Financing carbon emission reduction from SMEs to governments

Everybody is aware that governments and corporations all around the world have made commitments to become net zero. The term net zero has three limbs:

1. Calculate the carbon footprint.

2. Reduce GHG emissions to a minimum.

3. Offset the residual emissions.

That seems fairly straight forward on the surface of it but misunderstanding abounds about the Scope 3 emissions that should be included in the carbon footprint (and that are not being included as per the rules of specified in the GHG Corporate Value Chain (Scope 3) Accounting & Reporting Standard). It is not unreasonable to predict that with the ever-rising frequency and severity of natural disasters caused by climate change, will come a greater scrutiny of the application of these rules to the carbon account. That means simply that the emissions to be accounted for will increase.

The other issue rearing its ugly head is the ever-rising costs of carbon offsets. We are seeing prices skyrocket in both the compulsory and voluntary markets. For example, Australia’s Emissions Reduction Fund has seen its ACCUs rise from $19 in July last year to $53 six months later (and still rising).

Relief isn’t available in global ETS markets either. For instance, an EUA in the EU ETS is on €82 and the UKA in the UK ETS is on GBP73. 

The second limb of net zero i.e. to reduce GHG emissions to a minimum, has always been stressed as the main objective in the net zero process. This approach evolved from the mere fact that worldwide emissions are too high, and they need to be reduced urgently to limit global warming. The rising cost of carbon credits adds financial incentive to reduce those emissions.

Reducing GHG emissions has two main streams: behavioural change and infrastructure upgrades. Infrastructure upgrades invariably mean a capital hurdle is involved. However the word hurdle is misleading. Capital upgrades in energy efficiency and renewables are projects which invariably save  lot of money and pay for themselves in reasonable time.

A way to compare upgrade opportunities is by ranking possible projects by their internal rate of return and the tonnes of GHG emissions saved after the upgrade. 

Additionally, where appropriate, the savings on carbon offset purchases that won’t have to be made after the upgrade should be built into the return-on-investment calculations. For instance, if the solar upgrade is going to reduce an SME’s carbon emissions by 20 tonnes per annum, that is $1,000 approximately per annum in ACCUs that do not have to be acquired to demonstrate net zero status. This saving is quantified in the ROI calculation.

So before making a capital upgrade decision, work out the ROI, tonnes of emissions to be saved and compare the results between different project opportunities. Then, the source of finance is the next question to ponder.

If you have some spare cash, it may be worthwhile to throw it at a project that is going to give you a 20% plus return, rather than reap a huge half-a-percent interest return from an IBD, or 5% from an investment fund.

Commercial finance is also cheap at the moment, so here is another alternative, with the interest impost only slightly tarnishing the project opportunity.

If we look at net zero ambitions from a global perspective, trillions of dollars are needed to meet an ever-increasing list of participants. The Asian Development Bank has estimated that $1.7 trillion per year of annual investment is required for Asia alone if it is to meet the demand for sustainable, resilient infrastructure required to mitigate the impacts of climate change. 

This is where green bonds come into play to help bridge the finance gaps that cannot be covered by the public purse to finance projects. These projects might be specifically aimed at energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, the protection of aquatic ecosystems, clean transportation and sustainable water management.

The Climate Bonds Initiative which is “an international, investor-focused not-for-profit……….working solely on mobilising the $100 trillion bond market for climate change solutions” predicts the global green bond issuance will likely pass the $500billion mark in 2022, rising to $1trillion in 2023.

The Initiative is predicting that the issuance from national governments is likely to continue to grow in the next two years, as nations seek to bolster long-term net-zero targets with more clarity on decarbonising high-emitting sectors.

The Climate Bonds Initiative’s head of research and reporting Krista Tukiainen said late last year: “We expect a stream of COP26-timed commitments from the financial sector, more sovereign green issuance and an acceleration of policy measures, including the EU bond program, will all drive market growth towards a record 2021 and strong start in the first half of 2022.”

Meanwhile, the UK government, late last year listed its inaugural GBP10 billion green gilt (bond) on the Sustainable Bond Market of the London Stock Exchange, followed up by a second issuance, lifting total sales of GBP16billion. These issuances are part of the UK government’s Green Financing Programme, with proceeds being allocated to projects that meet the environmental eligibility criteria set out in the Green Financing Framework. Specifically, they will be used to fund the UK government’s spending in six key categories including:

Renewable energy

Clean transportation

Energy efficiency

Living & natural resources

Climate change adaptation

Pollution prevention & control

Whilst this all sounds encouraging, it would be remiss not to mention at this stage that there is currently no official global overarching regulation that defines a green bond. Many issuers however, do tend to follow the Green Bond Principles, which is a good start. These principles and guidelines are endorsed by the International Capital Market Association and define the eligible use and management of proceeds, the evaluation process for projects and the reporting to investors, but it all voluntary and not legally binding.