The private sector's capacity to manage climate risks and finance carbon neutral energy infrastructure

Abstract

This dissertation examines the financial aspects of climate change relating to the private sector's capacity to manage climate risks and finance carbon neutral energy infrastructure. The dissertation examines (a) potential risks posed by climate change to private sector investment in critical infrastructure, (b) the potential effectiveness of standard private contractual methods for mitigating risks posed by climate change, (c) the capacity of private capital markets to finance carbon neutral energy infrastructure, and (d) the potential for market failure in developing carbon neutral energy infrastructure. The dissertation first identifies climate risks to infrastructure by examining scientific evidence concerning climate change from studies and atmospheric models. Based on this data, it modifies a framework widely used by practitioners in the finance field for purposes of evaluating financial risks in infrastructure projects. Using the modified risk assessment framework, the dissertation identifies financial risks posed by climate change to financing and developing infrastructure. The dissertation then assesses whether these climate risks can be mitigated and managed by employing private contractual methods typically used in infrastructure finance, such as insurance, derivatives, and carbon offsets.

(cont.) Each contract is evaluated based on the following six criteria: (a) scope of risk covered, (b) geographic coverage, (c) contract duration, (d) availability, (e) price, and (f) market capacity. Based on these criteria, the potential for these private contractual methods to address long-term climate change risks is assessed. The evaluation of climate risk and methods to address these risks are similar to the identification, allocation, and mitigation of risks that is commonly preformed by banks and project sponsors in order to evaluate the risks of an infrastructure investment. The conclusion of the dissertation's analysis is that climate risks will pose fundamental problems for infrastructure finance, including that no party may be best positioned to accept and mitigate climate risks, and that private contractual methods typically used by the private sector will be inadequate to address climate risks in a comprehensive and cost-effective manner. If this is true, climate risks should reduce the private sector's willingness or ability to invest in or develop infrastructure. The risk assessment analysis will be supplemented by three case studies focusing on different financial aspects of climate change in sectors of the economy that are critical to developing carbon neutral energy infrastructure:

(cont.) (i) the capacity of capital markets to supply adequate investment capital to develop a portfolio of carbon neutral electricity infrastructure providing 10-15 TW of power within a 50-year period, (ii) the financial effects of increasingly intense storms on the electric utility industry in the Eastern United States from 1990 to 2005, and (iii) the financial effects of the increasing frequency and intensity of natural catastrophic events on the insurance industry from the 1970's to 2005, especially in connection with underwriting risks for energy infrastructure. The research is supported by a survey of the insurance, derivatives, banking, and energy industries with respect to their use of private contractual risk management methods and an examination of the models used to price these contractual instruments. This dissertation is intended to contribute to economic and policy literature concerning climate change by providing an analysis of how the financial aspects of climate change might influence the capacity and willingness of the private sector to invest in carbon neutral energy infrastructure.