The finance industry can actively lead and shape the transition to a low-carbon economy

New Zealand has long benefited from a high percentage of renewable electricity generated from hydropower and, increasingly, from wind. Electricity generation, which is currently 82% renewable on average, is responsible for 4.4 million tonnes of carbon dioxide equivalent (CO₂e), or 5% of New Zealand's emissions, whereas transport and process heat account for nearly 30%. Reducing emissions in the transport and industry sectors is therefore vital if we are serious about transitioning to a low carbon economy, and largely relies on switching from fossil fuels to electricity. A recent report of the Interim Climate Change Commission (ICCC) says this will require total generation from affordable renewable energy to increase from 82% to at least 92% by 2035, while at the same time reducing overall emissions —including avoided emissions in transport and process heat — by a net 5.4 Mt CO₂e. Historically, new generation has been demand led, with investment cases based on purely economic models reflective of an industry that has, until very recently, been unconstrained in its use of fossil fuels for both baseload and peaking requirements. If we are to significantly reduce emissions by accelerating the electrification of transport and process heat, however, we can no longer rely on models, norms and rules that do not reflect environmental externalities, including climate change, or respond to changing societal expectations. Relying on traditional investment approaches with their economic biases, inherent risk aversion and long lead times is unlikely to drive the adoption of new technologies or innovation at the speed that is required, while at the same time ensuring that energy prices remain sufficiently affordable to stimulate the necessary demand. THREE STEPS How is this transition to be achieved? The pivotal Aotearoa Circle and ICCC reports, read together, provide insightful, yet challenging, guidance. The solutions fall into three categories. First, if we are to actively pursue low carbon outcomes, the mindsets of industry leaders must change. Generators must commit now to consented and additional or “greenfield” investment in large-scale renewable energy. Potential new technologies, such as deep hydro, large battery storage, hydrogen and biomass, will ultimately be necessary in some combination if we are to avoid reliance on fossil fuels to manage the peaks and intermittency inherent in a hydropower-centric system. Rather than optimising and protecting short-term financial returns within the current regulated environment, transmission entities must revisit their fundamental purpose and become active facilitators of New Zealand’s clean energy future. Community support and participation in the energy system through distributed energy resources, rooftop solar, storage capacity, micro-grids and virtual power plants will be crucial. Such initiatives should be embraced as opportunities, not disincentivised by barriers designed to protect current monopolies no longer fit for the future. Innovation and data sharing to facilitate consumer demand response will be vital in accelerating electrification and requires strong, purposeful leadership from transmission operators. This will unlock flexibility, incentivise energy storage, optimise network loads and improve co-resilience, promoting much required energy efficiency. Generators, distributors and regulators must actively support the electrification of process heat by partnering with industry so that connectivity is available when demanded, including for new generation. Electrifying transport requires access to reliable and affordable charging infrastructure. Collectively these measures are dependent on the sophisticated integration of transmission with generation and a much closer alignment of investment horizons. Secondly, greening of the finance sector by integrating social and environmental impacts in investment decisions is required to support sustainable energy generation and speed up the rate of investment. Existing regulatory settings must be urgently adapted to shape the future low carbon landscape, including by giving proper weight to the benefits of emissions reductions in the consenting process. An effective emissions trading system that incentivises low carbon renewable energy in investment decisions will be pivotal. The large potential increase in customer-funded renewable generation and community participation will require substantial changes to the operation of the electricity market and, properly managed, could turn the risk of price volatility into an opportunity. Above all, investors must be prepared to accept lower short-term financial returns in anticipation of the significant gains in sustainable longer term performance and value creation that will result from accelerated electrification. Thirdly, green financing of energy projects that redirects capital to support a rapid transition to a low carbon economy will be essential. Compared to other sectors of the economy and notwithstanding the highly regulated environment, the energy sector can provide attractive opportunities for green investment at appropriate levels of risk. Realignment of our regulatory and financial policies will, however, be required to enable the financial system to contribute to, rather than hinder, our transition to a low emissions, resource efficient, just and inclusive economy. Although we have many positive factors in play, New Zealand has a long journey ahead to transition to a low carbon economy. By creating a new energy future in which the electrification of transport and process heat is accelerated, facilitated by a regulatory environment and financial markets that prioritise and enable sustainable renewable generation, this ambition has every chance of success.The Aotearoa Circle is a partnership of New Zealand public and private sector leaders, committed to the pursuit of sustainable prosperity by reversing the decline of New Zealand’s natural resources. We are seeking feedback on our Sustainable Finance Forum interim report.pdf), which is the first step towards designing a sustainable roadmap to 2030, to be produced by mid-2020. The Aotearoa Circle acknowledges the support of EY in providing the SFF secretariat.

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