This blog post was originally featured on the Wharton Energy Club Blog.
In 2015, the private sector funded only $25B in project-level equity of the $391B in global climate finance. The balance either flowed through government budgets and the multilaterals that use these funds, or balance sheet financing, which tends to support the lowest risk investments.
This pales in comparison to the $5.7 trillion (yes, trillion) in investment needed to reach the climate objectives set out in the Paris Agreement. Specifically, this means transitioning the $5 trillion we currently spend on energy infrastructure to renewable or climate-friendly sources, while finding another $700B to close the gap.
Many national governments cannot support this kind of investment. The funds needed are simply too large, and since government deficits are growing, fewer funds are available for direct financing. The sociopolitical environment can be challenging as well, when considering the shameful climate change skepticism in the US government or the demands for low-cost coal power in India, which challenge the country’s commitments to its INDCs.
To make matters worse, the limited access to capital is primarily occurring in countries where the biggest investments are required. In many developing countries, where there is an opportunity to leapfrog fossil-fuel based utility-scale generation technologies, banks and investors shy away.
This includes countries where new build is occurring, where rural electrification or grid reliability have not yet been achieved, where there are growing populations, or where an increasingly mature and diversified industrial base require new power.
These areas present the biggest investment opportunity while addressing the challenges of climate change.
Realists will agree that the primary way to address this challenge is to create an attractive risk/reward environment for private sector investors, while creating the right institutional environment that attracts capital. Investors need the returns, as well as a level of comfort that they will have the appropriate banking, legal, and risk management resources available to ensure the success of the investment throughout its life.
There are some improvements that indicate that we are moving in the right direction. The small group of investors that is seeking returns with social purpose is investing in the growing Green Bond market, which earmarks funds for renewable energy projects. For other investors, asset managers like Arabesque provide investment opportunities that are evaluated based on Environmental, Social, and Governance (ESG) factors.
Innovative financial structures (as scary as that sounds) are also helping the cause. Allianz last year developed an innovative revenue swap structure that allowed them to hedge wind volume risk and proceed in their investment in a 178 MW Kansas wind farm.
These are encouraging signs, but not nearly enough to overcome the challenge that lies ahead. Nor are they tapping those who truly hold the power and influence to enact change in the contemporary neoliberal economy: the private sector investors who manage the flow of capital.
To truly make progress, governments and policy-makers should focus on stabilizing their institutional environment to facilitate capital inflows. This will help marry the social purpose objectives of nations with the profit-seeking goals of the private sector.
Leaders in need of energy infrastructure should learn lessons from Argentina and Poland, where auctions for new generation are attracting investors while lowering the cost of electricity to consumers. Albeit by leveraging the benefits of a monarchic regime, Morocco has demonstrated its commitment to renewable energy by developing both the legal frameworks and institutional stability required to attract private foreign investors to stage 2 of its massive Ouarzazate solar project.
A transformation needs to occur, and the individuals or organizations that are able to unlock the $5.7 trillion in spending stand to make a fortune while doing some good for the world.