The adaptation imperative

Financing requires rethinking infrastructure risk, value creation

Posted by MIRA Funds

Sep 09, 2019



Overview

The effects of climate change are now so profound that simply building more green projects and changing behaviours are not likely to be enough.

With the risk that global temperatures climb by as much as 3°C above pre-industrial levels by the end of this century,1 an increasing number of academics and climate experts are advocating for large-scale efforts to adapt our societies, including critical infrastructure, to the realities of a warmer world with less predictable weather.

Effective climate change adaptation calls for significant shifts in the way we plan, design and finance communities and related infrastructure. Catalyzing finance for this shift requires a change in how we assess risk and assign economic value to future-proofing efforts. In order to invest for resilience, all stakeholders in the financing effort need to determine how to link adaptation benefits to revenues, cost-savings, risk reduction, and other quantifiable cash flows.


A long-term return

While some resilience investments will be capital intensive, adaptation offers an attractive long-term return. The Global Commission on Adaptation (GCA) estimates that investing $US1.7 trillion globally in adaptation from now to 2030 would yield more than $US5 trillion in net benefits, adding that adaptation investments have benefit-cost ratios ranging from 2:1 to 10:1.2

Climate change should be a fundamental consideration for anyone in infrastructure or public planning roles, said Christopher Leslie, Executive Chairman of Macquarie Infrastructure and Real Assets (MIRA), Americas. Recalling past conversations with a US government architect, Leslie said, “One of the key questions to anybody building new infrastructure is, which climate scenario are you building to? One degree, two degrees, three degrees, four degrees warmer? If you haven’t asked yourself that question, then you haven’t woken up to the problem or properly set out the investment case for the asset.”

 


 

Paying a triple dividend

Adaptation’s benefits are not exclusively limited to surviving a destructive storm or weather event. Instead, adaptation action offers a “triple dividend” – the social, environmental and economic benefits of investing in resilience.

An example of this is the Thames River Barrier, which helps protect 1.3 million people and $US275 billion in property value in greater London.3 After population growth and climate uncertainty created a water-stressed area, Thames Water built a desalination plant to increase the volume and reliability of supply. It has also built a large storage facility to address combined sewer overflow issues after storms.

Though the case for adaptation is compelling, the GCA report contends that most major investment and planning decisions made today do not consider climate change. “There’s a lack of appreciation of how much money could be saved through early or upfront spending on adaptation, given that climate change is going to be a persistent and ongoing phenomenon,” MIRA’s Leslie said. “There is going to be significant capital expenditure on recovery from climate change-related issues, which will drain GDP growth. Fiscal prudence and fiduciary duty demand that we invest in adaptation now rather than recovery later

Studies show that upgrading infrastructure to be more climate-resilient adds about 3 per cent to upfront costs. The return is particularly attractive in developing countries. The World Bank found that $US1 trillion in incremental spending to make infrastructure more resilient in developing countries would generate $US4.2 trillion in benefits.4

“One of the key questions to anybody building new infrastructure is, which climate scenario are you building to? One degree, two degrees, three degrees, four degrees warmer? If you haven’t asked yourself that question, then you haven’t woken up to the problem or properly set out the investment case for the asset.”


Transformative change needed

The GCA outlines four broad areas needed to transform the financing of climate change adaptation:

  1. Shift how investment decisions are made 
  2. Scale up and deploy public finance more effectively
  3. Scale up contingent finance and insurance mechanisms
  4. Harness private capital for resilience

To maximise benefits, adaptive principles should be built into investment and financing decisions from the beginning, not considered as an add-on after other financing decisions have been made. Resilience should be integrated into all infrastructure assets and systems throughout their lifecycles. Government institutions and agencies, developers, operators, owners, data providers and communities each play crucial roles.

Financial protection strategies, which combine financial reserves, pre-arranged credit and insurance, have a role to play in supporting the resilience of critical infrastructure. The GCA believes these measures will improve overall risk assessment, encouraging proactive risk reduction and enabling more rapid recovery post-disaster. Over the long term, companies that adopt sensible risk-reduction and management strategies will face lower costs of capital.

 


 

Changing the playing field

Another useful tool is the concept of “blended finance,” in which public and private sector institutions work together to incentivize capital flows into adaptation efforts. Private capital responds to commercially attractive, risk-adjusted returns. For example, models that link infrastructure with land value capture – which enables stakeholders to recover investment costs through land value increases – can help make adaptive measures more commercially rewarding and investable. 

While the challenges posed by climate change can be complex and require a high degree of coordination by multiple stakeholders across the public and private sectors, there is reason for optimism, said Brooks Preston, Managing Director at MIRA. “In many cases, we don’t need new technologies or new designs to solve it. It just takes another layer of investment discipline and systems thinking to merge the climate change implications with asset design and operations. We are seeing evidence that investors get rewarded for that discipline.”

 

Macquarie Group CEO Shemara Wikramanayake is a founding Commissioner of the Global Commission on Adaptation.


Keywords: Renewable, Energy

Find out more about Macquarie Asset Management.

1 https://www.unenvironment.org/resources/emissions-gap-report-2018

2,3 GCA report, September 2019 “Adapt Now, a global call for leadership on climate adaptation”

4 Lifelines: The Resilient Infrastructure Opportunity, Hallegatte, et al, June 2019, World Bank

 

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