Advance Market Commitments for Climate Change

Some considerations for an AMC in the climate context

Outline
Advance Market Commitments and general pull-mechanisms (‘AMC+’) in climate finance.
Lessons from the vaccine AMC for the climate context.
An analogy, and its limitations.

AMC or ‘AMC+’...?
Pull-mechanisms or ‘AMC+’
A mechanism that provides a value enhancement to overcome uncertainty over whether investment costs can be recouped.
AMC
A pull mechanism that seeks to create a sustainable market by subsidizing demand in exchange for capacity creation.
X-prize Renewable energy standard No demand subsidy Feed-in tariff Original AMC Demand subsidy No dedicated capacity Requires dedicated capacity

AMC+ climate applications must seek to leverage private funds.
Current climate funding commitments:
Funds are scarce;
Many rival uses, from forests to adaptation;
Not clear how much funding is new;
Not clear how reliable.
Therefore:
Where possible, invest public funds to reach tipping point where markets become sustainable.
Source: WDR 2010, Copenhagen Accord. Climate funding commitments vs. need estimates $63bn $300bn $100bn $10bn

How to learn from the vaccine AMC
A key lesson of the vaccine AMC is that the specific product, market, industry, and policy context matter!
Do not try to just transplant the concept.
Rather, define the project, then tailor a financing instrument.

The original vaccine AMC is complex…
Supply commitments sought for 200m doses annually for 10 years
With tranching
AMC subsidy entitlement (proportional to supply commitment)
Rate of subsidy
Demand guarantee
Tail price ceiling
The principal goal: create a viable market that sustainably serves poor countries.

… this was made necessary by diverse challenges in the market environment
Problematic market features:
Indivisibilities in capital investment
Demand risk and asymmetric information on demand
Asymmetric information on cost
Strong market power:
Only two players in the short run, one assumed to have higher unit cost
Possibility of entry
In principle, addressing complex market failures is a strength of AMCs

Writing the AMC contract required a good sense of many parameters
Overall supply commitment size (driven by need estimates)
Tranche size (driven by timing of entry)
AMC subsidy entitlement (driven by capital investment cost)
Rate of subsidy (driven by signaling effect)
Demand guarantee (driven by industry risk perception)
Tail price ceiling (driven by marginal cost)

Both demand and cost curves were fairly well understood in the Pneumo AMC (demand more so).
Demand projections were the result of close cooperation with developing-country counterparts, and intimate knowledge of the policy environment.
Yet, it still proved hard to get the parameters right.
There are risks in AMCs:
Non-participation;
Windfall profits.
Understanding demand and cost well is crucial in limiting risk.
A lesson for climate AMCs: know the industry and the policy environment Source: GAVI Strategic Demand Forecast, 2009

Social efficiency facilitated decision-making
Uncertainty over cost estimates – could reduce it, but not eliminate
Market power: needed to get several firms to bid
Very high and robust social value
Therefore: precaution called for maximizing the likelihood of success, rather than marginally reducing cost
AMC subsidy per unit of capacity Tail price Social efficiency of AMC investment ($ per DALY) Robust efficiency Robust efficiency Source: adapted from World Bank, 2009 $4.00 $33 $3.50 $3.00 $2.50 $2.00 $10.00 $7.50 $6.00

Another lesson for climate AMCs: know the product’s social returns
Because of asymmetric information, and/or because technology is not yet there, uncertainty will remain despite due diligence
It will generally be hard to answer the question “what are the optimal parameters?”
IF social efficiency of the proposal is high and robust, it is enough to answer the question:
“ Are the proposed parameters reasonably efficient and have a chance of leading to a successful AMC?”

Two possible analogies for an AMC in the climate context – and their limitations

Two possible analogies for an AMC in the climate context – and their limitations
An analogy based on good social returns: robust off-grid renewable energy.
A different analogy, based on knowledge of the policy environment: support for uncertain government FiT.

An analogy based on good social returns: robust off-grid renewable energy
High social returns;
Clearly defined need;
Contract could require long-term delivery/maintenance to force capacity dedicated to developing countries.
Indivisibilities in research cost incurred to adapt product to low-cost, locally maintained deployment;
Market test inherent in AMC may be better suited than X-prize to ensure technology is robust.
Thought experiment: is a traditional AMC suitable for financing off-grid renewable energy in developing countries that can be installed, operated and maintained with local capacities?

Limits of the analogy
A very different market, with far less market power;
Social returns may be less clear in comparing clean tech v. traditional off-grid;
Hard to monitor performance;
Need may be less clear in long-term, as grids may expand.
Product characteristics are less naturally defined than for vaccines:
Offer contract for a specific technology?
Or request general “off/micro-grid technology with certain generating capacity, at certain cost and emissions level and certifiably (by whom?) suited for local O/M”

A different analogy, based on knowledge of the policy environment: support for uncertain government FiT
Many developing countries are legislating market incentives for clean energy, such as FiT.
However, suppliers often perceive uncertainty over:
Whether funds will be allocated to these subsidies;
Whether the physical and administrative infrastructure will be in place.
Could think about leveraging strong existing engagement with power sector in developing country for an AMC or AMC+ support.
There is of course moral hazard (for the government) in this scheme.
This is also the case with the vaccine AMC – governments must pay their part;
The scheme is only viable if donors have confidence in counterpart capacity and intentions;
It will be very much easier to consider if the social benefits are high and robust.

Takeaway message

Some good questions to ask in approaching a climate AMC
Basic conditions for an AMC:
Is there a market failure due to uncertainty over recouping investment?
Do we know the demand and cost curve for the product well enough to reasonably size the AMC?
Narrow down candidate AMCs:
Is the social return high and robust?
Do donors have a knowledge/trust advantage on government policies?
Make sure AMC has a comparative advantage:
Has the market failure frustrated other efforts to incentivize clean technology?
Is the investment eligible for funding under other financing mechanisms?

Takeaway points
For pull-mechanisms (AMC+) in the climate area, leveraging private funds is key;
A full-fledged AMC like vaccine AMC is powerful, because it can address multiple market failures;
But the structure is complex;
And there is both political and non-performance risk in AMCs;
Getting it right requires a good knowledge of the details:
Product;
Market;
Industry;
Policy environment.
So, think carefully about whether to apply an AMC, and tailor it to the desired purpose.

Advance Market Commitments for Climate Change

by cgdev on Mar 16, 2010

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