What It Takes To Attract Private Investment To Climate Adaptation

Investment in renewable energy reached parity with investment in fossil fuels for the first time in 2022, marking a long-awaited shift toward climate-friendly financial flows. But while reducing emissions is crucial, it is only one aspect of comprehensive climate action.

As the latest report by the Intergovernmental Panel on Climate Change makes clear, the world is rapidly approaching a level of warming that will make it significantly harder to manage drought, heat waves, rising sea levels and other climate-related disasters. Along with scaling efforts to curb emissions, therefore, we must invest substantial resources in building climate resilience and adapting to the changes already underway.

But increasing private sector finance for climate adaptation presents unique challenges. While renewable energy is a promising sector with revenue models well understood by investors, the same cannot easily be said of adaptation measures. Few investors are experienced with adaptation finance, and even fewer are experts at it. This has led to uncertainty about whether the private sector can — or should — fund adaptation on a larger scale.

Still, under specific circumstances, private sector involvement in climate adaptation is possible. Indeed, a compelling case is emerging that the private sector can play an important role in helping fill the adaptation finance gap and making vulnerable communities more resilient to the worst impacts of climate change. Here’s what to know.

Current adaptation finance falls short of the world’s needs

Adaptation finance refers to financial resources aimed at helping communities, companies, countries, and regions adapt to the impacts of climate change. Examples include financing the relocation of an infrastructure project away from areas with rising sea levels, supplying drought-resistant seeds for farming, or building a dam with a larger retention basin to account for increasingly variable rainfall.

Recent climate-driven disasters such as catastrophic floods in Pakistan, Nigeria and Chad, and the prolonged drought and famine in the Horn of Africa, highlight the urgent need for investment in adaptation. Developing countries require an estimated $160-$340 billion per year by 2030 to adapt to increasing climate impacts; this amount is projected to increase to $315-$565 billion by 2050. Right now, however, less than $50 billion — or just 10% of all climate finance — is allocated to adaptation. As emphasized at COP27, the amount of adaptation finance to developing countries needs to increase by 5 to 10 times.

While adaptation finance can come from both public and private capital, the vast majority so far has been public. Corporations and institutional investors provided just $1 billion, or 2%, of tracked adaptation finance in 2019 and 2020, compared to 98% from public sources. (This number accounts only for investment in adaptation projects with public benefits; spending by companies to make their own business models more resilient is not included.)

Measuring private sector climate finance

Tracking climate finance, especially private investment in adaptation, presents significant challenges. Due to the lack of common definitions and tracking mechanisms to capture private expenditures on reducing climate risks, there is limited or incomplete information available regarding the funders, administrators and recipients of adaptation financing. Limited data and knowledge gaps also make it difficult to identify factors that impact private sector investment in adaptation.

Why is private investment in climate adaptation so low?

Some adaptation projects may naturally attract private capital if they operate on a shorter time scale and offer proven cash-flow potential — for example, retrofits to water and sanitation infrastructure. However, many adaptation measures do not fall within this box and will have a more difficult time bringing in private investment.

Private investors may hesitate to invest in adaptation due to several significant barriers, including some that apply to climate projects in general, such as mispricing of natural resources and distortionary subsidies. The three challenges below are especially relevant to adaptation projects.

·      Perception that there is no money to be made: Private investors expect to earn competitive risk-adjusted returns from investments. Adaptation projects may be perceived as riskier due to the uncertainty and complexity of climate impacts, and often result in public benefits rather than direct financial returns.

·      Information asymmetries and knowledge gaps: Investors may contend with limited access to information on climate impacts, future risks and likely adaptation outcomes. The impact of key approaches such as ecosystem-based adaptation has not been systematically measured; nor have the full range of potential environmental and social benefits been monetized and calculated. This makes it difficult to reliably calculate returns on investment and make informed investing decisions.

·      Investment horizon and size of adaptation projects: Most adaptation projects are inherently long-term, taking 10-20 years to implement. It is hard to make the business case for potentially large upfront costs today set against relatively long payback times. In addition, adaptation projects often have relatively small ticket sizes (around $30-$50 million) which may not appeal to traditional investors.

[Author: ESTHER SEKYOUNG CHOI, EUNKYUNG JANG AND VALERIE LAXTON, WORLD RESOURCES INSTITUTE | MAY 16, 2023]

[https://climatechampions.unfccc.int/what-it-takes-to-attract-private-investment-to-climate-adaptation/]