This article is part of the series — Raisina Files 2021.
As countries worldwide recover from the shock of the ongoing COVID-19 pandemic, focusing on sustainability and clean energy investment offers a huge opportunity to stimulate economic activity, provide reliable clean energy, employment, and put global emissions into structural decline. With several competing priorities and development progress in free-fall in many parts of the world, it is not surprising that several countries are looking to address more pressing concerns and putting their climate and sustainability efforts on hold. However, evidence suggests that this will be a huge mistake.
The COVID-19 pandemic has exposed the severe vulnerabilities and structural inequalities resulting from chronic underinvestment in energy access in developing countries. Health facilities are under-energised and so unable to deal with the increasing number of patients from the pandemic, while critical equipment and the handling and distribution of vaccines is hampered by the lack of access to secure and reliable energy. This has brought to the fore the key role of energy supply in advancing development priorities, which, when seen through the prism of global energy investments, makes the economic case for clean energy. While COVID-19 has adversely impacted all market segments of the energy sector, clean energy spending was relatively resilient as compared to fossil fuel investment, contributing a third of global energy investments in 2020.
However, the US$ 600 billion invested in clean energy and energy efficiency is far short of the US$ 1.1 trillion required annually till 2030 to reach the world’s climate and sustainable development goals,
predominantly flowing into the developing world.
With several competing priorities and development progress in free-fall in many parts of the world, it is not surprising that several countries are looking to address more pressing concerns and putting their climate and sustainability efforts on hold.
While the global economic downturn may not suggest this to be a favourable time, seizing the opportunity of fiscal responses can support the investment needed to meet access and sustainable energy goals. Recognising the opportunity to pivot towards enhanced sustainability through public infrastructure spending such that economies prepare themselves for the future, an increasing number of geographies are allocating an important share of their recovery packages to support energy efficiency and renewable investment. One of the most important co-benefits of the enhanced adoption of renewable energy and energy efficiency is job creation. Investments in clean energy create three-and-a-half times the number of jobs as an investment of the same size in fossil fuels.
To respond to climate, act on energy
There is global consensus that extreme weather and disruptions — such as drought, flooding and conflicts over natural resources — excessively affect the developing world, particularly the poor and most vulnerable. Air pollution kills more Africans than childhood malnutrition or contaminated water.
World Health Organization data shows that of the annual 2.2 million environment-related deaths on the African continent, 600,000 are linked to outdoor air pollution.
Further, in 2019, African countries were estimated to be spending between 2 percent and 9 percent of GDP in responding to climate events and environmental degradation.
Thus, the need for action is both urgent and important. However, it is important to note that climate-linked outcomes are a manifestation of energy actions. Energy use for electricity, industry, transportation and buildings, among others, accounts for 76 percent of global greenhouse gas emissions.
Thus climate action is deeply interlinked with action on energy, which in turn has strong interlinkages with development and economic growth prerogatives.
Energy use for electricity, industry, transportation and buildings, among others, accounts for 76 percent of global greenhouse gas emissions.
To get on track for net-zero emissions by 2050, the amount of investment required in clean electricity (generation and grid/storage infrastructure) will need to rise to over US$ 1.6 trillion per year by 2030.
This is over four times more than what was invested in these sectors in 2020.
According to estimates by the United Nations Economic Commission for Africa, in regions like Africa, installed electricity capacity will need to double from its present value of 250 GW by 2030 and increase at least five-fold by 2050.
There is, therefore, an urgent need to shift gear in terms of enabling the flow of investments required to meet the targets of Sustainable Development Goal (SDG) 7 (ensure access to affordable, reliable, sustainable and modern energy for all), support attainment of the other SDGs, and enable a just transition to the global energy transformation that puts the world on track for carbon neutrality by 2050. Till these investments are not mobilised at the scale, and affordable price required, the common goals of sustainability and limiting climate change will remain out of reach.
Mobilising capital for a just, inclusive and equitable energy transition
Despite compelling drivers to transition to clean energy and energy efficiency, financial flows to these sectors in developing countries remain woefully small due to a litany of real and perceived risks. The quantum of finance required to accelerate the green transition is a small share of the global capital available. Institutional investors hold US$ 100 trillion globally in securities, real property assets, insurance, pension funds and sovereign wealth funds.
This low-risk, long-tenured institutional capital must be mobilised, especially as environmental, social and governance (ESG) considerations take centre stage. However, low-carbon energy investments tend to have high upfront capital intensity, making financing costs an important affordability component. Providers of debt and equity capital price project risks into their cost of financing, including market and regulatory uncertainty, following a risk/reward dynamic. Higher risks thus increase costs but may also curb investment appetite, resulting in lower capital availability. The policy challenge is how to address perceived risk assessments and what actions to take to lower real risks to improve the attractiveness of investment opportunities across the immense green transition landscape in developing countries.
Low-carbon energy investments tend to have high upfront capital intensity, making financing costs an important affordability component.
There is a need to rapidly increase the number of projects available through an improved enabling environment for clean energy investments and more projects being brought to market to meet the sustainable energy goals and targets. A market that is considered small has lower investor interest. A market that is perceived as difficult is also one that has low investor confidence. However, even as the world sees an increasing share of investments going towards renewable energy in developing markets, this investment is highly concentrated in a few markets and technologies. There is a need to improve and increase the availability of capital to fill clean energy and infrastructure gaps across the globe. This should be based on improved complementarity and coordination between public and private finance, and a shared vision among different financial institutions, including international financial institutions, local banks and institutional investors. While the rise of ESG-linked financial instruments, such as green bonds, is creating more liquidity seeking clean energy investments in an already liquid environment, the risk appetite of market participants is often more limited. The cost and availability of finance are closely related to the enabling environment for new clean energy projects.
Attracting private financing depends on the energy policy frameworks, including infrastructure planning, fiscal incentives, and market and regulatory issues. Development finance institutions and international financial institutions can play a critical role in bridging some risk gaps and addressing market failures. Public banks need to step up their role as catalysts for investment, for instance, through blended finance and market-making subordinate roles in riskier projects.
Even as the world sees an increasing share of investments going towards renewable energy in developing markets, this investment is highly concentrated in a few markets and technologies.
While institutional capital brings the promise of immense scale and can be mobilised under the right circumstances, multilateral guarantee mechanisms could contribute to the credit enhancement required to make institutional capital more comfortable in newer clean energy markets. Designed to lower the counterparty for investors, not only local political risk but also the credit risk associated with offtake agreements, risk guarantee mechanisms could unlock the quantum of capital required to drive the transition at scale. For instance, to access the Indian bond market, a credit enhancement mechanism of US$ 649 million over five years can facilitate a 16x leverage and help double ground-mounted solar installations from 31.6 GW to 63.5 GW.
Investment decision-making should respond to climate risk
Even as much greater effort and innovation is required in accessing affordable capital at scale for clean energy markets, hindered by risks, investment decision-making largely continues to ignore another set of risks — climate risk. The ongoing pandemic has played an important role in raising awareness about previously unmapped existential threats and their adverse impact on the financial sector at large. Climate change poses one such imminent existential threat, the effect of which will be far greater than anything witnessed before. Evidence from stress tests conducted by some central banks clearly signal the enormity of the risk and the lack of preparedness to cope with it.
,
Currently, across geographies, several green ratings and risk measures exist parallel to the central credit rating mechanisms. Therein lies the flaw; to suggest that climate risk is separate to the overall credit risk would be myopic.
Climate-related risks are usually divided into two categories — physical risk, which is the economic impact stemming from the expected increase in the frequency and magnitude of natural hazards; and transition risk, which is the financial risk on investments associated with the adverse impact of policies or regulation that advance the transition to a low carbon economy. Currently, across geographies, several green ratings and risk measures exist parallel to the central credit rating mechanisms. Therein lies the flaw; to suggest that climate risk is separate to the overall credit risk would be myopic. One estimate suggests that if temperatures rise to 4°C above preindustrial levels over the next 80 years, global economic losses could amount to US$ 23 trillion per year.
Beyond the physical risks, the financial system could be destabilised as an increasing number of carbon-intensive investments become stranded or commercially unviable as policies and regulations move towards more sustainable standards. This risk acts as a double-edged sword. On the one hand, the imminent shift towards greener policies and regulations is necessary to redirect capital towards clean energy projects and away from those that exacerbate the physical risk of climate change. On the other, the opportunity cost of the improved policies and regulations is the transition risk that is likely to manifest in stranded assets for investors. One estimate puts the present value of potential losses at US$ 18 trillion.
Strong financial regulation could play a critical role in mainstreaming the integration of climate risk into decision-making.
Integrating climate risk into investment decision-making needs capacity building and new tools to evaluate risk exposures. Strong financial regulation could play a critical role in mainstreaming the integration of climate risk into decision-making. Global efforts are underway through the Taskforce on Climate-related Financial Disclosure and the Network of Central Banks and Supervisors for Greening the Financial System. However, much more is needed to expand the footprint of these efforts such that their recommendations begin to impact large volumes of global transactions.
Balancing common goals of ending energy poverty and advancing clean energy
Energy poverty, not unlike economic poverty, has wide-ranging impacts, including on livelihoods, health, education and economic value creation. Nearly 90 percent of energy investment in 2018 was concentrated in high- and upper-middle-income countries and regions.
With just over 15 percent of the global population, high-income countries accounted for more than 40 percent of energy investment in 2018. In studied contrast, lower-middle and low-income countries accounted for less than 15 percent of energy investment, despite housing well over 40 percent of the world’s population.
An inclusive, equitable and just energy transition must urgently address this mismatch.
Energy poverty, not unlike economic poverty, has wide-ranging impacts, including on livelihoods, health, education and economic value creation.
Financial markets are getting greener and increasingly reward ambitious transition policies. As a result, financing is expected to become increasingly available for clean energy projects, translating to lower financing costs. This trend is accelerating across the financial sector, but not at the pace or scale required. New rules on corporate disclosure and emerging sustainability commitments by these actors can significantly bolster capital allocation towards clean energy. The market for sustainable debt, including green bonds is growing rapidly. Governments and companies are expected to issue US$ 500 billion of green bonds in 2021 alone, an increase of 50 percent of the stock of green bonds.
Investment funds and equity investors are taking climate risk increasingly seriously. Transition risk is priced in for carbon-intensive projects and companies. Many asset managers are in the process of reducing their exposure to or divesting entirely from, energy activities and companies involved in coal, oil and gas.
Given the long-term commitment to net-zero emissions by 2050, there is a growing trend among development finance institutions to withdraw from fossil fuel investment, including the World Bank’s decision to cease funding for upstream oil and gas development
, and the new restrictions on financing downstream gas development currently being considered by the European Union, the UK and the US. While well-intentioned, this move does not consider the principles of common but differentiated responsibility and leaving no one behind that are enshrined into global treaties around sustainable development and climate action. Such a move also disregards the importance of gas as a means to urgently address energy poverty in a technologically and economically viable manner.
The energy investment available to developing countries will determine the pace of their economic and energy transition.
There are currently over six billion energy consumers in the developing world whose demand is projected to grow another 30 percent over the next 15 years, up from 7,000 million tonnes of oil equivalent (Mtoe) in 2015 to 9100 Mtoe in 2030.
This will be powered in large part by rapidly expanding economies, specifically industrial growth and rising standards of living. The energy investment available to developing countries will determine the pace of their economic and energy transition. Limiting the availability of capital through direct regulations on capital flows to gas, or indirectly by signalling to private sector and removing support mechanisms funded by development finance initiatives, thwarts the right of developing countries to progress on low carbon development pathways. Although gas is a fossil fuel that contributes to greenhouse gas emissions, increasing its use in power generation allows several developing countries to phase out more polluting fuels such as coal, diesel and heavy fuel oil, while integrating more renewables into its energy mix — using gas as a balancing fuel. Further, the role of gas for cooking cannot be emphasised enough. LPG-based policies and schemes are critical to realising universal access to clean cooking by 2030, giving 2.8 billion access to clean cooking solutions for the first time, and will need global investment of US$ 4.4 billion annually till 2030.
The policy decision to decarbonise capital flows are important in driving the necessary shift towards a more sustainable and resilient global order, but the shift must be nuanced and responsive to on-ground political realities, and target economies and sectors that have the most work to do to decarbonise. Public finance, including multilateral development banks and national development banks, has an important role in financing the energy sector to address energy poverty and advance the energy transition. They must balance the SDG-7 targets with the net-zero emissions target of 2050, and provide low cost and long term financing that is not otherwise available and can crowd-in private financing to advance clean energy. This, in some cases, may need the support of transitionary fuels. Overall, the move to sustainable energy must leave no one behind, including through the transfer of employment opportunities from one sector to another to avoid creating a divide between those who do and those who do not benefit from the energy transition. It is not enough to merely scale up investments, but it must be ensured that they are flowing into countries, sectors and programmes that reach the poor(est) and most vulnerable, while also addressing the social consequences and distributive effects of the transformation of energy systems to ensure a just energy transition.
International Energy Agency,
World Energy Investment 2020, IEA, May 2020.
Richard Dobbs et al., “
Resource Revolution: Meeting the World’s Energy, Materials, Food, and Water Needs,”
McKinsey Global Institute, 2011.
Solar PV in Africa: Costs and Markets (Abu Dhabi: IRENA, September 2016).
Rana Roy, "
The cost of air pollution in Africa,"
OECD Development Centre Working Papers, no. 333 (2016).
World Health Organization, “
Quantifying environmental health impacts,” WHO.
World Metorological Organisation,
State of the Climate in Africa, WMO, 2020.
IPCC AR5 Climate Change 2014: Mitigation of Climate Change, IPCC, 2014.
United Nations Environment Programme,
Emissions Gap Report 2019, UNEP, 2019.
International Energy Agency,
World Energy Outlook 2020, IEA, 2020.
United Nations,
High-Level Dialogue on Energy 2021, UN, 2021.
“
Institutional Capital: Closing the Energy Transformation Investment Gap,”
IRENA.
Vaibhav Singh, Arjun Dutt and Gagan Sidhu,
RE-Financing India’s Energy Transition Limited Period Subsidised Credit Enhancement for Domestic RE Bond Issuances (New Delhi: Council on Energy, Environment and Water, 2020).
Avery Ellfeldt, “
How a Climate ‘Stress Test’ Can Foresee Collapsing Banks,”
Scientific American, 4 November 2020.
Luis de Guindos, “
Shining a light on climate risks: the ECB’s economy-wide climate stress test,”
European Central Bank, 18 March 2021.
Tom Kompas, Van Ha Pham and Yuong Nhu Che, “The Effects of Climate Change on GDP by Country and the Global Economic Gains From Complying With the Paris Climate Accord,”
Earth’s Future 6 (8) (2018).
Network for Greening the Financial System,
The Macroeconomic and Financial Stability Impacts of Climate Change, NGFS, June 2020.
“World Energy Investment 2019”
“World Energy Investment 2019”
Billy Nauman, “
Analysts expect as much as $500bn of green bonds in bumper 2021,”
Financial Times, January 2021.
“
World Bank Group Announcements at One Planet Summit,” World Bank Group.
Jess Shankleman, “
U.K. Is First in G-20 to End All Overseas Oil and Gas Funding,”
Bloomberg, 12 December 2020; Kate Abnett, “
EU to restrict support for gas projects, citing climate goals – draft,”
Reuters, 10 December 2020; “
US plans to end fossil fuel finance overseas, threatens billions in support for oil and gas,”
Climate Home News, 28 January 2021.
Philippe Benoit, “
Energy and Development in a Changing World: A Framework for the 21st Century,”
Columbia Center on Global Energy Policy, 4 March 2019.
Sustainable Energy for All,
Energizing Finance 2020, SeforALL, 2020.
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
PREV
