Mobilizing green capital for sustainable energy
Success in meeting the Paris Climate goals and reducing societies’ carbon footprint depends on mobilizing additional private finance and increasing innovation in sustainable energy technologies. Energy demand is expected to increase 60 percent by 2040, and 85 percent will be from developing countries.6 Clearly, the current range of technology solutions available for wind, solar and biomass needs to be complemented with new solutions in areas such as storage, carbon capture and hydrogen. Greater efforts are required to support increased energy efficiency that can be adapted to developing and developed economies alike.
Economies in the developing world face twin challenges: the outsized impact of climate events on their populations, and the greater policy uncertainty surrounding regulation and the macroeconomic environment that undermine access to long-term private capital. This makes mobilizing green capital for sustainable energy technologies in low-income economies a challenge.
Is it all about the money?
The starting point should be a recognition that the costs of not adapting to the climate change are high. We are already seeing the impact on agriculture, health and economic development in emerging countries. Recurrent headlines highlight the devastating social impact of climate events and the enormous costs of disaster relief and rebuilding communities. In addition, developing economies have large unmet energy needs that add further layers of complexity and vulnerability: 1.2 billion people globally are without access to electricity.
Against this background of urgent needs, it is noteworthy that there is no shortage of available capital worldwide seeking long-term investment opportunities. Capital in pension funds insurance firms, sovereign wealth funds and capital markets totals in the trillions of dollars. Already, private capital flows to the developing world average roughly US$1_trillion/year from direct investment, loans and portfolio investment, not to mention large transfers of remittances from residents in developed economies to their families overseas. At issue is how to tap these resources for greater social purposes, like innovation in sustainable energy, particularly given the perceived level of risk.
Making the shift to green capital
To create low-carbon economies, we have to address the barriers that inhibit greater technological innovation and limit its adoption in middle- and low-income countries. In the following pages are three key areas that, if targeted appropriately, offer great potential to expand private investment and accelerate the climate agenda.
Attracting private capital requires an investment-ready policy environment. This is a complex issue since the innovations in renewable energy cut across a range of new and disruptive technologies. Policies will need to address the infrastructure for off-grid, ‘pay-as-you go’ distribution networks, mobile telecommunications for tracking usage and billing, blockchain and AI to optimize energy delivery and biotechnology, among other new sources of energy. Developing economies have the potential to leapfrog existing technologies and move to new business models that offer wider, more equitable access to sustainable energy.
Making this leap requires investment-ready policies. These policies include establishing the institutions and rules for property and land ownership and the legal structures that enable assets to be used as collateral. Sound regulation is needed to make capital markets transparent and reliable as a means to raise local currency finance and offer ‘exits’ for investors at different stages of the investment cycle. In addition, improved training and education are essential to create a technology-literate workforce.
A first step for policymakers is to review successful practices from other countries on topics such as feed-in tariffs for renewables, the effective use of power purchase agreements, design of competitive models for service provision and the use of capital market instruments to fund renewables. There is also a role for multilateral development agencies to support these policies and build capacity among the new regulatory and oversight institutions.
Blended finance and overcoming the innovation deficit
Even in the best policy environment, however, there are inherent technology and commercialization risks that can inhibit innovation. Innovators must bear these ‘first-mover’ risks, in the hope of making profits, if these are to be overcome. In most developing economies, this type of risk-taking is constrained by insecure property rights and the limited role of early-stage risk capital or robust capital markets to provide equity for growth.
One approach to reduce the innovation deficit is to blend private and public capital. A blended finance approach uses public sector resources — whether from international donor agencies, multilateral banks, or national entities — to finance riskier mezzanine tranches that can catalyze additional private investment. When designed properly, this approach can ensure adequate longer-term finance for bankable projects, create an arm’s-length relationship with investees for the public sector, protect intellectual property and successfully leverage private capital. An example of a blended-finance structure is the Sustainable Energy Innovation Fund currently being developed by KPMG and the World Economic Forum.
The development of early stage funding should not be viewed in isolation of the entire financing ecosystem. Additional sources of equity finance, mezzanine debt and long-term debt are needed to meet the needs of firms throughout their growth cycle. The innovations in the green bond market and the establishment of green banks show promise that lifecycle funding will be available as the sustainable energy markets mature.
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