GEF financing incremental costs for climate change mitigation projects

by Ming Yang, USA/China/Australia, ELP 2013

 

The Global Environment Facility (GEF) unites 183 countries in partnership with national governments, international institutions, civil society organizations, and the private sector to address global environmental issues while supporting national sustainable development initiatives.  The GEF is operating as a financial mechanism for international cooperation for the purpose of providing new and additional grant and concessional funding to meet the agreed incremental costs of measures to achieve agreed global environmental benefits in seven focal areas. Climate change is the area with the largest share of funding utilization in all focal areas. Developing countries and countries with economies in transmissions are interested in the GEF, because they are keen on using the GEF resources to overcome incremental costs to achieve global environment benefits. This blog presents basic microeconomics theory to help readers understand “incremental costs” and “global environment benefits”.

Per microeconomics theory, supply and demand determine prices and quantities of market consumption for goods and services. In general, marginal cost of production or supply per unit of a particular good or service is increasing, while marginal benefit of demand or consumption per unit of the good or service is decreasing. In a perfect competitive market, price for a particular good will vary until it settles at a point where the quantity demanded by consumers at the current price equals the quantity supplied by producers at the current price, resulting in an economic equilibrium for price and quantity. Four basic laws of supply and demand apply in such as market. They are (1) if demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price; (2) if demand decreases and supply remains unchanged, a surplus occurs, leading to a lower equilibrium price; (3) if demand remains unchanged and supply increases, a surplus occurs, leading to a lower equilibrium price; and (4) if demand remains unchanged and supply decreases, a shortage occurs, leading to a higher equilibrium price.

In a power industry without government intervention, a power firm tends to use the cheapest technologies and fuels, such as coal-fired power generation technologies to generate electricity to meet the market demand for power (Curve S1 in Figure 1). Curve S1 simulates the baseline of the power development project, namely what would happen if the GEF or the government does not do anything in the market. In the meantime, the power firm has an option to provide green power, namely solar power to meet the demand (Curve S2 in Figure 1). The solar power generation technology in most countries today is more expensive than coal-fired power generation technologies since the external costs of coal-fired power plants are not accounted.  Curve S2 simulates production costs of solar power generation technologies.  The additional costs between the two technologies are C2 less C1. In the GEF, we call it as project incremental costs. These costs are different from marginal costs of production. The marginal cost of production is the change in total cost that comes from making or producing one additional unit of good or service. For example, C3 less C4 is the marginal cost of production of the solar power generation technology if Q4 less Q3 is equal to 1.

The GEF provides grant to cover incremental or additional costs (but not marginal costs). With the support of the grant, the firm may invest in solar power technology rather than in coal-fired power technology. This takes place particularly when the government has a policy to regulate the power firm for green power technology development. Generally, there is policy development component in a GEF project. Once the solar power technology is financed and developed to replace the coal-fired power technology, greenhouse gas (GHG) emissions are mitigated and global environment benefits are generated.

 

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Figure 1 Model of power demand and supply market

 

Since 1991, the GEF has financed over 3200 projects, and many of which are in climate change mitigation. The GEF recipient countries have received over $3.68 billion GEF grant for climate mitigation projects. On average, every one GEF dollar investment in climate change area mitigated one tonne of carbon dioxide equivalent (CO2e) and leveraged eight dollars of co-financing from developing countries and countries with economies in transitions. The GEF will continue financing green technologies to reduce CO2e emission and protect the global environment. For more information, please visit http://www.thegef.org/gef/