The Edge

Who will fund the energy transition?

Green stimulus can draw in US$ trillions of private capital

Serious momentum is building to address climate change. China’s net-zero commitment by 2060 was a big moment, Japan and South Korea followed suit with net-zero 2050 targets. The UK’s 10-point plan last week precedes legislation on the EU’s Green Deal, expected by end Q1 2021, while re-joining the Paris Agreement will be one of the Biden administration’s first initiatives.

Biden’s own Green Deal may even be ratified in 2021, before COP26 in November 2021 in Glasgow – assuming he can get it passed by a divided Senate. The delay of COP26 by a year because of Covid-19 now looks serendipitous, allowing time for better alignment than had it gone ahead this very month.

If ambitions on climate change are high, so, too, will be the cost. We reckon a bare minimum of US$30 trillion to US$40 trillion of investment is needed to put the world on a 2 °C or lower pathway. Where’s the money going to come from? I chatted to Prakash Sharma and Jonny Sultoon of our Energy Transition team and Peter Martin, Head of Economics.

How will the money be raised?

Governments will seek to ‘crowd-in’ investment – using incentives to pull in private capital alongside their own investments. It’s worked wonders with renewables all round the world where feed-in-tariffs and guaranteed offtake have underpinned returns for investors. The influx of capital has led to a scaling-up of capacity as well as technological and efficiency improvements. As a result, costs have fallen steeply and renewables can now compete on costs with new fossil fuel plants in many major markets.

Can it work for the new zero-carbon technologies?

In theory, yes. What’s different is the focus is shifting down the value chain from power generation to the consumption end. Electricity on its own won’t work for big emitting sectors like steel, cement and industry, which need high-temperature heat as well as process change. The next suite of technologies includes hydrogen, CCUS, bioenergy, and longer duration energy storage. These are proven technically but not commercially and will take years to scale up.

Guaranteed tariffs and offtake may be as effective for parts of the value chain as they have been in renewables, but not for all of it. Hydrogen’s a good example where a one-size-fits-all incentive may not work. The value chain includes production of hydrogen fuel itself; the smart grid to deal with the vast, intermittent volumes of renewable electricity; and infrastructure to deliver hydrogen to the point of consumption across multiple end-use segments plus logistics.

The approach will have to be more targeted so hard-to-decarbonise sectors like steel and cement are incentivised to cut emissions but don’t lose their competitiveness in export markets. Carbon pricing, or equivalent regional border taxes, will play an important part. We may see novel and innovative incentive mechanisms emerge as more nations focus on stimulating investment.

What do governments need to do?

Play that crucial role in the very early stages of R&D, as they do in other sectors, such as military and health (most recently, for the Covid-19 vaccine). On energy, governments have to get going soon because developing the technologies and building the scale we’ll need is going to take time.

Governments can promote a wide range of early-stage technologies, setting the ball rolling with multiple pilot plants. As winners emerge, they can set clear goals on technology adoption, drawing in private capital for scaling up, as well as consumer acceptance.

The pilot phase will have failures, too. Governments will need to act fast and reprioritise investments to demonstrate long-term benefits to consumers.

Who are the private investors?

The groundswell of policy, societal mood, ESG and low-interest rates is attracting private investors of all types. Many have a dual interest – they’re looking both at their own corporate targets to be carbon-neutral and for long-term, climate-friendly growth projects.

The early, development stage of new technologies is higher risk and will attract equity investors – venture capital and private equity. Some corporates – including the Euro Majors – also want to be in early, to learn and gain first-mover advantage. Again, hydrogen’s a good example, the hot technology where there’s a race to be the one that makes the commercial breakthrough. Early investors will be conscious that sometimes it’s tech’s fast followers that reap the rewards.

As new technologies mature, returns will fall, and it becomes more of a volume game. Start-up investors may switch out and banks, pension funds and institutional investors will move in as well as corporates from across the energy spectrum, all attracted by the prospect of stable cash flows.

When will we see the money begin to flow?

It needs to start soon, with the EU Green Deal expected to set 2030 emissions reductions targets of 55% compared with 1990. Collectively, governments are poised to inject US$12 trillion to drive global economic recovery over the next 18 months, with around one-third, or US$4 trillion, specifically at the green economy. We’d expect a private capital multiplier of two to three times to ‘crowd-in’. If the projects are there, that’s a massive US$12 trillion to US$16 trillion that can kickstart the drive towards a 2 °C or lower pathway.