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On 13th December 2014, more than 190 countries agreed to the “Lima Call for Climate Action”. Along with preparing the ground for a global climate deal in Paris at the end of this year, this decision from the climate change negotiations underscores the agreement between governments to limit the long-term increase in global temperature to 2 degrees Celsius. Achieving this goal means that fossil-fuel combustion without carbon capture and storage will essentially no longer be possible in the second half of this century and that greenhouse gas emissions reaching the atmosphere will have to move to zero—on a net basis—by 2100.
This will have profound relevance for the $90trn that will be invested over the next 15 years in infrastructure in the world’s cities, agriculture and energy systems as well as for the near $100trn of assets under management by institutional investors searching for stable yield in a post-financial crisis world.
The Industrial Internet could generate $15trn of added value by 2030. But barriers must fall before the approach becomes widespread. A clean energy future, for example, would require a cumulative investment of $53trn by 2035 in low-carbon energy supply and energy efficiency, according to the IEA. That is only 10% more than the $48trn that would likely be invested in any case under a “business as usual scenario”, with most additional investment destined for energy efficiency.
The challenge is immense. In a 2014 survey of large pension funds by the OECD, direct infrastructure investments—green and brown—accounted for only 2% of the average portfolio. The green fraction of that 2% is just as small (perhaps 3% according to an earlier Bloomberg New Energy Finance study). In other words, only a very minor part of an otherwise vast pool of capital currently finds its way to investments that support low-carbon and climate-resilient infrastructure.
Reasons cited for these low allocations include a range of investment barriers—some macroeconomic and others driven by risk-return imbalances, regulatory restrictions, inadequate investor practices and constrained balance sheets. EU utilities, for example, have seen their market capitalisation fall by more than EUR 500bn between 2008-2013.
New regulations in response to the financial crisis have also prompted banks to reduce investments across illiquid asset classes and shorten tenors (the duration of loans), limiting access to finance for infrastructure—or at least making it more expensive. Basel III and Solvency II, which were aimed at strengthening the global banking and insurance sectors, respectively, have had some voicing concerns that these new rules could result, for example, in reduced readiness from banks and insurers to provide long-term project or corporate loans. Adding to the challenge is a shortage of aggregate demand, largely a consequence of investor uncertainty about the shape of the future economy.
The result is a waiting game where, in an environment of unprecedentedly low interest rates and excess supply of savings, under-investment in infrastructure nevertheless continues to undermine long-term growth prospects in almost every economy – irrespective of per capita income level or development model.
Part of the solution, therefore, will be to create new financial instruments and funds that can “de-risk” green investments and provide private actors with investment-grade opportunities.
So-called green investment banks (GIBs) are an important innovation in that regard. These special-purpose institutions use limited public capital to leverage or “crowd-in” private capital for renewable energy and energy efficiency projects. While the phenomenon is recent—the UK’s green investment bank, the first of its type , was established in 2011—more than 12 GIBs are now in operation, according to the OECD. Other debt products, such as green bonds, have seen substantial growth over the last few years, with $36.6bn of green bonds issued in 2014 and $2.3trn of assets under management calling for continued growth in the market. Yieldcos have also emerged as a potential solution on the listed equity side, raising more than $8bn from institutional and retail investors for green infrastructure between since 2013.
Financial innovation is not going to be enough on its own, however, and unabated fossil-fuel investment will continue unless sufficiently clear signals are seen that emitting carbon will become progressively more expensive and that storage space for it—whether in the atmosphere or underground—is finite.
This is such a big challenge that neither public nor private actors can afford expensive solutions. That is why nearly 70 countries and 1,000 businesses around the world agree that pricing carbon is overwhelmingly the best and most affordable way forward.
The reform of fossil-fuel subsidies represents another clear win-win strategy. These subsidies totaled $548bn in 2013—more than four times the global subsidies to renewable energy or the amount invested globally in improving energy efficiency. Removing them is not only good for the environment, it’s good for budgets and it’s good for economic efficiency. Policy stability, predictability and coherence will also be crucial as retroactive changes, such as those implemeneted in Spain and Bulgaria, can undermine investor confidence for years.
The last 10 years has seen some 700GW of coal-generating and 750GW of gas-generating capacity brought on line. And there’s more in the pipeline. Investors will need to know if these plants are going to run for the next 40 years or if they will become stranded assets. The stakes are high; companies have $28trn at risk over the next two decades, according to Mark Lewis, an analyst at Kepler Cheuvreux SA in Paris and leading financial figures, including Mark Carney, governor of the Bank of England, have expressed concern that some fossil-fuel companies may, in fact, be overvalued because of the high carbon content of some of their assets.
Influencing the destination of trillions of dollars of investment capital in long-lived plant and infrastructure over the years ahead is both urgent and doable—but it will require credible and coherent policies that stick if green investment capital is to flow.
Originally published January 11, 2015. Updated in April 2105 to reflect latest figures and developments.