will be dependent on foreign finance.

Beyond the sheer availability of finance, there isthe question of how to encourage investmentinto low carbon opportunities. Investors makedecisions on the basis of risk-adjusted returns,and so there are two potential problems withsecuring finance for low carbon investments indeveloping countries:

The first is that returns are not highenough. In the absence of carbon pricing,at least in the short term, support policiesfor low carbon energy, including energyefficiency trading schemes and feed-intariffs for renewable energy, or even justgrants, will be essential to attract privatecapital. In countries where alternativeuses of capital have very high returns andshort payback periods,27 it may also benecessary to complement supportmechanisms with additional financialtools, such as subordinated equity.The second is that risk is too high. Evenwith a supportive policy framework, manypotential low carbon projects indeveloping countries will look too risky toattract backing, either at all, or only at aprohibitively high cost of capital.

There are a range of real or perceived risks thatraise the cost of capital for potential projects, ormake it unavailable (see Table 3), including thosegeneric to developing countries such as politicalrisk, currency risk and counterparty risk, andthose more specific to low carbon investments,such as policy and regulatory risk, technologyrisk, execution risks (especially where supplychains are undeveloped) and unfamiliarity risksreflecting the fact that investors may not knowanything about the kind of project or theassociated business model (which itself may notbe tested) and that acquiring that knowledgetakes time and incurs a cost.

Public finance can be used to leverage privatefinance by addressing these risks. Theemphasis on risk reduction avoids problemsof excessive subsidy. There are a number ofapproaches, including guarantees or insuranceto reduce risks for debt financing, andkeystone and subordinated stakes for equityfinancing. In a keystone approach, a publicinstitution (for example, an MDB or donor)takes an initial equity stake in a project, to giveconfidence to private sector investors, andsignal the viability of the project. In asubordinated equity approach, the publicinstitution puts in equity on a first in, last outbasis, ensuring private investors thatrepayment of their stake will receive priorityover that of the public institution.

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Reducing equity risk is a particularly effective wayof leveraging private finance, because a smallstake can not only bring in other equity, but thatequity can then be used as the basis of attractingdebt. Most infrastructure projects will befinanced by a mix of equity and debt in a ratio ofbetween 20/80 or 30/70. Thus, while definitionsvary, these mechanisms can be expected toleverage in between two and ten times thevolume of private capital. Different risk reductionmechanisms are suitable for different types ofrisk and different contexts (see Table 3).

Loan guarantees and policy insurance will beneeded in politically unstable contexts whereinstitutions and regulatory oversight are weak.In more stable contexts, equity mechanismswill be appropriate for mitigating technologyand unfamiliarity risks (both of which shoulddiminish over time for low carboninvestments). Technology risk can also behelped through publicly fundeddemonstrations and procurement, gettingtechnologies through the ‘valley of death’inherent in the innovation process. Executionrisk (and other risks more broadly) can also be

reduced through public policies, such asimproving infrastructure in general.

Many of these approaches are in widespreaduse, especially by the MDBs (for example,through the World Bank’s Clean TechnologyFund, which in June 2011 was providing $4.35billion in funding in 12 countries).28 The ADB’sClean Energy Fund and Clean Energy FinancingPartnership Facility currently leverage totalfinance of $1.1 billion from investments of $80million. The UK is working with the ADB toshare risks with a commercial lender in India toprovide lower cost loans to Indian solar farmdevelopers. This is expected to stimulate anestimated £265 million of private sectorinvestment in solar power capacity. Other actorsactive on leveraging private finance forrenewable energy include Germany’s KfW andthe US’s OPIC. A new proposal to maximise thepotential for leveraging private finance for lowcarbon investments is the Climate Public PrivatePartnership (CP3) (see Box 10).

Currently almost 80 per cent of public climatefinance currently goes to mitigation, excluding

Table 3 Matching type of leveraging tool to type of risk and context

General vs. specificto low carboninvestments

Low carbonspecific investment risk

Generic investment risk

Nature ofenvironment

Politically stable,strong institutions

Politically unstableenvironment,dysfunctionalinstitutions

Type of risk

Unfamiliarity risk

Technology risk

Execution risk

Policy or regulatory risk

Currency risk

Counterparty risk

Political risk

Example of de-risking/leveraging tool

Equity funds, advancedmarket commitments

Subordinated equity fund,demonstration projects

Equity pledge funds

Policy insurance

Forex liability facility

Loan guarantees

Loan guarantees

Source: Adapted from Brown and Jacobs (2011).

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reforestation and avoiding deforestation (whichreceives 6 per cent), much of which is focusedon energy.29 The large funds, including theHatoyama International Climate Fund ($11billion) and the Clean Technology Fund ($4.5billion), support a mix of large-scale energyefficiency and renewable energy projects, withthe majority of funding going to the latter. TheHatoyama Fund is quite heavily focused onChina and India, and while the CleanTechnology Fund is more widely disbursed,none of it flows to low-income countries.30

Unleveraged private finance in low carboninvestments in developing countries is likely toflow to MICs, especially Asian MICs and toChina in particular, and to the energy andindustrial sectors, so public finance leverage iscurrently reinforcing market based flows. Thereis therefore a strong case for bilaterals to focustheir efforts on leveraging private finance into awider range of countries, and encouragingglobal climate funds to do likewise.

Box 10 CP3DFID, together with the ADB and the IFC,has launched a Climate Public PrivatePartnership (CP3) Fund that aims to tacklea number of risks and other barriers toprivate finance simultaneously. DFID andthe MDBs will act as strategic equityinvestors, attracting private institutionalpartners, buying into projects via a Fundinvestment platform. At the same time, CP3will coordinate the use of existing riskmitigation instruments to leverage inadditional debt. DFID will also providetechnical assistance to support projectdevelopment. The aim is to use a smallamount of public finance to leverage inprivate equity finance, and then in turn,private debt. CP3 is expected to mobiliseinvestments that will generate more than7,000 megawatts of clean, reliable energy.

Source: Brown and Jacobs 2011;www.dfid.gov.uk/News/Latest-news/2012/Private-investment-to-help-tackle-climate-change/.

25 In many urban and peri-urban areas where there are distributionlines, willingness to pay for electricity is likely to be low, ashouseholds may be accessing it illegally for free.

26 Shell Foundation (2010) notably reports scale-up success bysupporting only new ventures.

27 In Indonesia for example, investors expect an internal rate of returnin the region of 25–40 per cent, with capital payback within 3–4 years.

28 See Clean Technology Fund Semi-Annual Report 2011,www.climateinvestmentfunds.org/cif/sites/climateinvestmentfunds.org/files/CTF%204%20Semi-Annual%20Report%20on%20CTF%20Operations%20june2011%2068.pdf (accessed 26 February 2012). This excludes a conditionalinvestment of $250 million in Nigeria and includes a regional CSPproject.

29 See www.climatefundsupdate.org (accessed 12 January 2012).30 Data from www.climatefundsupdate.org/ (accessed 26 February

2012).

Critical dimensions of low carbon energy and development

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Identify opportunities within povertyreduction strategies for reducing carbonemissions at low cost and assess politicaland institutional feasibilityTools such as marginal abatement cost curvesare important to guide identifying opportunities,but understanding political economy, leverageand the best way to deliver climate finance willalso have a major bearing.

Seek poverty outcomes through directand indirect pathwaysSome interventions will directly reduce bothpoverty and emissions. However, there may alsobe some big opportunities for emissionsreduction that also have major potentialbenefits for poor people, but which have anindirect pathway to impacts, and needcomplementary policies or planning.

Recognise risk and invest in innovationto achieve transformationSuccessful low carbon development willtransform an economy, but will involve takingrisks. Risky interventions should be taken wherethere is a good chance of success, but therecould be a better evidence base to make suchjudgements, and better indicators to measurepolitical and institutional transformations aswell as the outcome of tonnes of carbon abated.

Develop a good understanding of thepolitical economyA good understanding of the political economyof development is key, for engaging

governments on the importance of LCD, forpower sector or fossil fuel subsidy reform, forminimising project corruption risk and fordistinguishing rhetoric from ability to deliver.

Identify the right balance of fundingmechanisms – via MDBs, vertical fundsand direct funding – for your contextThere are pros and cons on both sides. MDBshave specific expertise, may have greatertraction with governments and often have largeprojects ready to go, but can also be slow todisburse, and hard to hold to account. Directfunding allows learning and innovation, butcarries other risks.

Address the constraints faced by SMEs inscaling up markets for low carbon energyIn some places it may be the lack of a scalablebusiness model, in other places this may exist,but financing is the problem, or access totechnological skills and supply chains. Workingdirectly with the private sector is a way toaccelerate learning.

Use the full range of tools to mitigate therisks preventing private finance beinginvested in low carbon developmentThere is a range of mechanisms for reducingrisk and improving the flow of finance for lowcarbon investments in developing countries.Donors have increasing knowledge aboutfinance and risk, and the MDBs haveconsiderable experience but all publicinstitutions have a shortage of deal-makers.

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