Financing the Transition

07 Financing the Transition
07 Financing the Transition

Finding capital to save the planet

The transition to a world of low emissions poses a significant risk, as well as a huge opportunity, for everyone involved in deciding how to allocate capital in the economy.

For investors as well as for the public at large, climate change is no longer a problem of the future. Meeting the global goal of limiting warming to 1.5 degrees Celsius will require cutting emissions approximately in half by 2030, a mere eight years from now, and it will require that emissions fall nearly to zero by 2050.

Thus, decisions made by investors today will have a huge effect on whether these goals can be met. Unfortunately, climate action today remains undervalued. To address this, Generation expanded upon the familiar concept of the time value of money to consider the time value of carbon. The idea is that cuts in emissions that occur now are far more valuable to the world at large, and to individual companies, than promises of cuts in the future. The reason is that the remaining “carbon budget” — the amount that can be emitted while keeping global warming below the goals of 1.5 or 2 degrees Celsius — is rapidly being depleted. Putting off serious action now — that is, pushing all the hard work into the future — creates a risk that companies in the future will have to take wildly expensive steps to meet climate targets, if they can still be met at all.

Heading towards $1 trillion

Even though investment in the clean economy is still far from what will ultimately be needed, it is rising at a brisk clip. Bloomberg New Energy Finance calculated that in 2019, worldwide investments in clean energy and clean transport totalled $506 billion. The figure jumped by $89 billion in 2020, and again by $160 billion in 2021, to a total of $755 billion. The growth in clean transportation has been particularly impressive, with investment jumping 77 percent in a single year. A decade ago, clean transport was attracting essentially no investment; for 2021, the figure hit $273 billion.1

China is leading the world in clean-economy investments, spending $266 billion a year. The United States comes in second, spending $114 billion a year, less than half as much as China. Germany is a distant third, at $47 billion.

Annual investment in the clean economy appears certain to exceed $1 trillion in the next few years. Yet that is not enough: to get on a path consistent with the 1.5-degree goal, BloombergNEF calculates that investment needs to reach $2 trillion by the middle of this decade, then double again by 2030.2 Given the new climate bill in the United States and the new commitment to the energy transition in the European Union, investment in both regions should jump sharply, so that the BloombergNEF targets are not beyond the realm of plausibility. That company’s calculations are not far off figures published by the International Energy Agency to meet the same temperature target.3

Figure 31: Global investment in climate solutions through 2021, compared to investments needed for a 1.5°C scenario

All the wrong places

While the rising investment in the net-zero transition is encouraging, far too little money is going into solving the hardest problems. Instead, much of climate finance, public and private, is flowing into a narrow set of investable solutions whose business models have been proven. We call this the impact gap, with several sectors mentioned above — steel, cement, agriculture and others — still starved for the capital needed to develop more sustainable practices.

An additional issue is that, with the exception of China, these growing sums are being spent largely in the advanced economies. It is necessary for them to drive their emissions to zero, of course, but far from sufficient. Under current climate policies, future emissions growth in the developing world is expected to swamp declines in the rich countries, meaning total global emissions will continue to rise.

This means there is an urgent need for a radical increase in climate finance flowing to the developing world. Some 800 million people in the world still lack access to electricity. Bringing power to them is among the highest priorities of their governments — and the world at large. If these countries are to skip the high-emissions phase of development and jump directly to clean energy, they need to be putting up wind farms, solar panels and grid-sized batteries at a fast clip. Yet they are struggling to do so.

Source: World Bank

Hundreds of millions of people still lack access to electricity, one of the world’s most pressing moral problems. The number of deprived people had been declining, but ticked upward in recent years due to the COVID-19 pandemic. Planning of new grid connection projects slowed during the pandemic and 15 million sub-Saharan Africans who recently gained basic electricity access lost the ability to pay for it.

A major reason is high interest rates for these kinds of projects in the developing world. Where wind or solar farms can be financed in the rich countries at something like four or five percent interest, the interest rates in poor countries are sometimes seven times greater. There are serious reasons for the gap, mainly a perception among investors that these assets are riskier in countries with unstable governments and currencies, high levels of corruption and a weak commitment to the rule of law. Yet the gap urgently needs closing.

Global development banks have an essential role to play in identifying and managing climate risks, including systemic risks, as well as accelerating the transition to a sustainable economy, including partnering with the private sector and mobilising much larger flows of climate finance. Net-zero banking should become the organising principle for central banks and development banks across the world.

In addition, natural climate solutions, including carbon sequestration in soils and forests, can and must play a large role in developing economies. However, the current state of thinking around carbon markets and other financial incentives to protect existing carbon sinks as well as encourage additional sequestration opportunities is underdeveloped — it is crucial that this is accelerated quickly while putting in place the appropriate guardrails to ensure environmental integrity.

Anti-climate finance

Getting the economic incentives right requires another big step, mainly on the part of governments: an end to what could be called anti-climate finance. By that we mean subsidies for the production and consumption of fossil fuels. The fossil-fuel industry has received extensive government aid throughout its history. Today, in rich countries, the direct subsidies for fuel production are relatively small, but in some middle-income countries, governments have long spent enormous sums to subsidise prices for consumers. This is a volatile and sensitive issue: attempting to cut these subsidies often results in street protests or riots, and governments can and do fall if they try to cut too fast. Some progress had been made in reducing fuel subsidies, but that is rapidly being reversed due to the global energy crisis precipitated by the Ukraine war. Rich countries that had long eschewed consumer subsidies are now adopting them as the public faces soaring energy bills. In a joint report, the International Energy Agency and the Organization for Economic Cooperation and Development calculated that subsidies almost doubled in 2021, to nearly $700 billion per year. This short-term response to a crisis is understandable, but once the price situation begins to normalize, these new subsidies must be reversed and those of long standing must be wound down.

Estimates of fossil fuel subsidies published jointly by the International Energy Agency and the Organization for Economic Cooperation and Development, covering 51 economies. Data are expressed in constant 2021 U.S. dollars; 2021 data are preliminary.

The opportunity

The urgency of the climate crisis requires entire sectors to be transformed: energy, agriculture and food, fishing and ocean protection, forestry, the built environment, mobility and transport and other carbon-intensive businesses such as chemical processing, metallurgy, cement and heavy manufacturing. In addition, industries not typically associated with climate change — like technology, healthcare, finance and investment management itself — will be materially affected as we decarbonise. This transition will be the most significant change in economic history. The sustainability revolution will be as far-reaching as the Industrial Revolution and could well match the speed of the digital revolution.

At the United Nations climate-change conference in 2021, investment firms with an astonishing $130 trillion of assets under management committed themselves to the net-zero transition.4 That means they have pledged to press the companies in which they invest to get on track with global climate goals, and to use those same goals to guide which investments they make in the first place. To make good on those commitments, we need a system in which all financial institutions and allocators of capital integrate the climate emergency into their decisions across all classes of financial assets and all sectors of the economy.