Private sector funding critical to reach global climate goals

    18 Feb 2023

    When the UAE assumes the Cop28 presidency this November, one goal is paramount: mobilising private investment.

    To keep the Paris Agreement’s warming target of 2ºC on track, while limiting industrial levels to 1.5 ºC, the UN estimates that between $4 trillion and $6 trillion of investment in low-carbon infrastructure will be needed every year.

    This would require annual spending greater than the total of US President Joe Biden’s Inflation Reduction Act.

    The scale of money needed to fund the energy transition is what makes private investment so critical.

    The world cannot reach $6 trillion of climate investment annually by adding up individual government pledges: there is simply not enough money that the public sector can offer.

    Instead, the capital must come from the private sector, with banks, investors and private companies financing the lion’s share.

    Private investment will be particularly crucial in the Global South, which now accounts for two thirds of annual carbon emissions.

    While scrutiny has rightly focused largely on advanced economies’ decarbonisation, unless rich nations also catalyse sustainable development in places such as India, Indonesia and Nigeria, global emissions will balloon.

    So, how can the UAE’s Cop28 presidency mobilise the trillions of dollars necessary to fund investment in the developing world?

    One strategy is to lower the cost of capital for projects that reduce emissions. This key measure for lowering the cost of capital, represents the return paid to investors in a project.

    The higher a project’s perceived risk, the higher the cost of capital needed to attract investment. This goes for any project, be it renewable energy, energy efficiency or electric transport.

    If we can lower the cost of capital for carbon mitigation in emerging markets, more projects will be able to afford raising investment, resulting in more clean infrastructure and lower emissions.

    The good news is that the UAE presidency will inherit a host of international initiatives with the potential to lower the cost of capital where it is needed.

    We can take the example of the US-led Energy Transition Accelerator that the US special presidential envoy for climate John Kerry announced last year and expanded on this January in Abu Dhabi. This transition accelerator aims to channel billions of dollars towards weaning emerging markets’ electricity supply off hydrocarbons such as coal.

    By cutting the emissions of the power sector, renewable energy producers will earn carbon credits that they then sell to private companies, creating a new revenue source.

    Higher revenue for renewable energy projects equals more profits for their investors. Higher profits create a more attractive investment with reduced risk, resulting in a lower cost of capital and more investment in clean energy.

    Another star of Cop27 was Prime Minister Mia Mottley of Barbados, whose Bridgetown Initiative would suggest reforms to support institutions such as the International Monetary Fund and the World Bank.

    The proposals would support lending to projects in the developing world at concessional rates. This would lower emerging markets’ cost of capital through the principle known as blended finance. Here, cheap loans from the IMF and World Bank “blend” with private investment, pushing down the project’s overall cost of capital.

    These initiatives are a start, but from 2019 to 2021 there were only $14 billion worth of blended finance deals, and the picture was even bleaker in 2022. The problem is that amid precipitous debt burdens and rising interest rates, investments in developing countries are riskier than ever.

    Global policy must, therefore, go beyond sweetening private investment in green projects. The “carrot” of lowering the cost of capital for carbon mitigation must be paired with the “stick” of raising that cost for carbon-intensive investments.

    As discussed, cost of capital is a measure of risk and, in today’s world, a crucial financial risk is the energy transition. Because investments are long-term, investors must ask: will there be a buyer for fossil fuel-based power or high-carbon industrial products in 2050 and beyond?

    If not, such investments will become riskier, pushing their cost of capital higher.

    To raise the risk of investing in pollutive industries, and make green investments comparatively more attractive, global policymakers must therefore convince the private sector that the world is serious about decarbonisation.

    Long-term pledges made at international forums such as Cop28 change how the market sees the risk profile of their investments. A pledge to phase-out fossil fuels is not simply about the action governments themselves take; it is a signal to the private sector that long-term investment in pollutive industries is risky.

    We have reason to be optimistic that the UAE can deliver on these goals at Cop28, with several initiatives already starting to gather pace.

    As one example, in January, the UAE hosted a roundtable with Masdar, the state renewable energy company, to build on a recent policy white paper from the Harvard Kennedy School. The Harvard proposal suggests that a crucial part of the Paris Agreement — Article 6 — can be leveraged to lower the cost of capital for green projects in the developing world, thereby supporting private sector investment.

    This roundtable, attended by leaders from both the private and public sectors, was one of many discussions within Abu Dhabi Sustainability Week, which marked the start of the UAE’s outreach ahead of its presidency.

    Such efforts have potential and provide essential tools for private sector mobilisation. The cost of failure, however, would be high. Not only for capital, but for energy transition itself.

    Ely Sandler is co-author of the recent Harvard Kennedy School white paper, Financing the Energy Transition through Cross-Border Investment


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