3 things governments can do to finance the net-zero transition

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Manuela Stefania Fulga, Platform Curator, Banking and Capital Markets, World Economic Forum, Jianyi Chen, Project Fellow, Financing the Transition to a Net-Zero Future initiative, World Economic Forum

• Over 90% of global economic activity is covered by an emissions reduction target, but turning targets into reality will require trillions of dollars.
• Governments can assist in this effort by introducing innovative financing schemes and policies that ease the transition and reduce risks.
• Innovative regulation, such as the US Inflation Reduction Act, and tax incentives can speed the transition to net-zero while also creating competitive economies.

“We need a transition at the scale of the industrial revolution and at the speed of the digital
transformation. For this to happen, a radical transformation of the financial system is
required.”— Mark Carney, UN Special Envoy on Climate Finance

Public and private financial institutions have announced a slew of ambitious net-zero commitments in recent years. According to the Net Zero Tracker, today over 90% of global economic activity is covered by an emissions reduction target.

Members of the Glasgow Financial Alliance for Net Zero (GFANZ) — including more than 450 banks, insurers, investment managers, asset owners and financial services providers worldwide — have collectively committed more than $130tn of capital to support this transition over the next three decades.

However, it is not easy to translate these commitments into capital flows that support concrete net-zero projects. Supply and demand barriers prevent the mobilization of capital towards decarbonization technologies, as concluded by the Forum’s “Financing the Transition to a Net-Zero Future” initiative last year.

The International Energy Agency (IEA) estimated in its net-zero pathway that almost half of the CO2 emissions savings needed for net-zero by 2050 depend on climate technologies that are not available at commercial scale today. These technologies are key to the net-zero transition of the harder-to-abate sectors of our economies, such as heavy industry and transport. Until decarbonization technologies like clean hydrogen, zero- or low- carbon fuels or carbon capture and storage become cost-competitive against their carbon-intensive alternatives, it will be impossible to close the investment gap and mobilize the trillions needed for the transition.

At COP27 in November, over 200 countries are expected to convene and raise their ambition on climate action after a summer characterized by heatwaves, floods, droughts and wildfires — but taking action in the midst of an energy crisis is challenging.

Governments should continue to focus on supporting the commercial-scale deployment of decarbonization technologies and making these solutions financeable in the next decade.

Here are three things governments can do now to incentivize the mobilization of capital toward net-zero climate solutions.

1. Advance strategic policies that create new markets around decarbonization technologies.

Targeted and strategic policy actions are needed to mitigate the risks associated with climate technologies and to create an enabling environment for investments to flow towards decarbonization projects. Strong support mechanisms and green surcharges, like a carbon contract for differences (CfD), are needed to improve the bankability of these technologies and enable their commercialization in the next decade.

At the Annual Meeting this year, the Forum’s Financing the Net-Zero initiative published a set of policy recommendations to improve the mobilization of capital in the steel and aviation sectors.

Policy intervention is most impactful if it generates stable demand for green products and encourages the development of new markets around decarbonization technologies. Whenever possible, governments should work to support the availability of green production inputs such as hydrogen, biomass and clean energy, enabling reliable and scalable supply chains. Governments should also design policies that leverage blended finance and innovative financing models, provide de-risking support to early adopters of climate technologies and ‘crowd in’ further sources of financing.

Take, for example, the US Inflation Reduction Act (IRA), signed into law in August 2022 by President Joe Biden. The Act sets the country on track to cut greenhouse gas emissions by about 40% below 2005 levels in 2030, earmarks $369 billion to support clean energy and climate mitigation initiatives and provided tax credits of $3 per kg of hydrogen produced, turning the US into one of the cheapest countries in the world to produce clean hydrogen.

It also put in place a $5.8 billion programme to support investments in hard-to-abate and energy-intensive sectors such as steel, cement and chemical production. The Act is ultimately changing the rules of the game for climate solutions, improving their commercial availability and providing strong market signals.

2. Identify innovative financial de-risking structures.

Companies in competitive and mature sectors such as steel production, chemicals and aviation operate in an environment of small margins and cannot always afford the capital needed to repurpose and replace their existing industrial asset base. They rely on billions of dollars worth of equipment and supporting infrastructure, optimized over decades of operations — something not readily available for climate solutions that are not deployed at commercial scale today. Private investors, therefore, tend to shy away from these projects because of the high investment risks associated with the project, whether perceived or real.

Governments have a set of tools they can deploy to de-risk projects and mobilize large amounts of private capital. As summarized by the “Financing the Transition to a Net-Zero Future” report: tax incentives, loan guarantees and capex grants could mobilize the capital needed to kick-off the project; early and later operations can be supported via contracts for difference and feed-in tariffs. By using small amounts of concessionary capital to mitigate specific investment risks, and by providing incentives to make up the “green premium” of green products compared to their carbon-intensive alternatives, governments can catalyze and direct the large capital flows needed.

3. Collaborate with industries and net-zero financiers.

While some governments have announced visionary plans to change the energy mix their economies rely on, corporations today still face difficulties in raising capital for the deployment of a new climate technology. The issue is not simply one of market inefficiency — it is one of market failure.

Evidence suggests that the delta in cumulative market returns between a green versus a carbon-intensive portfolio is insignificant: transition and climate risks are not yet reflected on the markets.

To be truly effective and support the areas of the economies that will be most impacted by the net-zero transition, governments must continue to advance the dialogue with industries and finance stakeholders. It is particularly true for hard-to-abate sectors, where a supportive policy environment can ensure that capital is available to support them in their net-zero transition, while helping them to mitigate further disruption.

To support this dialogue and encourage collaboration, the Financing the Transition to a Net-Zero Future initiative will organize a series of dialogues convening policymakers, industry, hydrogen innovators and financial institutions to identify new methods of collaborations at the Sustainable Development Impact Meetings and in the lead-up to the World Economic Forum Annual Meeting 2023.