Can result-based climate finance speed up the oil phase-out?

In the last 15 years, climate finance has evolved considerably, witnessing the emergence of innovative international collaboration tools aimed at combating climate change. Significantly, certain mechanisms within climate finance hold promise in accelerating the transition away from fossil fuels, responsible for 80% of CO2 emissions.

I) Carbon markets

There are valid reasons to approach carbon markets skeptically, and research has documented the intricacies of controversies surrounding REDD+ projects. However, recognizing the imperfections, it's possible to view carbon markets as pathways for a desirable end. It makes sense for companies and states to reduce their carbon emissions to actively offset the fundamental emissions. 

A) Voluntary carbon markets

Individuals and companies can voluntarily purchase carbon credits to offset their carbon emissions. Leading NGOs like Verra, ACR, and Gold Standard endorse methodologies for carbon credit generation and oversee registries facilitating credit registration and trading. Projects encompass a variety of initiatives, spanning from renewable energy projects and forest protection to cookstove initiatives, among others. Since 2020, approximately 100 million credits (equivalent to 100 MT CO2) have been retired annually. McKinsey projects that the worldwide demand for carbon credits could surge to 1.5 to 2.0 GtCO2 by 2030.

The Voluntary Carbon Market is already targeting the fossil fuel supply side. For example, the Energy Transition Accelerator (ETA) framework, introduced by the U.S. Department of State, the Bezos Earth Fund, and The Rockefeller Foundation, encourages private investment energy transition strategies using new jurisdictional-scale carbon credits. This includes the Coal to Clean Credit Initiative (CSI), creating a roadmap for carbon credit generation through the phased retirement of coal plants and replacement with RES. One similar initiative could be imagined to prevent the opening of new oil wells.

B) Article 6 mechanisms

Additionally, the Paris Agreement's Article 6 supports the establishment of a public international carbon market. Under Article 6.2, countries can voluntarily trade emission reductions and removals (ITMOs) through bilateral agreements, counting them towards their Nationally Determined Contributions (NDCs). Article 6.4 aims to create a global carbon market overseen by a United Nations 'Supervisory Body.' Although these markets are still in their infancy and not yet fully operational, they hold considerable promise.

Ghana, Switzerland, and Vanuatu have collaboratively approved the first-ever voluntary ITMO cooperation under Article 6.2. Switzerland is committed to reducing emissions through sustainable practices in Ghana and providing renewable energy access in Vanuatu. Those collaborations are expected to be more and more frequent in the coming years. They could be swayed to help oil-producing countries wean off of oil: Could Norway financially incentivize Timor Lest through ITMOS to relinquish future oil developments?

II) Just energy transition partnerships

Just Energy Transition Partnerships (JETPs) have emerged as a budding financing collaboration between developed and global South countries, primarily aiming to assist heavily coal-dependent regions in achieving a fair energy transition. The contributing nations, forming the International Partnership Group (IPG), actively seek to leverage their investments by engaging with multilateral development banks, the private sector, sovereign wealth funds, and philanthropic foundations. Funding mechanisms encompass grants, subsidies, concessional loans, guarantees, export credits, and technical assistance.

The first JETP partnership was unveiled in 2021 at COP26, with South Africa securing substantial financing of USD 8.5 billion from the UK, the US, France, Germany, and the EU to achieve a coal phase-out by 2050. The addition of Senegal, a nation with minimal coal usage, has expanded the partnership's scope, potentially making the model applicable to all fossil fuel-dependent nations. Western countries have stated their ambition to multiply the use of JETPs, and one day, they will be directed toward the oil phase-out. 

III) Debt-for-climate-swaps

Debt-for-climate swaps represent a strategic mechanism wherein the alleviation of debt burdens coincides with a debtor country's dedicated commitment to climate-related spending and policies. The most pertinent scenario for such swaps arises when climate adaptation proves to be efficient, fiscal risks are elevated, yet the debt is not inherently unsustainable. In such instances, the budgetary impact does not exceed the debt reduction, concurrently addressing climate and debt challenges and averting reputational costs and economic dislocations associated with traditional comprehensive debt restructuring.

For example, The Belize 2021 debt restructuring involved the government of Belize, TNC, the US Development Finance Corporation (USDFC), and commercial creditors holding a sovereign bond with a face value of $553 million (about 30 percent of GDP). Using the proceeds of a “blue bond” issued to the market, a subsidiary of TNC arranged a “blue loan” to the Belize government to finance a bond-for-cash exchange at 55 cents per dollar of face value. On its part, Belize agreed to use part of the debt relief to pre-fund a $23.4 million endowment supporting marine conservation. It also committed to spending $4.2 million annually on marine preservation and expanding its protected ocean area from about 16 percent to 30 percent by 2026. Currently, these deals primarily focus on nature conservation. However, they hold potential for adaptation to assist oil-producing countries in seeking economic alternatives to oil extraction.