| Disclaimer: This post is based on Episode #189 of the Energy Transition Show with Chris Nelder. You can listen to an abridged version below, and become a subscriber to hear full episodes at https://xenetwork.org/ets/ |
Getting to net zero (ASAP)
In an earlier post, we spoke about how global emissions must reach net zero by the middle of the 21st century to meet the temperature goals of the Paris Agreement, which are to hold the increase in global average temperature to well below 2°C above pre-industrial levels, and pursue efforts to limit the temperature increase to 1.5°C. Reducing global emissions as soon as possible will provide the best opportunity to achieve these goals.
Since the Paris Agreement was struck, the IPCC highlighted the benefits of restricting warming to 1.5°C, relative to 2°C, and the need to achieve net zero emissions by the middle of the century.
The latest reporting by the IPCC highlights the new urgency of achieving net zero emissions even sooner and the size of the global task.
The graphic below shows how achieving this would be a dramatic shift away from what we’ve always done—increase emissions year on year.
The graphic also shows how energy accounts for around two-thirds of total greenhouse gas emissions. You’ll notice the pattern of historical energy emissions tends to mirror that of overall emissions, underscoring the importance of reducing energy emissions to achieve broader emissions reduction goals.
Putting the world on a path to achieve net zero by 2050 requires a substantial increase in clean energy generation across all regions and all economies.
We also know that despite the challenge of climate change, the response is also well underway.
Advanced economies have seen the writing on the wall and are on the path to a net zero future, aided by the falling cost of solutions.
The question is whether emerging economies can also do things differently.
Investing in net zero (ALSO ASAP)
Clean energy is being deployed in greater numbers as the cost of production decreases over time and the political will to act increases.
This trend has unlocked projects and project finance as they become feasible and effective policy creates an environment that will spur investment.
The private sector is key to this investment continuing at the scale required. The IEA estimates around 70 per cent of clean energy investment over the next decade will need to be carried out by private developers, consumers and financiers.
The future is distributed
Often when we think of renewable electricity generation, we tend to think of something like this:
There is another type of renewable energy generation which is set to play a crucial role in the energy transition—distributed generation.
Distributed generation, or DG, includes rooftop solar, household storage, microgrids and more.
These systems are often decentralized, modular, flexible, less than 10 MW, and are situated close to the consumer.
There are many benefits to distributed generation, including:
- Low deployment cost
- Lower infrastructure costs
- Quicker deployment and installation
- Systems continue to run during power outages
- Systems allow more efficient personal energy use
- Greater employment benefits
Emerging markets are different
Given these benefits, it would make sense to deploy these technologies in emerging economies across Asia, Africa and Latin America.
Yet, the IEA has stated that during the past decade, emerging economies have lagged behind others when it comes to clean energy investment. This is despite rapid growth in electricity demand and several cost-effective opportunities for emissions reduction.
If the world is to meet clean energy and emissions reduction targets, these low levels of investment must be turned around.
the international finance problem
Depending on their structure, international financial institutions have two key goals:
- make a return on their investment
- reduce global poverty, improve living conditions and support economic development.
Different types of banks play role in facilitating these activities, with money often starting at a major international institution and funnelling through to a local commercial bank.
- A multilateral development bank (MDB) focuses on development and poverty reduction. It provides finance and technical advice to aid development in emerging economies. Many MDBs provide finance that adheres to sustainability, resilience and inclusiveness requirements.
- An investment bank is a financial services company that acts as an intermediary in large and complex financial transactions. It provides financial advice, facilitates mergers and its clients can include corporations, governments and pension funds. Many declare support for energy transition and sustainability, while some continue supporting high-emitting, fossil fuel projects.
- A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit. Some are large and multinational in scope, such as HSBC and Citi Group, while others cater to local clients and understand local conditions.
When this system works effectively, resources are directed towards profitable investments. They are also targeted at supporting sustainable economic, social and institutional development.
The installation of distributed generation assets in emerging economies could fulfil both of these objectives.
A project could deliver greater energy security to a remote home or business. It can also provide a reliable return. Clean energy assets typically have higher upfront investment costs and lower operating and fuel expenditures over time, allowing pay back within a short time.
what’s causing the breakdown?
Despite the cost-effectiveness of clean energy, the need for greater energy security and the advantages of distributed generation, there hasn’t been a massive roll out of rooftop solar in emerging economies.
Access to finance remains a key barrier for these countries.
The cost of capital
Emerging markets are different. Decision makers in these countries often face hurdles that keep them from accessing the finance needed to build cost-effective distributed generation.
One such hurdle is the cost of capital, which reflects the expected financial return for investing in a project. This expected return is linked with the amount of risk associated with the project’s cash flows.
Emerging economies will face additional barriers that drive up the cost of capital, such as currency risk or geopolitical risk.
As finance travels from an MDB to a project on the ground, it will face additional costs as each institution takes a separate cut. This pushes the initial credit, which may be at 6 per cent interest, towards 10 per cent or higher.
The bureaucratic process (particularly within local banks) can lead to significant project delays, which has the potential to terminate a project.
A preference for large projects
Multilateral development banks tend to overlook distributed generation projects, which involves a number of smaller installations, limited information and exhaustive due diligence requirements. These banks have typically been accustomed to taking on large, centralised projects, which favor traditional lending models.
Limited domestic capacity
State-owned enterprises account for around half of energy investment in emerging economies. Yet many state-owned utilities are in a poor financial situation and unable to invest in electricity supply and transmission.
Public funds are also scarce, and governments have limited fiscal capacity to respond the the need for greater investment in clean energy. This places further pressure on countries to look externally for solutions.
A lack of understanding about energy transition from investors
The energy transition has brought new technologies into the market and unlocked new ways of thinking about energy.
The financial system, preferring major energy projects, hasn’t updated its systems to match shifting dynamics in the sector, including towards distributed assets.
Finding a way through
Several barriers stand in the way of international financial institutions investing in distributed generation, which can speed up energy access, alleviate energy poverty, provide a return on investment, and contribute towards net zero.
So what are the possible solutions?
Recognise urgency and enhance support
There is an urgent need for the widespread deployment clean energy across all regions in order to limit warming to 1.5°C.
The IEA’s 2022 World Energy Investment Report calls for additional financial and technical support, and capital to bridge the gap between investment in advanced and emerging economies.
Concessional funds (below market finance) and blended public-private finance models can further accelerate development objectives.
Simplify everything
Bureaucratic delays and complications are a clear barrier to investment. Simplifying the process could save time and make an investment in distributed generation more efficient and appealing. This includes:
- Creating an asset class for distributed infrastructure, simplifying the process for investors.
- Standardizing contracts, performance guarantees and other financial processes.
- Creating super funds dedicated to distributed generation in emerging economies.
Shorten the line between donors and recipients
Money provided by the World Bank can go through different institutions before arriving at a recipient.
Shortening the pathway between investor and recipient could unlock greater investment. Could the local banks be circumvented, with MDB money arriving at its customer directly? Could investment banks or major commercial banks play a greater role in facilitating new distributed energy projects?
MDBs are becoming less essential as DG (and other forms of clean energy) slide up the commercial readiness scale and become bankable assets. This creates new opportunities for other actors to invest directly.
Leverage existing solutions
Could lessons about investment in distributed assets in emerging economies be learnt from other sectors? For example, in the agriculture sector and for other SME lending.
Could existing solutions, such as Odyssey Energy Solutions, be scaled and deployed across nations?
Redefine the roles of the key actors
Could we give international finance institutions a stronger strategic mandate to finance clean energy transitions? This may improve the delivery of finance, promote the deployment of blended finance to mobilise additional private capital, or incentivise markets to fund a broader range of clean energy opportunities.
The international community can take steps to improve the borrowing terms of emerging economies, including extending the horizon of credit ratings beyond three years.
Governments can also set supportive policies that encourage greater investment in their countries? Given the rapid deployment of distributed generation, markets can react quickly to effective policy, as demonstrated in Vietnam.
Financial distributed generation in emerging economies is a sticky issue. It has been understood for years, with few breakthroughs.
The following clip is from Episode #21 of the Energy Transition Podcast in 2016 highlighting many of the same issues that remain in 2023.
This is a mid-transition challenge, where the existing fossil-based system coexists alongside a new low-carbon energy system, generating new policy challenges.
| In January 2023, the World Bank announced it would review its operating and financial models to better address the scale of development challenges such as climate change. These reforms may unlock different funding models that could tackle some of the issues listed in this article. |