INSIDER: Development Bank Investments in Electricity Transmission and Distribution Should Align with the Paris Agreement

Parties to the Paris Agreement have committed to "making finance flows consistent with a pathway towards low GHG emissions and climate-resilient development.". As we have argued elsewhere, this means that multilateral development banks should shift from a climate finance paradigm to a Paris alignment paradigm, which means not only scaling up climate finance, but making sure their entire portfolios are Paris-aligned and help advance the transition toward a net zero-carbon economy.

The energy sector is central to this process of decarbonization. To stay within 1.5° C (2.7° F) of warming, the world must completely phase out the use of unabated fossil fuels for electricity by 2050. By that time, electricity must be primarily generated from solar and wind.

It is especially critical that energy-sector infrastructure is Paris-aligned, given the large carbon lock-in potential of investments and the scale of investment needed in the coming years in the developing world.

We know that the sources of electricity need to shift from fossils to renewables. However, to achieve this shift, we also need to make sure that electricity transmission and distribution (T&D) investments are also Paris-aligned.

Development banks have a key role to play in that transition. But so far, they are not doing all they could to align T&D investments with the Paris agreement. Here we outline a methodology to help them do so.

Why Does T&D Matter?

While there have been some recent efforts to assess the alignment of energy-sector investments, including electricity generation, with the Paris Agreement, previous assessments simply considered T&D investments conditional, with no further project-specific evaluation. Other climate finance tracking efforts, although not explicitly focused on alignment with 1.5/2°C, have generally considered T&D to be climate or clean-energy finance if the investment facilitates renewable energy and/or reduces energy use or electricity losses.

However, a specialized methodology for T&D investments is needed to fully appraise the alignment of energy-sector investments. First, T&D is very prominent in multilateral development banks' (MDBs') energy portfolios. For example, T&D projects constituted around half the total volume of financing and about 40 percent of the total number of energy projects for both the ADB and World Bank in a recent study. Second, many MDB T&D investments are stand-alone projects separate from electricity generation projects.

Methodology for Assessing Paris Alignment of T&D

In our new paper, we have proposed a methodology to assess Paris alignment of T&D investments based on three factors: (1) the need to adopt a systematic approach that assesses T&D in the context of a larger energy system, (2) the imperative of factoring in high-emissions lock-in risk, and (3) the importance of considering broader, country-specific climate plans and strategies. This methodology is focused on screening of projects, but in aggregate, it would allow one to assess the alignment of the overall energy portfolio.

Most T&D projects would consist of multiple components and investments. These T&D project components can be classified into only two types. The first type involves investments in dedicated transmission and distribution lines for a single power generation source that connect it with the grid. The Paris-alignment in this case depends on whether it supports a power plant that is zero-carbon (aligned), unabated coal (without carbon capture and storage) (misaligned), or other generation.

The second category would include general T&D technologies that do not support a particular power plant, for example, investments in new or upgraded transmission lines for several power stations or across the entire grid or entire country, substations, transformers and converters.

An important point to note is that T&D technologies by themselves are carbon-emissions agnostic and can carry power from any source. While certain T&D technologies will need to be scaled up to enable a high degree of integration of renewables or more distributed sources, such as high voltage direct current (HVDC) transmission lines or smart grid technologies, both of these technologies can also convey fossil power.

In the case of T&D investments that don't support a single power source or support fossil fuel generation other than unabated coal, to be considered aligned, the project component would need to be supported by a two-step climate and economic analysis:

1. Justification with a shadow carbon price. This would involve using a robust carbon price in a social cost-benefit analysis (CBA), with prices in-line the High-Level Commission on Carbon Prices recommendation of $40–80 per ton CO2 by 2020 and $50–100 per ton CO2 by 2030. It is important that a project with the highest net present value (NPV) among a set of reasonable and feasible alternatives, not just a positive NPV, is selected. For example, a T&D project that reduces electricity loss on a highly carbon-intensive grid with a goal of expanding access might have positive net benefits, but an alternative that consisted of renewable energy generation with new distribution might be even better, with the price of carbon included.
2. Consistency with long-term decarbonization plans for the electricity sector. Every T&D investment component or overall project would need to explain credibly, in a qualitative fashion, how the project will help facilitate long-term decarbonization of the electricity sector, as set forth in a country's long-term strategy submitted to the UNFCCC or other comparable sectoral plan. Showing how a T&D project is congruent with a country's Nationally Determined Contribution (NDC) would not be sufficient in and of itself. The first set of NDCs are only for the period up to 2030 and collectively fall short of the mitigation needed to keep warming within 2°C as laid out in the Paris Agreement.

The two criteria ensure that alignment considers the near term (15 to 20 years) project economics (inclusive of a carbon price), while avoiding long-term carbon lock-in. Based on recent developments in carbon pricing and the expectation that many countries will submit long-term strategies to the UNFCCC by 2020, we do believe that trends are in the right direction. Many development banks already employ carbon pricing and there is the expectation that many countries will submit long-term strategies by 2020. In the absence of either the incorporation of shadow carbon pricing into CBA or a long-term decarbonization plan, T&D projects not dedicated to supporting a zero-carbon generation source will remain classified as misaligned.

Recommendations for Development Banks

The immediate action development banks can take it to ensure a shadow carbon price is incorporated in cost-benefit analyses and has a determinant impact on project approval. These institutions should begin to disclose the cost-benefit analyses of both the selected project and alternatives in the project documents. MDBs should ratchet up ambition and adopt prices in accord with the ranges put forth by the High-Level Commission on Carbon Prices.

Beyond this, MDBs should help recipient countries develop more robust climate-change commitments, including long-term decarbonization plans. Once these are in place, the development banks then need to justify in publicly available documents how T&D—and, ultimately, all—investments are congruent with these long-term decarbonization plans.