Financing the global
energy transition

National elections in the US, Taiwan, India, Pakistan, Mexico, and landscape. For the world of sustainable finance, a fragmenting world makes it more difficult for ’collective’ action on global environmental and social issues. It was therefore surprising that the COP28 Climate Summit in Dubai, in December 2023, resulted in the historic commitment South Africa through the course of 2024 provide an important to transition away from fossil fuels and to triple the world’s installed window into the fast-emerging, multipolar, geo-political renewable energy generation capacity to at least 11,000 GW by 2030.

As well as being encouraged by climate policies, the falling costs of clean technologies are aiding the growth of renewables, notably those of onshore wind and solar PV, and the increasing rates of installation.

In terms of the growth in installation, the solar industry deployed some 400GW in 2023 – roughly nine times the total installed in 2014.
In September 2023, Fatih Birol, the IEA’s executive director, predicted that the “age of seemingly relentless growth” in fossil fuel demand “is set to come to an end this decade.”

The IEA forecast a global peak of fossil fuel use by 2030 driven primarily by Chinese economic slow-down and rebalancing. In simple terms, China does not need as much steel and cement for stocks of housing, urban, or transport infrastructure. Consequently, the next phase of Chinese growth is forecast to be less fossil-fuel intensive.

The amount of renewable energy capacity added to energy systems around the world grew by 50% pin 2023, reaching almost 510 gigawatts (GW), with solar PV accounting for three-quarters of additions worldwide, according to data from Renewables 2023, the latest edition of the IEA’s annual market report on the sector published in January 2024.

According to Our World in Data, around one-seventh (14%) of the world’s primary energy is now sourced from renewable technologies — a combination of hydropower, solar, wind, geothermal, wave, tidal and modern biofuels, while globally almost one-third of electricity comes from renewables.

Annual global investment in energy transition technologies rose to $1.77 trillion in 2023 – a new all-time high and a 17% year-on-year gain – shows BNEF’s 2024 report. Electrified transport, which tracks spending on EVs and charging infrastructure, has overtaken renewable energy to become the largest sector for spending at $634 billion in 2023, up 36% year-on- year. Electrified transport saw the largest absolute gain of any sector, reflecting a continued acceleration in global EV adoption. The IEA links the increase in renewables to “expanding policy support, growing energy security concerns and improving competitiveness against fossil fuel alternatives”, suggesting these positive factors outweighed the challenges faced by the industry in 2023.

Many EU countries have been particularly forthcoming in taking policy action to boost renewables since the February 2022 Russian invasion of Ukraine, which highlighted their over reliance on a single gas supplier. Indeed, policy decisions taken by various European nations after the war began led the IEA to revise upwards, by 40%, its forecast for renewable capacity additions in the EU for 2023 and 2024.

Over the last two years higher power purchase agreement prices on both sides of the Atlantic have benefited renewable energy producers. For both the EU and the USA equipment costs are stabilising, and internal rates of return are now at a level where they compensate for higher financing costs.

Electrification remains a persistent macro growth area for the next decade with the IEA forecasting a rise in the share of renewables in the global power generation mix from 29% in 2022 to 35% in 2025, reaching 50% by 2030. As a significant theme, electrification opens a range of strategic long term business opportunities in the fields of generation, grid distribution, storage, metering, efficiency, technology substitution, thermal heating, mobility, electrolysis, and fuel cells to name a few, all of which require massive scale out in the coming decade.

However, for the moment, the standout global renewables leader is China. In 2022, the country accounted for almost half of all new renewable power capacity worldwide, says the IEA.

Despite all this action, however, global greenhouse gas emissions continue to rise, reaching a record high in 2023. There is“no end in sight to the rising trend”, said the UN-backed World Meteorological Organization (WMO) in a sobering report published in November 2023 ahead of COP28. In 2023, global averaged concentrations of carbon dioxide were 50% higher than in the pre-industrial era, said the WMO. Alongside this, a report from the International Monetary Fund (IMF) revealed that high fossil fuel pricing pushed governments to manage consumer energy price shocks with explicit subsidies, growing from $0.5 trillion in 2020 to $1.3 trillion in 2022. It is telling to note that the COP28 agreement also called for a phase out of “inefficient fossil fuel subsidies...” — a new clause, not included in previous COP agreements.

The WMO reports that the current trajectory “puts us on the pathway of an increase in temperatures well above the Paris 1.5 degree pathway.”

“There is no end in sight to the rising trend.”

— WMO (World Meteorological Organization)

Data published in January 2024 by a wide range of scientific bodies from several countries concluded that 2023 was the hottest year on record. The US’s National Oceanic and Atmospheric Administration (NOAA) reports that, “Not only was 2023 the warmest year in NOAA’s 174-year climate record — it was the warmest by far.”

According to NOAA’s calculations, last year’s global temperature was 1.35C hotter, on average, than the pre-industrial era, while EU scientists suggested the temperature rise reached 1.48C. Meanwhile, Berkeley Earth, a California-based non-profit organisation, suggested 2023 had already breached the 1.5C warming threshold set in the Paris Agreement, with the temperature, on average, 1.54C above pre-industrial levels.

These extremes begin to move the world closer towards so-called tipping points, defined by the Intergovernmental Panel on Climate Change (IPCC) as, “critical thresholds in a system that, when exceeded, can lead to a significant change in the state of the system, often with an understanding that the change is irreversible». The Global Tipping Points Report, published in December 2023, indicated that five major systems are already at risk of crossing tipping points at the present level of global warming. The systems in question include the Greenland and West Antarctic ice sheets, permafrost regions, coral reef die-offs, the Labrador Sea and subpolar gyre circulation.

Increased temperatures and volatility in extreme weather events have driven property catastrophe re-insurance rates to 20-year highs. Demand for cover has grown as natural disasters continue to cause property damage across the ever-increasing human footprint, resulting in global economic losses of $275 billion in 2022 of which $150 billion were uninsured, according to research by Swiss Re.

Before falling into the doom and gloom trap, it is important to understand that the technologies to turn this around already largely exist, presenting significant business and economic opportunities related to investing in solutions to decarbonise.

Achieving the desired emissions cuts the world over is a vast undertaking. Meeting long term climate ambitions is not simply a technological or a financial challenge, it also requires societal and industrial reform, which in turn has co nsequences for jobs and social security. It is thus no surprise that the idea of a socially just transition is central to much of the global funding and law-making efforts.

In practice, this will mean economic aid to support people in declining industries to retrain for work in the green economy. Additionally, there is a need to provide economic support to enable the scaling of ’green technologies’ in a cost competitive manner. This effect is notable for heat pumps and electric vehicles which both required government incentives to initially compete with their fossil fuel alternatives.

Responding to these challenges will depend on political will and the ability of governments to implement enabling legislation, manage energy security risk, and agree the details of large scale public private investment frameworks.

As previously mentioned, different markets are approaching the transition from fossil fuels to renewables in different ways. Wider geopolitics are also influencing national energy policies, notably the impact of the war in Ukraine on the EU’s push for renewables to replace Russian gas.

The simple narrative is that the EU prefers policies and laws to try to speed up emissions reductions and the move away from oil, coal, and gas, while the US has focused on economic incentives through its IRA, though the on the ground reality is more nuanced.

The IRA initially caused some consternation in the EU due to the fact that the bill’s climate support comes through tax subsidies, a practice the EU largely avoids to not upset the workings of the single market. The EU reacted to the IRA by adapting its own state aid rules, allowing climate subsidies through its Recovery and Resilience Facility and via various legislative proposals, such as the Net Zero Industrial Act. The European Commission has also suggested other responses could be forthcoming to ensure that Europe’s energy transition is, as far as possible, “made in the EU”.

The EU has expressed particular concern about the ’buy American’ provisions in the IRA and fears that the size of the tax provisions offered could hamper EU exports to the US or entice EU firms to relocate there. While there were initial concerns about the IRA and its compatibility with WTO rules, an in-depth analysis published by the Franco-German Council of Economic Experts suggests the real effect of the bill on the EU’s clean energy industry is likely to be much less aggressive than some have feared.

The Council concludes the total investment by the IRA, estimated to be between $390 and $900 billion for the period 2023-2031, is comparable to the overall financing of the various EU climate and energy transition programmes.

“In this context, a subsidy race should be avoided with the US as well as within the EU.” In fact, both jurisdictions are beginning to realise the collective threat of China’s dominance of ’green metal’ processing and clean energy manufacturing capacity, including wind, solar, EV’s and batteries.

The experts also suggest the EU’s “policy mix”, involving carbon pricing and industrial intervention is “superior” in responding to the challenges of decarbonisation, compared to the IRA’s focus on subsidies. The EU’s Emissions Trading System (EU ETS), launched in 2005, was worth around €751 billion last year, up 10% from the previous year and representing 87% of the global carbon market. The price of carbon permits on the EU ETS averaged over €80 a tonne last year, 50% higher than the year before as energy prices surged following the war in Ukraine.

Both the EU and the US have a range of tools at their disposal to fund the energy transition. However, numerous reports insist on the need for much more financing to be directed towards developing and emerging markets.

At COP15 in Copenhagen $100bn a year of public financing was promised by 2020 (in actuality this was finally delivered in 2023) yet this amount still falls massively short of the estimated $6 trillion in funding by 2030 the UN estimates developing countries need to meet half of their existing climate commitments. As the OECD reported in November 2023, ahead of COP28, mobilised private climate finance for developing countries remains “stubbornly low” with poorer countries receiving $14.4 billion in 2021, or 16% of total private climate finance. Similarly, adaptation finance for developing countries dropped by $4 billion in 2021, a fall of 14% compared to the previous year.

“Adaptation finance is essential to building resilience and private finance from a range of commercial actors in developed and developing countries and to closing the financing gap for investments in climate action, notably in clean energy systems, agriculture, forestry, land-use, adaptation, and resilience,” said OECD Secretary-General Mathias Cormann.

The issue of energy transition financing for poorer countries is a priority for the Glasgow Financial Alliance for Net Zero (GFANZ) Workstream on Mobilizing Capital to Emerging Markets and Developing Economies. A report published by the initiative in November 2022, shows that domestic investment into renewable energy plants in emerging markets and developing economies (EM&DEs) increased 19% in 2020-2021, reaching new highs and recording the largest increase since 2015. Overall, renewable energy investment in EM&DEs increased 40% in 2017-21 compared to the period 2012-2016. Despite this, the report emphasises that “much more is needed,” and international financial flows, in particular have been “less positive in recent years”. Energy transition asset finance in EM&DEs remained flat in 2021 at $67 billion, the same level as in 2019 and a marginal decline from the $73 billion peak reached in 2018, and the climate finance mobilisation gap between the developed and the developing world is widening, shows the report.

The report concludes that changes need to be made by African authorities and investment companies and vehicles wanting to invest in the continent to ensure it too can benefit from the energy transition. These changes include ensuring that international funding is “substantially more concessional” to avoid increasing debt distress, while African states should see what changes they can make to their institutional architecture to enable greater climate spending. The report suggests measures such as liberalising energy markets, subnational borrowing and centralised coordination of climate planning.

The lack of climate financing in developing and emerging countries is not, as the OECD says, limited to Africa.

The IEA’s 2021 report - Financing clean energy transitions in emerging and developing economies - identifies similar problems around the world. It underlines how the falling cost of key clean energy technologies offer a “tremendous opportunity to chart a new, lower-emissions pathway for growth and prosperity.” The IEA warns that “if this opportunity is not taken, and clean energy transitions falter in these countries, this will become the major fault line in global efforts to address climate change and to reach sustainable development goals.”

Indeed, for IEA Executive Director Fatih Birol, the biggest challenge for 2024 is “rapidly scaling up financing and deployment of renewables in most emerging and developing economies, many of which are being left behind in the new energy economy”. He insisted at the launch of Renewables 2023 that success in meeting the tripling renewables goal agreed at COP28 “will hinge on this”.

The global market for key, mass-manufactured net zero technologies is set to triple by 2030 to reach an annual value of around €600 billion, says the European Commission.

Even in industries where the EU is relatively strong, like wind turbines and heat pump sectors, the EU’s trade balance is deteriorating and policymakers are concerned that China, with its ability to turn around goods quickly and cheaply, could take over the market.

The Net Zero Industry Act, currently being negotiated by EU institutions, proposes a list of strategic net zero technologies that would receive specific support. Exactly which industries should receive support is still under discussion — EU member states and the European Parliament are proposing a longer list of industries than the Commission, including nuclear power. The Parliament is also proposing that countries should allocate at least 25% of their national EU Emissions Trading System revenues to support the regulation’s objectives.

The other piece of legislation being negotiated in the EU is the Critical Raw Materials Act aimed at creating a regulatory framework to boost domestic production and to diversify supply chains away from China, in particular.

The proposed regulation sets clear targets, requiring that by 2030 at least 10% of the EU’s annual consumption for extraction, 40% of its annual consumption for processing, and 15% of its annual consumption for recycling, happen domestically. It is also clear that diversifying supply chains will mean not only investing in Europe, but also in other countries to help them extract and process minerals for export to the EU.

The European Commission confirmed that critical raw materials will play an increasingly important role in trade agreements, as has been the case in recent trade deals with New Zealand and Chile and critical raw material partnerships with Canada, Kazakhstan, Namibia, and Ukraine.

Cleantech for Europe, an organisation supported by Bill Gates’ Breakthrough Energy initiative, says that if the EU is to compete with the US and China, it must complement its planned regulations “with a cleantech-focused EU-level public funding instrument that crowds in the private investment needed for a secure and environmentally sound critical minerals value chain.”

The European Climate Neutrality Observatory, an independent initiative monitoring the EU’s progress towards climate neutrality, also agrees the EU must increase investment through more public funding in the technologies needed for the net zero transition if it is to achieve its climate targets.

In a recent report, the Observatory says European public financing through the EU Innovation Fund and the European Investment Bank is vital to speed up the development of clean energy technologies. Public financing can “supercharge EU clean tech ambition” by filling these funding gaps and “derisking investments to crowd in more private capital” and get projects up and running, according to the analysis.

As well as implementing policies to stimulate investment and change, countries are also looking to introduce policies that would block imports of goods that do not meet environmental standards.

The most notable of these is the EU’s Carbon Border Adjustment Mechanism (CBAM), the first phase of which came into force on 1 October 2023.

“The consequences will be vast,” says Wood Mackenzie in a report published in September 2023. Over the next five years or more, the CBAM will “reconfigure international trade flows”, it says. “In the longer term, it will put pressure on other economies to cut their emissions.” It remains to be seen whether concerns raised by Wood Mackenzie and others will be realised and one unintended consequence of the policy will be to make the transition more expensive in Europe than elsewhere.

The UK, in any case, has decided to follow suit, and other countries like India have said they are looking to introduce their own border tax. The UK’s scheme is expected to kick in by 2027 on imports of aluminium, cement, ceramics, fertiliser, glass, hydrogen, iron, and steel.

And while the EU complains about the US’s efforts to create a “made in US” energy transition with the IRA, as policies like the NZIA and CBAM show, it too would like its clean technologies to create jobs and prosperity inside its borders.

Further, in an effort to try to avoid a repeat of what happened with its solar panel industry, which, 10 years ago, disappeared over night in the face of low-cost panels from China, in October 2023, the European Commission said it had formally launched today an anti-subsidy investigation into the imports of electric vehicles from China, worried about the number of vehicles coming into the EU. The investigation will first determine whether BEV value chains in China benefit from illegal subsidies and whether any subsidisation may cause economic injury to EU producers.

The EU has also said it will keep a close eye on what is happening in the wind industry given concerns about the rising number of cheaper Chinese turbines being sold in the EU, but it has not yet opened any formal investigation.

The EU is likewise leading the world with its adoption in 2020 of its green taxonomy that establishes a classification system of environmentally sustainable economic activities. The taxonomy sits with the Sustainable Finance Disclosure Regulation and the Corporate Sustainability Reporting Directive, which together call on financial institutions and corporates to screen, assess, and report on the extent to which their investments and undertakings are environmentally sustainable and aligned with the EU’s goal to become net zero by 2050.

While generally seen as good progress in clarifying what is a sustainable economic activity, the taxonomy has, however, come under some criticism for allowing nuclear energy and natural gas to be classed as “green” or transition energy.

The EU is far from alone in adopting some form of green taxonomy, with China, the UK, South Africa, Russia, and Colombia, having also introduced similar frameworks.

China focuses its efforts on its Green Bond Endorsed Project Catalogues, issued yearly since the mid-2010s. These essentially list criteria for what projects can be attached to green bonds and have much the same result as the EU’s green taxonomy.

In August 2023, the Australian Sustainable Finance Institute started developing the country’s sustainable finance taxonomy with the appointment of a Taxonomy Technical Expert Group. Canada also has plans to publish a taxonomy in the coming years.

Given the current backlash by some Republicans against sustainable finance, the US would be likely to struggle to implement any form of green taxonomy. However, the country’s market watchdog, the Securities and Exchange Commission is introducing disclosure and environmental, social, and corporate governance regulations.

In an attempt to try to offer some harmonisation across taxonomies and global sustainable finance regulatory measures, the International Platform on Sustainable Finance was established in 2019 as a forum for countries to share best practices, challenges and opportunities.
Under the aegis of the platform, the EU and China initiated a Working Group on taxonomies in 2020 to collaboratively assess their respective taxonomies and identify similarities and differences in their approach. This work resulted in the IPSF Common Ground Taxonomy report, which can be used to help countries shape their own taxonomies. Meanwhile, the World Bank has established a guide to developing national green taxonomies for emerging markets.

Measures are also coming into place to ensure that such taxonomies also have real world impact. From January 2024, EU banks will be required to disclose their Green Asset Ratio (GAR) for the financial year 2023. In the long term there are some commentators who point towards the use of GAR as a basis for defining capital requirements.

Doubtless all these rules and regulations are moving the needle in the right direction, but the amount of money needed to transition the world away from fossil fuels, triple renewables, and double energy efficiency, as agreed at COP28, is huge. Consultancy Wood Mackenzie has put the cost of tripling renewables at $2.7 trillion a year from now until 2030.

In a report published ahead of COP28, the IEA announced that the recovery from the Covid-19 pandemic and the response to the global energy crisis had provided a “major boost to global clean energy investment”, which rose to more than $1.7 trillion in 2022. However, this is still far from the amount needed and the majority of financing is still going into advanced economies.

Indeed, spending on clean energy in EM&DEs outside of China has stagnated in recent years at around $250 billion a year, finds the IEA, which calculates that a seven-fold surge in clean energy investment is needed in these countries by 2035 to align with the Paris Agreement and the sustainable development goals.

Analysis increasingly shows that investments in renewables make sense for investors, as well as for the climate and, without putting too fine a point on it, for the future of us all.

The Financial Times’ Lex column reported in December 2023 that “despite some bad headlines, investments in renewables are starting to yield a reasonable return”. It cites Total Energies’s integrated power unit — which includes oil and biofuels, natural gas and green gas, renewables, and electricity — as reporting “return on capital employed of almost 10% in the 12 months to the end of September”. This figure is “about in line with the long-term average return for oil and gas projects — but with a lot less price volatility,” writes Lex. “Incentives are aligning for energy companies seeking to accelerate their green efforts.”

This also translates into sustained M&A and financing deal activity in the sector. M&A intelligence provider Merger Market highlighted in a January 2024 paper: “Dealmaking in the renewable energy sector was hit by 2023’s headwinds including supply-chain volatility and lower-than-expected subsidies. Volumes were down 3% year on year falling to $25.2 billion over 73 transactions in 2023 from $26.02 billion across 93 deals in 2022.”To put this in context, overall global M&A volumes were down in excess of 20% in 2023, meaning a relative outperformance of the renewable energy sector versus the broader market.

Despite these challenges, “capital continues to flow into low-carbon technologies, bolstered by government initiatives and private sector support as environmental, social and government (ESG) considerations increasingly shape dealmaking in the run-up to net zero,” continues Merger Market. It notes that deal volume for the second half of 2023 in renewables rose 52.6% to $16.8 billion across 38 deals compared to $11 billion across 52 deals in the second half of 2022.

Xavier Ledru, Head of Corporate Finance and Mickael Gibault, Head of M&A and Equity Advisory at Reyl, believe in the long-term growth prospects for equity and debt raising in the sector. They forecast continued momentum in M&A and capital raising activity, driven by huge investment requirements into renewable energy infrastructure across production, distribution and storage.

According to Ledru and Gibault, “The current higher cost of capital creates downward pressure on financial returns and asset prices in the sector, but there is a fundamental trend for corporates and investors to increase their exposure to green energy.

As regulators worldwide offer greater support to boost the energy transition and increase momentum towards a low carbon future, solar, wind and biomass will remain key investment themes in the renewables space in 2024.”

Ledru and Gibault suggest that these areas will be given additional impetus as countries, in the name of energy security, look at ways of “re-onshoring energy production,” given the challenging international context.

Specifically, Ledru and Gibault see digitalisation and software, integrated services, storage solutions and production assets as key drivers of activity. They conclude that, “Corporate appetite for consolidation and diversification will fuel further M&A activity in the renewables space throughout 2024.”

Whichever way you look at it, 2024 is set to be a challenging year.
War continues in Ukraine and the conflict in Gaza and the wider tensions across the Middle East show little sign of abating. At the same time, the political stakes are high as more than 40% of the global population, or 4 billion people, go to the polls across 2024 — including in the US, the EU, India, Indonesia, Russia, the UK, Pakistan, Bangladesh, Taiwan, Mexico, and South Africa. There are concerns from those working in sustainability and climate change that a potential shift n the EU, and the possible return of a climate sceptic to the White House, could seriously hinder the global energy transition.

Politics is not the only challenge. In addition to policy uncertainties, the IEA’s Renewables 2023 highlights challenges including: insufficient investment in grid infrastructure preventing faster expansion of renewables; cumbersome administrative barriers and permitting procedures; social acceptance issues; and insufficient financing in emerging and developing economies as key potential hindrances to climate action in 2024.

The markets do not seem to respond well to this turbulence. Data from Morningstar shows that global sustainable funds fell into negative territory for the first time in the final quarter of 2023, with the US suffering most — investors withdrew a record $5 billion from the country’s sustainable funds in Q4 and a total of $13 billion for 2023 as a whole. There are various reasons for this trend, not least uncertainty around policy development and the pushback against any kind of sustainable finance from certain Republicans and Republic states.

If the world is to achieve its goal of transitioning to net zero, politicians and investors will have to keep a steady nerve and continue to steer the ship forward in what are likely to be choppy waters. BNEF’s call for everyone to “get a grip, unleash, lock in” is well aimed and advice that investors would do well to heed: get a grip on wind power and grids; unleash clean energy deployment in emerging economies; and lock in demand for clean industrial materials.

Buckle up. It is going to be a bumpy ride, but the right policies and investment can help to smooth the journey for everyone everywhere. FW