Climate finance - it's still the one

Climate finance is one of the four issues on which a future climate regime will rest (the others being mitigation, adaptation, and technology development and transfer). It will also prove to be the main stumbling block during the Copenhagen meeting on climate change this December.

This weekend came the news that the Commonwealth Heads of Government Meeting (CHOGM) in Trinidad had agreed to UK Prime Minister Gordon Brown's and French President Nicolas Sarkozy's proposal to establish a $10 billion fund to help developing countries reduce their emissions and adapt to a changing climate. The fund, expected to kick in by 2010, is an important step - one more push towards securing at least a political outcome in Copenhagen.

But several issues remain unresolved. The most important is the 'additionality' of funding. This is jargon for the demand from developing countries that funding made available for climate change should be over and above existing allocations for official development assistance. In other words, they do not want climate change finance to simply substitute money intended for education, health and other development aspirations. Today, The Guardian reports that it has evidence that the European Union is trying to delete references to additional funding from the Copenhagen text. The United Kingdom supports additional funding, but even its climate-related aid allocations have come from existing aid budgets, not as extra money. As a clarification, a Department for International Development spokesman said, 'Additional funding for climate change would be made available from 2013...'

At one level, the question of additionality is problematic because it is difficult to distinguish between assistance for general development programmes, say improving water management systems, and activities geared towards climate adaptation.

But the bigger problem is that the funds required are several multiples of what is currently spent (only $1 billion a year on adaptation). On mitigation, too, scholars suggest that at least $50 billion might be needed annually in the form of public financing support (see my paper with Kevin Watkins; Lord Nicholas Stern repeats the point in an op-ed today). But current levels of public financing are much lower (since 1991, the Global Environment Facility has cumulatively provided only $2.5 billion for climate financing and leveraged another $15 billion).

A further problem - and related problem - is the long history of unmet commitments on development assistance, which has resulted in an atmosphere of sheer mistrust and bad faith between rich and poor countries. Moreover, the richest country (the United States) has yet to table any offer regarding climate financing. President Obama admitted at the G8 summit in July this year that the United States had 'sometimes failed to meet its responsibilities so let me make it clear those days are over.' It doesn't look like those days are over yet.

So, why will climate finance prove to be the stumbling block? Because all other actions will be contingent on the available funding. Over the last few weeks, we have seen one country after another offering unilateral commitments to reduce emissions (Brazil; Russia; South Korea; United States) or carbon intensity (China; even India is considering an announcement). Fast growing developing countries are adopting measures that they believe to be in their interest anyway. But any additional actions will depend on additional funding. As one developing country delegate in climate negotiations earlier this year complained, asking poor countries to take on climate-related actions without promised financing was like selling lottery tickets without announcing the prize! Such tickets would not find many buyers, he noted.

China doubles wind power capacity

At the end of 2008 China had an installed wind power capacity of 12.2 GW (behind the United States with 25.2 GW, Germany with 23.9 GW and Spain with 16.8 GW). Today China Daily reports that it has added another 11.8 GW of wind power capacity in the first six months of 2009, a year-on-year growth of 101% by end-June.

Meanwhile, in remote Gansu province in China's northwest construction has begun on the country's first 10 GW-sized wind power plant. The Jiuquan Municipal Development and Reform Commission projects that capacity could increase to 20 GW by 2020, making it the largest wind power station at a projected cost of $17.6 billion. If it succeeds, municipal authorities claim, it would rival the 18.2 GW Three Gorges Dam, thus fulfilling their dreams of building a 'Three Gorges on the Land'.

China's cleaner coal surge

It was only yesterday that I was giving a lecture on the need for 'cleaner coal' investments in China's power infrastructure, to raise efficiency and reduce emissions. Today the New York Times reports that China has overtaken the United States in its quest for building more efficient coal power plants.

Although the average efficiency of the U.S. plants (40%) still exceeds China's (29-30%). The best plants can reach up to 44-45% efficiency, cutting emissions by a third. More interestingly, by scaling up the investments, China is managing to generate cost efficiencies as well: an ultra-supercritical plant now costs a third less in China than a low efficiency plant in the United States.

Of course, there are many other ways to improve efficiency as well. As the International Energy Agency reported on China recently, rational mining, modern management practices, matching fuel quality to users' specifications, and reducing losses during transport can deliver efficiency gains along the supply chain.

A point of contrast with India is that China's higher efficiency plants are coming on stream towards the tail end of a decade-long building boom. As the economy slows, the pace of new (more efficient) plants will also reduce. India is about to embark on a similar journey of huge investments in the power sector (its coal power capacity is about 87GW, which has to rise to 440 GW by 2032). India has a chance to upgrade to higher technology plants from now itself, rather than locking itself in poorer infrastructure for another three to four decades.

For both China and India to deploy cleaner coal technologies, we would need an international agreement that encourages investments in such technologies, and facilitates them with public-private partnerships and credible technology transfer arrangements.

China wants a new international currency

Last week I blogged that China is concerned about the value of its investments in US Treasuries. This week, Zhou Xiaochuan, the governor of the People's Bank of China, proposed a new international reserve currency to replace the U.S. dollar. The full essay can be found here.

Zhou's main argument is that countries that issue reserve currencies face a conflict of interest: between their domestic monetary policy goals (inflation targeting) and the demand for the currency abroad. So, inflation-control measures at home would not meet international demand and, as China fears now, fiscal stimulus measures at home could create excess liquidity in global markets and reduce the value of Chinese dollar-denominated assets. Instead, Zhou argues that an international reserve currency would eliminate the 'inherent risks of credit-based sovereign currency' and allow the IMF to 'manage global liquidity'.

Zhou wants the IMF's Special Drawing Rights (SDRs) to be given an expanded role. (SDRs were created in 1969 to bolster official forex reserves, to be allocated to countries based on their IMF quotas. But their use has fallen since the collapse of the Bretton Woods fixed exchange rate system in 1973.) In the short to medium run, Zhou's plan would include: an increase in SDR allocations; a settlement system between SDRs and other currencies; greater use of SDRs in international trade; new financial assets denominated in SDRs; and SDR valuation based on a basket of currencies of all major economies, not just the four currencies used today. In the longer run, centralised management of the reserves of IMF member countries could mean that SDR allocations would eventually replace existing reserve currencies.

The dollar briefly fell 1.3% against the euro yesterday after Tim Geithner, U.S. Treasury Secretary, said that the U.S. was 'quite open to that' idea. He cautioned, however, that greater use of SDRs would be an 'evolutionary step', not a move towards 'global monetary union'. The U.S. insists that the dollar is still the world's dominant currency.

Given China's losses on investments in other currencies, at least in the near future China will still hold much of its reserves in dollars. And despite the proposal, calls for China to raise domestic consumption and stop artifically holding the renmimbi down to boost its exports are not going to get drowned out any time soon.

China in Africa - staying in or getting out?

The New York Times reports that, thanks to the global economic crisis, China is becoming more hesitant with its investments in Africa. With falling commodity prices and unstable political environments in some countries, the Chinese are apparently driving a hard bargain. But the government still wants to take a long view.

The Times's report focuses on Guinea, the West African nation awash with mineral deposits, especially bauxite and iron ore. In the current climate, China (according to its Ambassador to Guinea) finds the political situation 'not stable' and the international markets 'not favourable' for billions of dollars of investments in Guinean infrastructure in return for access to its minerals. Instead, China is building a 50,000-seat stadium in Conakry, the capital.

Similarly, a $9 billion deal struck in 2007 with the Democratic Republic of Congo (copper, cobalt, tin and gold in return for roads, railways, dams and schools) is stuck. Chinese investments are in the form of minerals-backed loans , so falling commodity prices means higher debt burden for African countries and lower potential investments by Chinese companies. Unlike until a year ago, when China was pouring billions of dollars into Africa, it is now making clear that large infrastructure projects are 'not gifts, but investments'.

But the story is more mixed than it seems. Ngaire Woods, professor of international political economy at Oxford, reports in a recent BBC documentary that even as Chinese companies are exiting Africa, the Chinese government is staying put. China's banking system is 'awash with liquidity' and the government has a strategy for using nearly $2 trillion in foreign exchange reserves. One such strategy is to buy mineral assets at low prices. In the same programme, Deborah Brautigam, who researches Chinese investments in Africa, argues that China has past experience in buying mines (like a copper one in Zambia in 1995) at 'bargain basement prices'. It is now looking for similar opportunities. Brautigam quotes the President of the Chinese Ex-Im Bank: 'We have a very long-term view...we're in Africa for the long-term...we have increased our reserves at the Ex-Im Bank.'

Postscript: Meanwhile, other continents might not be as welcoming. Chinalco (the state-owned aluminium company) wants to invest $19.5 billion in Rio Tinto, an Anglo-Australian mining giant. Although Australia's competition commission approved the deal yesterday, there is a stir among some Australian MPs that Chinese investments in Rio Tinto (and other mining companies) would be against Australia's national interest. (They draw inspiration from China's own rejection of Coca-Cola's bid for Huiyuan Juice.) Australia's Foreign Investment Review Board is now putting the deal through 'national interest' compliance tests. Tit-for-tat protectionism is on the rise.

Are China's assets 'SAFE'?

On Friday the FT reported that Wen Jiabao, the Chinese Premier, was worried about the value of China's investments in U.S. assets. Now we know why.

One reason is that China is the largest foreign holder of U.S. public. Increased fiscal spending in the U.S. to boost the economy (if not backed by spending elsewhere) could lead to inflation and a drop in the dollar's value.

Another reason is how China's investments have fared in the equity markets. The State Administration of Foreign Exchange (SAFE) started diversifying into equities early in 2007 and continued until the collapse of Freddie Mac and Fannie May in July 2008. During this time, some 15% of China's $1800 billion of foreign exchange reserves were pushed into the equity market. According to the FT, the subsequent fall in stock prices means that half the value of China's investments in equities has been wiped out.

To add to the lack of transparency in China's handling of its sovereign funds, SAFE uses a Hong Kong subsidiary to invest in foreign equities (Chinese investors are largely barred from investing overseas). Brad Setser of the Council on Foreign Relations reports that SAFE buys Treasuries both through China and through London. But the latter shows up in U.S. data only as purchases by a UK-based bank, thus understating the value of Chinese investments.

Meanwhile, the China Investment Corporation (the official sovereign wealth fund) has become the target of the Chinese blogosphere thanks to the losses it has incurred on investments in Morgan Stanley and Blackstone (the private equity group).

Are further losses in the offing and, if so, when will China's citizens - and the rest of us - get to know?

Economic crisis complicates climate crisis in more ways than one

California is a leader in the United States when it comes to environmental regulation. But the economic crisis threatens to undermine its climate-friendly plans. The New York Times gives the example of CalPortland, a cement company in Colton, which is struggling to find the resources to retrofit its plant to reduce CO2 emissions. Whereas lawmakers had estimated it would cost $200 million to upgrade all eleven cement plants in the state, now it looks like that much would be needed just for the Colton plant. And with the economic crisis, cement prices have fallen to levels that force a revision of the cost-benefit calculus for climate-related investments.

I think the bigger lesson is that the economic crisis presents policymakers with a "double distributive" burden: the distribution of costs and benefits resulting from a process of decarbonising our economies, complicated further by the loss of jobs and economic opportunities during a severe recession. It's one thing to claim that 'green' jobs can be created; quite another when the pressure of job losses in other sectors builds up. Any economic restructuring would involve distributive questions; this time it's just doubly challenging.

Which brings me to my final point: what happens when developing countries try to reduce their emissions? One feasible pathway for countries like China and India is to increase the efficiency of their coal-fired power plants, using already available improved technologies (more on those details in a few days). While improved efficiency would have economy-wide benefits, it is hard to find good estimates of how the incremental costs of upgrading plants would affect individual sectors of the economy (power generation, cement, iron and steel, etc.). Without such estimates, it would be harder still to measure the distribution of costs and benefits across sectors. And, more importantly, it would undermine developing countries' efforts to secure guaranteed financing from rich countries for technological upgrades.