How to use SVMAs to reduce the Carbon Pricing and Climate Finance Gap: numerical illustrations

A temporary gap is generated by the difference between the Social Value of Mitigation Activities (SVMA) and implementable carbon prices. A spectrum of options are available to handle this. These options encompass policy instruments that give different weights to ‘command and control’ measures and to economic incentives.

We analyze here how to combine an explicit carbon price that rewards mitigation activities every year and a notional price embedded in devices that reward low carbon investments beforehand through lowering their risk-weighted capital costs.The latter option is essential in order to hedge against two uncertainties that adversely affect technologies having high capital costs1.

The first relates to technologies which are at the beginning or mid-way of their experience curve. The second relates to the net signal launched by explicit carbon prices given the presence of noises that swamp it. We first illustrate, based on five case studies, the equivalence curves between carbon prices and percentages of reduction of capital costs.

We argue then that a notional price equated to the SVMA can maximize the economic efficiency of financial devices that reduce the capital costs of a low carbon project and we discuss the necessity of a world SVMA and of national SVMAs. We then introduce uncertainty in the analysis and show that contingent risks theoretically need carbon prices to grow to a level well beyond their political acceptability.

Reducing the risk-weighted capital costs and rewarding upfront low-carbon investments at the present value of the SVMA is an efficient way of overcoming these barriers.Finally, we show, in the case of India, how to assess a national SVMA that includes the climate benefits and the development co-benefits of mitigation activities.

We then discuss how to articulate a World SVMA (paragraph 108 of the Paris Decision), national SVMAs and explicit carbon prices (in line with NDCs) to bridge the funding gap, tackle the ‘100G$ and +’ issue, and maximize the gains of cooperation around climate policies.