As the world decodes the latest climate forecasts from over 270 scientists at the Intergovernmental Panel on Climate Change (IPCC), it is clear we need to transition towards clean energy to prevent a sixth planetary extinction. At COP26 in Glasgow, the international financial community raised $130 trillion to finance this transition. Even Mark Carney, the UN Special Envoy for Climate Action and Finance and Former Governor of the Bank of England remarked, “Up until today there was not enough money… And this is a watershed. So now, it's [about] plugging it in.”
The question is how?
A fundamental piece of energy transition is finance. On aggregate, ‘sustainable’ finance incentivises people to shift their entire energy grid to a sustainable one, and perhaps in times of crises, rely on oil/gas. If more polluting sources of energy are funded, then more oil, gas and coal plants will be built. If cleaner sources are funded, then more sustainable sources of energy will be built. Investors recognise this power, but because their investments (which is your and my money) are also stuck in carbon-heavy companies, they cannot simply move away either.
From an investor’s lens, there are some risks that are currently preventing this transition.
The first is market risk. If institutional investors who hold large positions divest quickly from polluting companies, normal retail investors would follow suit. This would simply run down the financial industry’s existing ‘carbon’ investments, and in-turn, people’s money.
The second risk is of technological uncertainty. With more blends of clean fuels, goods and cars coming up every day, it is tough to forecast which technology will become obsolete and a potentially dead investment.
Third, and most important, we need to acknowledge that investment companies are only intermediaries, they cannot simply move someone else’s funds to risky sectors without the guarantee of repayment. This leads them to charge high interest rates on capital and makes it costly for businesses to finance their new energy projects, thus slowing down the transition.
In some sectors, such as coal, there is a paradigm shift. Investors are financing fewer coal mines and making it costly for companies to open new plants. Instead, loans to solar and wind energy plants have catapulted and become cheaper. Still however, oil and gas remain an integral part of our energy mix and investor portfolios. To transition from these carbon portfolios we will require a stronger framework involving credible stakeholders, who can improve the goodwill of investments and secure them against non-repayment, and innovative portfolio structures, meaning dynamically shifting money to companies that have ‘greener’ practices and insulating against market risk through private equity or debt.
‘Sustainable’ finance is a key contributor to accelerating carbon neutrality by 2050 but it comes with risks that still encourage business as usual. To overcome this status quo, we need financial innovation that aligns all clients and investors to move towards clean energy, but stably.