New policies required to make investment flow toward net-zero

finance money

Investments in clean energy must quadruple within the next two decades, according to the latest report from the Energy Transition Commission (ETC) which highlights the critical importance of strong government policies relating both to the real economy and to the financial system if finance is to flow on the scale required.

The report – ‘Financing the Transition: how to make the money flow for a net-zero economy’ – also identifies ‘concessional/grant’ payments needed to support early coal phase-out, end deforestation and finance carbon removals.

Around $3.5 trillion a year of capital investment will be needed on average between now and 2050 to build a net-zero global economy, up from $1 trillion per annum today. Of this, 70 per cent is required for low-carbon power generation, transmission, and distribution, which underpins decarbonisation in almost all sectors of the economy.

Well-designed real-economy policies must create strong incentives for private investment in the energy transition. Examples include setting ambitious targets for renewable generation by 2030, carbon prices and product regulation to drive decarbonisation in heavy industry, aviation and shipping, and specified date bans on the sales of internal combustion engines.

Other key actions include various forms of financial regulation, targeted fiscal support for the development and initial deployment of new technologies, and net-zero commitments from financial institutions.

Conceptually separate from investment finance (which will deliver positive economic returns), the ETC said that ‘concessionary/grant’ finance will be required to help cover the economic costs of early coal phase-out, to offset the incentives to deforest, and to fund carbon dioxide removals.

“Adequate flows of finance are the key to delivering a net-zero future and limiting the impact of climate change. Private investment, government and philanthropic money are needed to deliver the large-scale funding and international financial flows to ensure we move from targets to action and deliver a low-carbon global economy,” said Adair Turner, chair of the ETC.

Part of the investment needed will be offset by reduced investment in fossil fuels, cutting the $3.5 trillion per annum requirement to a net $3 trillion. This is equivalent to 1.3 per cent of the likely average annual global GDP over the next 30 years. These investments will also create a lower operating cost energy system than today, which could realise savings of between $2 trillion and $3 trillion a year by 2050 and continue thereafter, depending on how fossil fuel prices evolve. In middle- and low-income countries, much of the investment would be required to support economic growth even in the absence of a climate change challenge.

The true incremental cost of the required investment is therefore far below the gross investment need. But the scale of capital mobilisation and reallocation required will not occur without strong real economy policies in all economies and actions to address financial sector challenges in middle- and low-income countries.

The ETC further noted that energy transition is capital intensive, pointing to a peak in investments around 2040 as we build the energy system of the future, before falling to a lower asset replacement rate thereafter.

There is enough capital globally to finance the energy transition. Although there are some short-term challenges to investment in the transition, such as high interest rates, renewables are cheaper than new fossil fuels in over 95 per cent of global electricity markets and there is now an impetus to invest in energy security and efficiency savings.

The scale-up of investment required differs by country income group. In high-income economies and China, annual investments to build a net-zero economy will need to reach roughly double today’s levels by 2030. In middle- and low-income countries, a four-fold increase is required by 2030.

In all countries, the vast majority of finance will come from private financial institutions and markets if well-designed real economy policies are in place. Yet even in high-income economies, public financial institutions should play a role in financing specific types of investment, such as first-of-a-kind technology deployments, shared infrastructure (e.g., hydrogen and CCUS transport and distribution networks), and residential buildings retrofits.

In some middle- and low-income countries, private financial flows alone cannot ensure adequate investment given the challenges created by high actual or perceived macroeconomic risks, inadequate domestic savings and other factors which increase the cost and reduce the supply of private finance. A significant increase in international financial flows to some lower-income economies is therefore required. As the Songwe-Stern report argued, this requires a major increase in the scale of finance provided by Multilateral Development Banks (MDBs), together with changes in MDB strategy and approach which can help mobilise greatly increased private investment.

Supporting action by financial institutions and financial regulation can accelerate capital reallocation. Financial institutions should develop net-zero transition plans, which can play a role in capital mobilisation and reallocation into low-carbon assets and technologies. Financial regulation should ensure the transparent disclosure and management of climate-related risks and strategies.

Provided good policies are in place, capital investment will deliver positive returns to investors. But achieving some emissions reductions will impose an economic cost – in particular, phasing out coal early where it still remains competitive with renewables, halting deforestation which delivers a positive return to landowners and businesses, and scaling up carbon dioxide removals.

Concessional/grant payments to offset these costs in middle- and low-income countries (excluding China) may therefore be essential and could amount to around $300 billion a year by 2030 if the world is to achieve its 1.5°C objectives. This money could, in theory, come from corporates via voluntary carbon markets, philanthropy, and high-income countries.

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