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Mobilise funds now to avoid the big cheques

The cost of the energy transition as it stands is astronomical. But the returns are even greater. The longer investment targets are missed and policy frameworks are neglected, the pathway to a decarbonised economy becomes longer and more expensive. Added support for the developing world is also needed

Global investment in climate funds is skewed towards developed nations, leaving emerging markets wanting


HUGE POTENTIAL
Returns from investing in the energy transition are substantial SLOW CHANGE
Despite having the desire to invest in green, banks and investors with fossil fuel investments are finding it hard to shift KEY QUOTE
There is a pervasive misconception that switching to clean, green energy will be painful, costly and mean sacrifices for us all—but that’s just wrong


The global opportunities for financial returns are vast. As former Bank of England governor Mark Carney has said, a net zero emissions future will allow banks, fund managers and insurers to invest in private sector plans and profit from the greatest commercial opportunity of our time”.

He added, in an address in 2020 at the Green Horizon Summit in London: Building a sustainable future will be capital intensive after a period when there’s been too little investment. It will be job heavy when unemployment is soaring.” Carney has been a UN special envoy for climate action and finance since 2019.

Investment in the energy transition is trickling. In 2020, investment for all energy was $2.5 trillion, with $1.4 trillion of that in clean energy, says Jonathan Coppel, an economist and head of the International Energy Agency’s (IEA) energy investment unit.

Clean energy investment has been accelerating for the past several years. Since 2020, overall growth has been 8% per annum, Coppel says, while clean energy’s growth has been 12%. Energy use accounts for 83% of the CO2 emitted across energy and land-use systems, according to a report by McKinsey, a consultancy.

Meanwhile, asset financing for renewable energy, electrified transport and electrified heat—the funding of projects and infrastructure—was $471 billion in 2020, according to the latest Climatescope report from BloombergNEF, the energy research arm of financial media service Bloomberg. This was up 11% from 2019 and annual volumes have more than doubled since 2013, it added.

Renewable energy accounted for 60% of that total in 2020. China, the US and Germany accounted for over half of 2020 investment. Not surprisingly, China, at $144 billion, was nearly a third of the total. The US followed at 17%, down from $84 billion in 2019 to $79 billion. Meanwhile, at $27 billion, Germany provided a 6% share.

Road to green Nearly a third of renewable energy investments were made in China in 2020


SLOW CHANGE

However, this investment is not enough. Gillian Lofts, the global sustainable finance leader at EY, a professional services firm, notes an estimated $32 trillion in investment will be needed by 2030 and $92 trillion in the subsequent two decades to reach net zero by 2050. She recalls that Carney called for $190 trillion by 2050. This includes investment for the circular economy, efficiency and adaptation as well as the energy transition.

By 2030, energy transition investment would need to be $3 trillion a year to keep the world on track for limiting global warming to 1.5°C, says the IEAs Coppel. This is more than double the amount in 2020, he notes.

For a net-zero scenario in 2050, more than $4 trillion per annum in investment until 2030 is needed, says IEA. The pace certainly needs to pick up. We also need to avoid a massive uptake in fossil fuels,” says Coppel.

RISK AVERSION

However, it is not the appetite of investors that is an issue, but other real and perceived risks. Renewable energy projects are capital-intensive compared with oil and gas and are especially sensitive to politics and policy risk in a country,” says Sonia Dunlop at E3G, a London-based climate NGO.

It is in much of the developing world that the influx of money—private and public—is lagging. The cost of capital in the global South is higher, financial systems are less developed and public financial institutions must play a greater role in de-risking investment.

Annual clean energy investment in emerging and developing economies needs to increase by more than seven times—from less than $150 billion in 2020 to more than $1 trillion by 2030 in order to put the world on track to reach net-zero emissions by 2050, according to the IEA.

Developing and emerging economies may account for two-thirds of the world’s population but attract only one-fifth of investment in clean energy and just one-tenth of global financial wealth, the IEA adds.

COSTLY TRANSITION

The energy transition is often seen as overly costly in economic terms, according to a number of individual forecasts.

The 2022 Sixth Assessment Report of the United Nations Intergovernmental Panel on Climate Change estimated that the additional cost of decarbonising the energy system to have a greater than 67% chance of keeping warming below 2°C corresponds to a global Gross Domestic Product (GDP) loss in 2050 of 1.3%–2.7%.

Meanwhile, McKinsey estimates that the fully-loaded unit cost of electricity production—operating and capital costs plus depreciation of new and existing assets—would actually rise about 25% from 2020 to 2040 under the net zero by 2050 scenario put forward by the Network for Greening the Financial System (NGFS), a network of 114 central banks and financial supervisors.

The cost could still be about 20% higher in 2050, says McKinsey, though technological advances could blunt this impact. The delivered cost could also fall below 2020 levels over time if flexible, reliable and low-cost grids are built, the report adds.

Finally, Wood Mackenzie, a research company, finds that keeping warming to 1.5°C would shave 2% off its base-case GDP forecast for 2050. But as costs come down, transition technologies will become more competitive than high-carbon alternatives, it says. We think the turning point will be around 2035, after which global GDP growth will outpace our base case, meaning lost economic output could be recouped by the end of the century,” the report concludes.

Some economies will feel the effects more than others. Hydrocarbon-exporting and carbon-intensive economies are likely to see the biggest hits to economic output, while less developed and low-income economies will bear a disproportionally high burden.

Of course, economies that are already closer to net-zero targets will see a smaller economic impact from now to 2050, the report continues. And those that are better positioned—typically wealthier economies with a strong propensity to invest in new technologies—may even benefit economically by 2050, it says.

OVERBLOWN PREDICTIONS

But the global cost is often overestimated, according to a new peer-reviewed study using probabilistic cost forecasts by University of Oxford researchers, published in the journal Joule. Transitioning to a decarbonised energy system by around 2050 could actually save the world at least $12 trillion, compared with a scenario in which current levels of fossil fuel use continue, says the study.

A decarbonised energy sector would not only result in lower energy system costs than a fossil fuel system—by ramping up solar, wind, batteries, electric vehicles and clean fuels such as green hydrogen—but it would also provide more energy to the global economy and expand energy access to more people worldwide.

There is a pervasive misconception that switching to clean, green energy will be painful, costly and mean sacrifices for us all—but that’s just wrong,” says J. Doyne Farmer, a mathematics professor who led the research at the Institute for New Economic Thinking at the Oxford Martin School.

Renewable costs have been trending down for decades,” he says. They are already cheaper than fossil fuels in many situations and our research shows they will become cheaper than fossil fuels across almost all applications in the years to come. If we accelerate the transition, they will become cheaper faster. Completely replacing fossil fuels with clean energy by 2050 will save us trillions,” Farmer adds.

In models projecting a higher cost of the energy transition, researchers often underestimate how fast the cost of renewables can drop and how fast they can be deployed. He explains that there is too little systematic knowledge of technological change or the exponential growth rate of renewables technologies. There is also a problem of incumbency. Fossil fuel and nuclear have all tried to spin this in their favour and spread lots of misinformation,” Farmer says.

Elsewhere, a report by the IEA and International Monetary Fund from May 2021, found the surge in private and government spending on clean energy technologies in the net zero by 2050 scenario creates a large number of jobs and stimulates economic output in the engineering, manufacturing and construction industries. This results in annual GDP growth during the latter half of the 2020s that is nearly 0.5% higher than the levels of current climate policies, says the study.

WIND ALONE

The benefits of CO2 reductions from increased wind power alone by 2050 are estimated at $386 billion, similar to Norway’s GDP, says another report by -KPMG, a professional services network, commissioned by wind turbine manufacturer Siemens Gamesa Renewable Energy.

Accelerating the uptake of wind energy would slash pollution, save lives and preserve vital water resources, says the report. KPMG found that wind power could increase its contribution to global electricity demand nine-fold by 2040 to 34% from 4% in 2019. Moreover, wind generation could account for 23% of the required reduction in carbon emissions by 2050: 5.6 billion tons of CO2, equivalent to the annual emissions of the 80 most polluting world cities.

This reduction would have real benefits for society, with increased renewable energy use saving up to four million lives a year and reducing health-related costs by up to $3.2 trillion dollars. Air pollution is thought to be the fourth leading risk factor for early death worldwide. In 2019, air pollution killed 6.75 million people, according to the Health Effects Institute and the Institute for Health Metrics and Evaluation.

JOBS GROWTH

In a net zero by 2050 scenario, jobs would increase in number across the board, although obviously there will be losses in sectors such as fossil fuels, which will not be spread evenly geographically, Wood Mackenzie notes. According to the IEA, energy jobs growth outweighs declines in the fossil fuel sector in this scenario.

The IEA estimates that 14 million new clean energy jobs will be created by 2030, while another 16 million workers shift to new roles related to clean energy. More energy self-sufficiency also means that more jobs will be created locally, says Kingsmill Bond at the Rocky Mountain Institute (RMI), a US think tank. Eight out of ten people live in countries that import fossil fuels, he says.

GLOBAL DIVIDE

A central issue, however—in terms of the availability of finance—is the disparity between the developed world and emerging or developing nations. The current energy crisis, hastened by the war in Ukraine, and Covid-19 pandemic have only exacerbated this.

According to BloombergNEF’s Climatescope report, in 2020 the world’s wealthier nations accounted for 57% of asset finance for renewables, electrified transport and electrified heating—around $262 billion—up from 41% in 2017. With $195 billion, emerging markets accounted for just 43% of the total, down from 53% in 2019 and a peak of 59% in 2017.

The funding gap cannot be bridged just by public institutions and private investment must be leveraged, says Kate Levick, who leads sustainable finance activities at E3G.

BANK RESISTANCE

Additionally, private institutions may push back, Levick notes, citing the major Wall Street banks threatening to leave Mark Carney’s Glasgow Financial Alliance for Net Zero (GFANZ). The banks still have a sizeable portfolio invested in fossil fuels and are finding it hard to shift quickly, says Levick.

GFANZ, set up in 2021 by Carney, is a coalition of 500 banks, asset managers and insurance companies with a reported $130 trillion in assets for tackling climate change.

Bank of America, Morgan Stanley and JPMorgan are among those who say they might exit the coalition because they fear being sued over its strict climate commitments, reported the Financial Times newspaper in late September 2022. The banks are reportedly concerned about demanding strict targets on phasing out coal, oil and gas investments introduced over the summer by the UNs Race to Zero campaign.

They are also anxious about imminent US regulatory rules on disclosure of climate risk for publicly traded companies by the Securities and Exchange Commission. In 2021, lenders already successfully resisted GFANZs demand that they immediately end financing of new fossil fuel exploration projects.

INTERNATIONAL FINANCE

Nor are multilateral banks leading enough, in large part because of internal inertia and political considerations, says E3Gs Dunlop. They are not fulfilling their role as change agents of the global financial system,” she says.

Multilateral bank leaders may act as blockers to progress. David Malpass, president of the World Bank and an appointee of former US President Donald Trump, refused to say that fossil fuel emissions are causing climate change at a public meeting as recently as September 2022.

NGOs were in an uproar and even Christiana Figueres, the former UN climate chief and a key player in the 2015 Paris climate agreement, tweeted: It’s simple. If you don’t understand the threat of climate change to developing countries you cannot lead the world’s top international development institution.”

The unfortunate comments by one individual should not overshadow the wider need for developed countries to adequately recapitalise Multilateral Development Banks and replenish the multilateral climate funds,” said Iskander Erzini Vernoit, a climate finance expert and former COP negotiator for Morocco.

COST OF CAPITAL

The cost of capital, based on risks and perceived risks, is crucial to the global disparity of climate finance. IEA analysis suggests that the cost of capital for a utility-scale solar PV plant in 2021 in key emerging economies was between two and three times higher than in advanced economies and China.

As a result, financing costs accounted for around half of the total levelised costs of a solar photovoltaics plant in these economies, notably higher than the 25% to 30% seen in advanced economies and China.

New IEA estimates suggest that reducing financing costs by 2% would bring down the investment needed to reach net zero emissions in emerging and developing economies by a cumulative $16 trillion by 2050.

Risks could be managed differently, suggests the IEAs Coppel. A multilateral development bank could guarantee a project’s income in case a power purchase agreement falls through. Blended financing—a mix of public and private—could also work well, he says. Speeding up permitting (page 30) and access to land would help reduce total costs.

Funding mismatch Investment in the developing world is lagging behind


LOCAL SUPPORT

The regional development banks should also be proactive. The African Development Bank recently proposed a plan to South Africa for $8.5 billion in climate financing—to help stop the country end its use of coal—pledged by the US, UK, Germany, France and the European Union.

The bank recommends South Africa place the funds in a special purpose vehicle (SPV), President Akinwumi Adesina told Bloomberg. The SPV can then obtain a credit rating and sell zero-coupon bonds to raise more funds—perhaps as much as $41 billion, the president told the news service.

To build momentum for climate finance in emerging markets, other governments and public banks must lead to help leverage private financing. In an age of multiple overlapping crises, meeting the global financing challenge at scale requires developed country governments to do better at working together across their ministries responsible for development, climate and finance with active guidance by leaders,” says Erzini Vernoit.

In September 2022, Nana Addo Dankwa Akufo-Addo, President of Ghana, called for urgent reform of the international financial system because the current monetary system is skewed against developing countries.

The financial markets have been set up and operate on rules designed for the benefit of rich and powerful nations, and, during times of crisis, the façade of international co-operation, under which they purport to operate, disappears,” Akufo-Addo said.

Erzini Vernoit believes the COP27 climate talks to be held in Egypt in November 2022 should be used to help secure the necessary changes and support from developed economies. A continuation of status quo climate finance budgets will not cut it, not during this critical decade in the history of life on Earth. COP27 should serve as a wakeup call for the wealthier countries to get their act together on financing a transition to safety, in a time of multiple deepening and unequal crises,” says Erzini Vernoit.

POLICY ENVIRONMENT

RMIs Bond believes establishing better policies in these emerging markets will help attract international fiscal support. He cites the examples of Vietnam and Morocco where helpful regulatory frameworks saw increased foreign investment—particularly in the wind energy sector. This is a policy issue not a capital issue.”

Bond also cites BloombergNEF’s Climatescope report as showing that countries which enable the right policies get the money and those with no policy framework get very little. Capital for investing in the energy transition is not in short supply, he continues, but what are lacking are good regulatory regimes.

The bottom line is that investors will invest where the growth and the opportunity lie,” he says. That is obviously in renewables now. And that is why the cost of capital in renewables has been falling and that of fossil fuels has been rising.” •


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