The global energy transition has reached a critical juncture, at which the deployment of technologies such as green hydrogen, energy storage, and offshore wind needs to be scaled up rapidly to keep pace with growth.
But this prospect is being stymied by rising inflation, which is bumping up acquisition costs. In a comment on a new report on this development, Francesco La Camera, director general of the International Renewable Energy Agency (IRENA), said rising interest rates are increasing the cost of capital for project financing.
There appears to be a critical need for low-cost financing for new technologies that can enhance the energy transition for various projections to work.
The latest report by IRENA, titled “Low-cost Finance for the Energy Transition,” revealed the lessons learned and new challenges facing the global energy transition using India’s G20 as a case study.
The report, published in collaboration with the Ministry of New and Renewable Energy of India for the Group of Twenty (G20) under the Indian Presidency, revealed that while countries around the world have embarked on an ambitious and essential transformation of their energy sectors to avoid costly climate change impacts, protect ecosystems, and improve social and environmental outcomes for their citizens, however, progress remains uneven across sectors and countries.
The growing urgency of the task ahead calls for a clear assessment of the challenges and the lessons learned from the energy transition to date.
One clear message from solar and wind power technologies of the past decade is that conventional wisdom has been a poor guide to how far and how fast small, modular technologies can scale, innovate, and decline in costs, the report said.
Globally, the cost of renewables has fallen over the last decade and more, with declines in the costs of solar and wind power being particularly large, according to IRENA’s Renewable Capacity Statistics 2023. has
Several energy transition trends show that despite the impact of COVID-19, supply chain challenges, and the fossil fuel price crisis in 2022, the energy transition is remarkably resilient and is accelerating.
For example, by the end of 2022, renewable capacity had reached new heights, exceeding 3,300 gigawatts (GW) of total installed capacity for the first time. The rate of heat pump installations has skyrocketed in a number of countries that are particularly vulnerable to the effects of the current gas supply crunch, for example, Germany and Poland.
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Sales of electric vehicles (EVs) rose by an estimated 57 percent in 2022 to over 10 million. As a reaction to the challenge of fossil fuel supply disruptions in 2022, some jurisdictions are proposing new policies that will help accelerate the energy transition in the short to long term, like the Inflation Reduction Act in the United States and the REpowerEU/Fit for 55 package in the European Union.
According to IRENA, the challenge the world now faces is that the rate of deployment of renewables and associated infrastructure, levels of funding, and inclusiveness of the transition all remain below what is required by the 1.5°C pathway.
IRENA’s report noted that to achieve the climate targets agreed to by countries under the Paris Agreement, scaling up the deployment of renewable energy, energy efficiency measures, and other facilitating technologies is critical. This requires at least $4.4 trillion per year of investments in energy transition technologies.
Access to funding in many emerging and low-income economies is not sufficient, and often too costly to accelerate the energy transition at the necessary rate. Lowering the cost of capital for financing the energy transition has therefore become more crucial than ever.
Although country-specific circumstances vary, country risk, or policy risk, is often identified as the primary impediment to international institutional capital flows.
A project’s risk profile is crucial to the cost of financing. In general, less-risky projects will be able to tap into larger pools of capital, with lower debt costs and more favourable terms.
Lenders will also be prepared to lend larger amounts, reducing the need for more expensive equity capital. At the same time, less risky projects will also require lower equity rates of return.
The difference can be substantial, with the weighted average cost of capital differing by as much as a factor of five or six between an advanced economy and an emerging market economy. To this structural problem can be added the current, increasing macroeconomic risks and the rising interest rates being used to try and combat inflationary pressures.
The importance of innovation in the energy transition cannot be underestimated, whether that is in terms of technology performance, business models, market design, or system operation.
Appropriate innovation frameworks are needed at each stage of the technology deployment pathway; from incipient research and development activities to market- and finance-enabling processes to achieving commercial deployment and the scaleup required. They can also be designed to reduce the transaction costs of technology transfers.
The private sector has stepped up its investments in energy transition projects. The public sector has not been idle, either, as it has set the policy frameworks needed for growth to date.
The public sector has also acted to reduce the risk profile of energy transition projects. It has endeavoured to provide a stable long-term policy framework and business environment conducive to giving the private sector confidence to invest in large, long-lived energy transition assets.
La Camera said the financial resources allocated by the public sector to support the transition are inherently limited, and much of the overall investment required will need to be mobilised from the private sector, including from national and international financial institutions.
“The active engagement of the private sector in the journey to net zero is therefore vital, particularly in providing low-cost capital to finance energy transition projects in a time of tightening monetary policy,” he said.
The public sector has thereby helped to attract private investors and developers to build and finance pipelines of bankable projects for the energy transition. Its role will continue to be crucial in the future, particularly when it comes to well-designed public support that reduces the risk profile of energy transition investments and allows private developers to access lower-cost debt and equity.
According to the report, beyond policies and measures to attract private investment, multilateral public funds and policies could be more actively channeled towards technologies and countries/regions that are currently not able to attract private capital.
“The public sector can also step up its role in providing concessional finance, that helps “crowd in” private sector capital. This “blended” finance approach to catalysing institutional capital at scale towards the energy transition will need to be given greater attention to mobilise the financial resources required for the transition.”
In addition to more traditional de-risking products, a more comprehensive way of defining risk is needed. Amid climate change, it is not just the private risk profile of a project that matters, the agency said.
“Policymakers need to adjust risk through policies that account for the external risks associated with the negative impacts of climate change on the environmental, planetary, and social spheres.
“For instance, what are the risks associated with leaving a large part of the population out of the energy transition and locking in underdevelopment? What are the risks of the Sustainable Development Goals not being met?” the agency queried.
According to IRENA, taking these risks into account suggests that public funds, including those that flow from the Global North to the Global South, need to play a much larger role in addressing the imbalance between private investors’ risks and the economy-wide risks of falling short in the energy transition.
