Environmental finance: mechanisms and applications

CEFC and the Future of Environmental Finance

The Clean Energy Finance Corporation (CEFC) represents the most aggressive environmental finance initiative sponsored by the Australian Government to date. The CEFC is an independent entity established as part of the Clean Energy Future Policy by the Australian government. As of March 2012, funding for the program totaled AUS $10 billion in government backed investments for the commercialization and deployment of clean energy technologies. This research will explore the CEFC and its role in the development and deployment of environmentally friendly energy sources and alternatives.

Governments around the world recognize the need for developing clean and renewable energy sources that reduce their environmental impact. The topic of global warning and climate change has increased the need for the development of less energy intensive and environmentally damaging energy sources. Although the role of human beings in these changes is a topic of debate, it is accepted that humans are doing more harm at least contributing to these climate changes (Department of Climate Change and Energy Efficiency, 2012). The need to invest in our future and ensure that ourselves and our children can live in a world that can support them is the key reason for interest in developing clean and renewable energy sources.

The need for the development of clean, alternative energy sources has been evident for many years. Research has focused on the development of renewable and clean energy sources. There are many technologies that are ready to deploy, but that face barriers to their deployment such as intensive capital investment, risk, and other practical concerns that have limited the adoption of renewable energy technology. The purpose of the CEFC is to reduce capital market barriers to the introduction of clean energy technology.

The CEFC targets three main areas. It targets the development and deployment of renewable energy and technologies that enable renewable energy sources to be utilized. It targets the development and deployment of low emission technologies and energy efficient products and services. The third area that the CEFC targets is the transformation of existing businesses to renewable and environmentally conscious energy alternatives (Institute for Industrial Productivity, 2012). The CEFC has chosen these three areas as their main target focus, as these are considered to be the main barriers to a renewable energy future. They have also been identified as the major hurdles to be overcome in the introduction of green technology for energy production. These three areas are considered the most critical barriers to the introduction of renewable energy sources.

The CEFC is more than just a funding stream that is dedicated only to the funding of Renewable Energy Products. The CEFC is not providing grants for Renewable Energy Products or research. This initiative by the Australian government is an investment upon which it intends to make a return in the future. The underlying theory is that the government will provide funding to private companies for the development and deployment of renewable energy sources. The Australian government intends to make a return on their investment through the collection of taxes and repayment of loans and the interest earned on them. The funding sources include private funding, which means that this program will also provide a boost to the Australian economy. As one can see, this program is expected to have many positive impacts on the Australian economy. The economy will boost the financial sector, create renewable energy jobs, and aid business growth in the renewable energy field.

The program will be operated by a partnership between experts in the banking, investment, and clean energy technology fields. The Australian government will oversee the program and will assure that the needs of all stakeholders are being addressed. Involving the government will assure that this new partnership achieves goals that will benefit Australian society as a whole. The role of the Australian government will be to implement rules and regulations to make certain that the program achieves its stated goals (Institute for Industrial Productivity, 2012.).

A New Financing Model

The CEFC represents a new financing model that is unlike traditional funding programs operated by the government. The traditional funding program has typically involved grants to support research and development of renewable energy sources. This was an appropriate source of financing for the early stages of renewable energy development. Companies that were into the business of developing renewable and clean energy technologies did not yet have marketable product and could not be expected to support themselves in the research and development stage.

this is not an unusual circumstance and affects the research and development of almost any product that one can name. Failures are as much a part of the research and development process as successes. It can be expected that when a new idea is proposed or the need for new products or service is identified many people will have ideas on how to solve the problem. Some of these ideas will not work, but in order to find those that do work the process of research and development must be funded. Grants are the most common form of research and development funding, particularly for projects that are expected to benefit the whole of society.

After the research and development stage, it becomes apparent which ideas were successes and which ones were failures. Those that have potential now need to move onto the next age in the process. They need to move from the research and development stage to a marketable product or service. Starting any new enterprise is risky. Even if the idea is excellent and needed, there is no guarantee that people will buy it. In the case of a normal product or service that does not benefit society as a whole, but rather that will benefit a single business entity, the burden of financing lies on those that wish to begin the new enterprise. If the business fails it has an impact on those individuals, but it does not have a noticeable impact on society as a whole.

The funding of renewable energy and clean energy technologies is different. Society needs for these entrepreneual endeavors to be a success. The government understands that beginning production of these new technologies and putting them into place is a capital intensive process. They also understand the riskiness involved. The purpose of the CEFC is to give these companies a greater chance for success than they would have on their own. The CEFC will evaluate the potential projects for funding to determine their likelihood of success. It will then help the companies to obtain financing from private and government sources. This helps to assure that money set aside for investment in renewable energy will be distributed to projects that have the greatest chance for success, thus resulting in an improved chance for recovery of the initial investment as well as interest earned for the banking industry. It will also help to assure that worthwhile projects have a greater chance of being funded then they may have on their own. The purpose of the CEFC is to marry the best projects with appropriate funding sources.

Government backing of investment in renewable energy will make banks more willing to take risks than they would if they did not have a chance to recover some of their investment in the future should the project fail. This new renewable energy funding source is not expected to "crowd out" private financing options. It is to work in conjunction with them, providing parties negotiating tools on both sides of the table. It is intended to act as a catalyst to private investment in a field where bankers may be wary of the risk involved.

In addition to the financing of major corporations and projects, the program is also providing assistance to households that wish to install and utilize renewable clean energy sources. The Household Assistance Package will begin in May of 2012, with an initial payment. This will be followed by tax cuts in July 2012 and then ongoing assistance through March of 2013. This program particularly targets low income Australian citizens and retirees on a fixed income (Department of Human Services 2012).

Design Features of the CEFC

The CFC will finance many types of projects. It will support large scale infrastructure projects for renewable energy including solar thermal, solar PV, geothermal, bioenergy, and wind. For these projects it will resolve many of the obstacles that have plagued prior infrastructure projects. These included difficulties to secure long-term debt, a lack of available local power, purchase agreements, challenges in the scale of the projects, large scale up front capital and bank debt that was too short. The CEFC will help to resolve these issues through its various financing mechanisms (Clean Energy Council 2012). .

The CEFC will also support small scale renewable energy projects such as community wind farms, landfill gas, and commercial solar PV projects. The CEFC well resolve many of the issues in securing commercial bank finance due to small project size, and relatively expensive energy forms. It will use bundling, and aggregation of multiple small projects to achieve some of these financing projects. You also utilize soft loans and growth capital as financing for these types of projects (Clean Energy Council 2012).

The CEFC will also fund commercial scale demonstration of technologies such as ocean wave in tribal Power Systems, as well a second generation biofuels and bioenergy. For many of these projects it will help to provide the large upfront capital needed, risk inherent in this type of technology, and the additional equity required to scale the project properly (Clean Energy Council, 2012).

The CEFC will finance a number of different projects in various asset classes. Various asset classes require different sets of benchmarks to measure the success of the investment strategy. However, the CEFC has published the following guidelines for its investments and projects:

The CEFC should generate a long-term return sufficient to enable it to be self-sustaining

A long-term investment perspective should be adopted

Investments and financing should provide funding where private capital was currently not available and avoid competing with private sector investors

The CEFC should act in partnership and co-investment with national and international capital providers

Investment risk across the portfolio should be managed by having investment limits over individual companies, technologies and asset classes

Investment should be managed against recognised benchmarks for asset classes and overall investment returns managed across the portfolio

Investments should not distort other complementary policies

Investments must achieve positive environmental or social impact through, for example, emissions reduction or new renewable energy capacity " (Clean Energy Council, 2012, p. iv).

These guidelines are general and encourage the development of specific benchmarks for various projects.. It is difficult to devise specific benchmarks for the CEFC because every project is different. These general guidelines allow the benchmarls to be established according to the project parameters. They serve as guidance, rather than specific benchmarks for the CEFC to follow.

Certain benchmarks have been defined by the government. They will serve as a filter for the projects that are selected. These benchmarks will not be as strict as they are in the private sector. Each type of asset class will be expected to provide a defined rate of return (Commonwealth of Australia, 2011). Some projects will be allowed to carry a higher risk than others. In some cases a lower rate of return will be accepted if the project is deemed to have sufficient social value (Commonwealth of Australia, 2011). A panel will decide the appropriate rate of return for specific projects and financing instruments. However, individual stakeholders will be allowed to apply their own rate of return and assessment instruments to the project as well (Commonwealth of Australia, 2011). The purpose of the CEFC is to serve as a filter to eliminate projects that will at least meet minimum requirements. However, the project may have to meet more stringent guidelines set by the stakeholder or individual lender.

Comparison to Similar Initiatives

The CEFC is not the first of this type of financing initiative. The UK Green Investment Bank launched a similar program and was the first of its kind. At present, a large scale international programs have not been developed, but several countries have recently instituted or began to develop programs such as the Green Investment Bank and the CEFC. As these programs develop, and become more numerous it is expected that international initiatives will follow.

The purpose of the Green Investment Bank is similar to that of the CEFC. They are committed to set the UK on a firm course to a growing and more environmentally friendly economy that promises long-term sustainable growth (Department for Business Innovation & Skills, 2012). One of the key similarities between the UK Green Investment Bank and the CEFC is the use of the commercial approach. Both of these programs intend to move clean energy beyond research and development to become capital enterprises. There are many similarities between the UK Green Vestment Bank and the CEFC, even though these programs have different benchmarks according to their needs and environment.

The financing of projects is the focus of the UK Green Vestment Bank and the CEFC. However, the broader focus is on impacts to the environment and investment in the future. The UK Green Investment Bank has broken the expected effects of various projects into several different categories according to their expected environmental impact. They consider the case for photovoltaics, solar energy, wind, offshore wind, and other potential categories of funding projects. The UK Green Investment Bank has determined that switching to renewable energy sources will result in long-term energy savings for many of the businesses that utilize green energy in the future. The purpose of the green investment bank is to help these businesses obtain the initial capital that they will need to realize long-term gains (BIS, 2011).

Both the CEFC and UK Green Investment Bank were designed for similar purposes and have similar mechanisms for achieving their goals. They expect similar outcomes in terms of long-term energy savings for the companies and organizations that utilize their programs. Both of them intend to serve as a catalyst for green energy investment. However, in terms of whether they are a success or failure, this is yet to be determined. The idea of green investment is relatively new and these programs have barely begun to function. It will be several years before it can be determined whether the CEFC or other similar programs can be deemed a success or failure.

The Effect of Externalities

Many stakeholders will experience externalities as a result of funding by the CEFC and private institutions. One of the positive externalities has been previously discussed in the long-term benefits of energy savings for companies that utilize green energy projects funded by the CEFC. A negative externality may be the effects of initial funding on the finances of the company. It is difficult to pinpoint specific externalities to the parties involved, as the situation, company, and financing mechanism chosen will have an affect on the externalities.

Externalities are often intangible and difficult to measure in specific financial terms. For instance, the external cost in manufacturing is pollution and greenhouse gases. A positive externality of projects funded by the CEFC may be reduction of pollution in greenhouse gases in the future. The projects such as solar and wind energy production will have externalities that can be expressed in financial terms such as lower energy costs in the long-term future.

Several externalities will have a direct effect on the CEFC and its financial gains or losses. These can represent barriers or advantages depending on the location and type of fuel source used. One of the key externalities that will affect energy production is variation in the energy supply. This is particularly true for wind turbine systems and solar systems that depend on availability of the natural resource. This natural resource can change unpredictably, requiring the need for backup power when the natural fuel source is not available (Commonwealth of Australia, 2011). Externality such as these will vary by location and one of airing effects on projects.

It is difficult to give specific examples in financial terms such as how they will affect the net present value or discounted cash flow, but they will have a direct impact on project funding. The impact of externalities on funding would be the same for any financial instrument utilized by the private sector banking industry. The effects of externalities would have to be considered on a case by case basis. Funding by the CEFC will be subject to the same barriers and affects of externalities as private sector financing instruments. Appendix I provides the various financing mechanisms inttended to be utilized by the CEFC, as well as the definition and roll of the CEFC in the financing instrument.

Loans as opposed to equity financing is expected to dominate the CEFC financing initiatives. It is expected that in the early-stage the CEFC, investments will be loans, as opposed to equity. This is largely because the companies chosen for investment will be in the final stage of research and development (Wagg 2012). The CEFC is investing in companies that do not yet have a commercial product to sell and therefore do not have equity available for financing. In the later stages of the program, companies that have viable products on the market may have equity built and will be able to financing expansion products with existing equity, but in the early stages of the program, loans will dominate CEFC financing due to a lack of existing equity from the companies that are being financed. Wherther debt or equity financing is more suitable for A specific project will depend more on the company asking for the financing than on the type of project or finance category.

There is been considerable concern over whether the CEFC initiative can work effectively with the existing Carbon Pollution Reduction Scheme (CPRS). The CPRS treats carbon emissions as quantifiable, The biggest polluters will have to pay for each ton of pollution they release into the atmosphere. This is expected to have two affects. The first is that the costs of businesses to cut their pollution, will suddenly seem more feasible than continuing to produce the pollution. This will serve as an incentive to participate in CEFC financed projects. These are two separate programs and will not be intertwined, except that the CPRS as will serve as an incentive for the worst polluters to become involved in renewable energy and pollution reduction strategies. In the past, switching to renewable energy sources and reducing pollution was a cost and there was an incentive to keep doing things the way they were doing them, rather than spend the capital needed to change. In the past pollution and renewable energy was a social issue, the CPRS as makes it a financial one, and one that favors positive change toward renewable energy and environmentally conscious actions.