Rewiring the financial system for the energy transition

Faced with high costs for fossil fuels and more frequent extreme weather events, the world is in no doubt about the need for a complete transformation of the global energy system.

For the most part, the technology already exists, renewable energy sources are already able to do many of the jobs done by fossil fuels for hundreds of years.

Scaling up that technology, however, is a challenge that will not be solved overnight.

“We're talking about trillions, particularly in emerging markets, to shift the ways we provide energy today and how we address the climate challenges of the future,” said Zoe Knight, Group Head of the HSBC Centre of Sustainable Finance and Head of Climate Change MENAT, speaking at HSBC’s flagship Global Emerging Markets Forum (GEMs).

“The role of business and finance in limiting temperature rises to 1.5°C is to invest in a way that tackles these challenges and contains future temperature rises.”

Globally, the world spends USD1.5 on clean energy technologies for every USD1 on fossil fuels, according to the International Energy Agency. To bring spending in line with a net zero trajectory, however, the IEA calculates every dollar spent on fossil fuels must be matched by almost USD9 of clean energy investment by 2030¹.

Mike Hemsley, Deputy Director at the Energy Transitions Commission², is in no doubt about the scale of the challenge ahead.

The financial sector will have a critical role to play in mobilising capital on that scale. Such sums are too vast to be met by a single institution, but the good news is that the industry is on board with the objective of a more sustainable future.

The Glasgow Financial Alliance for Net Zero (GFANZ)³, established ahead of the COP26 UN Climate Conference in Scotland in 2021, represents more than 500 financial institutions across 50 countries responsible for combined assets amounting to about 40% of the overall financial system.

Ronan Hodge, Technical Lead at GFANZ, emphasises that scaling up clean energy is essential to reducing the world’s dependence on oil and gas.

“It’s only with this ramp up of renewables that we can phase down fossil fuel use in line with the 1.5ºC objective,” he says. “GFANZ is really about making sure that the financial system has the tools, the frameworks and the guidance it needs to support that transition.”

Setting the right framework will be important. The global energy transition will require banks and investors to take a portfolio approach: as well as funding more solar plants or wind farms, capital providers must find a way to support new technologies and help carbon-intensive industries go green.

CCS is one of the major technologies that can help to decarbonise the fossil fuel sector – but the challenge with this and other technologies is scaling them up and the investment needed now to move fast enough", he adds⁴.

Renewable electricity is likely to remain the heaviest weighting in a future clean energy portfolio, but not enough is being produced.

According to the ETC, clean energy currently accounts for just 10% of electricity generation. By 2050, Hemsley predicts between 75% and 90% of electricity will come from wind and solar.

“Clean electricity feeding into the grid could be 70% of the world's energy needs by 2050,” he said. “Then, because electricity is so cheap, we could also use that to make low-carbon fuels such as hydrogen or synthetic aviation fuel, or even ammonia to put into ships. That could be another 15%. And then for the last 15%, you're looking at things like bioenergy, and fossil fuels.”

Bringing everyone along

Technological and financial solutions for the transition will also need to fit a variety of different economies, including emerging markets.

"While a lot of changes will happen if governments are forceful enough about the policies they create, there are some differences with emerging markets," says Hemsley. "Differences in political risk will impact the cost of capital in some regions", for example.

Some emerging economies may also lack the level of demand to support investable projects, requiring development finance and philanthropic funds to catalyse private capital flows – known as blended finance. The Business and Sustainable Development Commission’s Blended Finance Taskforce⁵ comprises representatives of business, finance, development, policy and civil society with a mission to overcome investment barriers in high impact sectors and regions.

A rapid switch to clean electricity will also require investors and energy companies to shut down fossil fuel infrastructure before it has reached the end of its planned economic life. In many emerging markets, which still rely heavily on coal-fired generation, this represents a significant financial cost that will need to be carefully managed.

“We need to think about how we phase out high emitting assets that aren’t compatible with net zero before the end of their useful life,” says Hodge. “The International Energy Agency and others include this in their projections – if there is a plan that involves early retirement or decommissioning at a date consistent with the broader transition, that's still a financial proposition.”

Policy push

While finance will be crucial to decarbonisation, capital alone cannot solve the climate crisis. Banks and investors will need to work with governments, regulators and industry experts to design a financial system that is fit for a sustainable world.

Knight believes this will require a fundamental shift in the way the financial sector factors carbon emissions into investment decisions.

“In the end, the crux of the matter is the price that you put on carbon,” she says.

“We need two things: the policy that establishes trading and a stable carbon market that gives a guarantee for long-term investment into these technologies.”

Hodge at GFANZ agrees that carbon pricing would be helpful. But he points out that governments representing 90% of the world’s GDP are now committed to net zero, and public policy incentives are moving in the right direction.

“Finance is only a catalyst of government policy,” he says. “Governments’ commitments are really important, and then what we need is more flesh on the bones of those commitments.”

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