Overcoming the energy transition investment gap
The transition to greener energy is gathering pace, with renewables proving particularly attractive to investors. But are enough billions flowing in yet to make a meaningful difference?
Driven by the urgent need to combat climate change, the world committed more than $500bn (£363bn) to decarbonisation projects for the first time last year, according to BloombergNEF. Well over half of this total was invested in renewable energy generation, but significant sums were also spent on domestic heat pumps, electric vehicles, hydrogen technology and systems enabling carbon capture and storage (CCS).
While this news appears encouraging, the numbers are still far below what is required, according to the International Energy Agency’s World Energy Investment 2021 report. It notes that, although $750bn is expected to be spent on clean energy projects in 2021, “investment would need to double in the 2020s to maintain temperatures well below a 2°C rise and more than triple in order to keep the door open for a 1.5°C stabilisation”.
Part of the problem is that finance is flowing faster than actual capital expenditure, according to Seb Henbest, BloombergNEF’s chief economist and lead author of its New Energy Outlook 2021 report.
“There is a rate-of-change problem,” he explains. “Getting the technology cheap is one thing, but then you have to deploy it through the global economy to displace the carbon-intensive generation infrastructure. That takes time.”
The report argues that investment in wind and solar generation alone needs to increase to between $760bn and $1.8tn annually between 2021 and 2030 to get on track for net zero.
Price uncertainty is also holding back the renewable energy market. Energy prices are typically set by the marginal cost of operation, which is very small for renewables.
“In other words, there’s a missing-money problem,” Henbest says. “As the level of renewables in the system increases over time, the wholesale power price falls and revenues start to look less good. To mobilise capital, there needs to be more certainty about future price signals.”
Building completely new markets
Thanks to falling costs and rising electricity demand, renewable energy is the low-hanging fruit for investors. Other low-carbon technologies, such as hydrogen, CCS, heat pumps and large-scale battery storage, are much further away from maturity and commercialisation.
“Just as renewables have had over the past 10 to 15 years, these markets will need robust policy and support mechanisms, as well as collaboration between the public and private sectors,” says Dr Edurne Zoco, executive director for clean technology and renewables at IHS Markit.
This is starting to happen. Consider hydrogen: the European Commission and six European countries published hydrogen strategies in 2020, followed by the UK this year. Through various funding mechanisms, $44bn has been made available for hydrogen projects in Germany, France, Italy, Spain and Portugal up to 2030, according to IHS Markit.
Zoco believes that such initiatives, along with policy measures such as Canada’s clean fuel standard, are incentivising and de-risking investment, but she adds that there are still likely to be winners and losers as the technology develops.
“While the overall market might boom, there will be some spectacular busts,” she predicts. “We’re expecting to see joint ventures and strategic partnerships to defray those risks.”
Hydrogen technology alone will require a total investment of almost $15tn between now and 2050, according to the Energy Transitions Commission, a think-tank funded by a range of organisations, including oil and gas companies. It estimates that 85% of this total would need to be allocated to electricity generation. The rest would need to be spent on aspects such as hydrogen production, storage and transport.
Alongside hydrogen, electric heat pumps will play a big role in decarbonising heating. According to New Energy Outlook 2021, an average of 18 million new heat pumps need to be installed each year to 2030.
Along with financial incentives, customer education is crucial in achieving this rate of uptake, says Ben Hertz-Shargel, global head of grid edge at the Wood Mackenzie energy consultancy.
“A lack of understanding about the total cost of ownership and the importance of clean heating, along with insufficiently trained contractors, is holding back deployment,” he says.
Each technology in the low-carbon field has its own barriers to overcome. For instance, to support the development of large-scale battery storage, there are plans to introduce 500GWh of new cell manufacturing capacity across Europe and North America, according to IHS Markit, but limited access to raw materials is creating nervousness in this sector.
For technologies such as CCS, which is needed to offset emissions from the fossil fuels that remain in the mix, national governments are trying to bring down costs through regional hubs. IHS Markit estimates that annual investments in CCS would need to double every five years in order for the technology to hit its carbon reduction targets.
David Elmes is professor of management practice and head of Warwick Business School’s Global Energy Research Network. He believes that an increase in investment in energy efficiency for buildings and transport, which in recent years has been flat, would go some way to bridging the funding gap.
“We need to talk about consumption with the same level of emphasis as we do supply,” he says. “We must have serious discussions about building standards and local energy systems.”
Hedging their bets
Part of the energy transition challenge is that governments aren’t sure what the market will look like and are yet to make firm decisions on its technological composition. It’s also unclear how they plan to manage, measure and regulate reporting on emissions, as well as whether there will be opportunities to trade them (as is outlined in article 6 of the UN’s Paris accord on climate change).
“More clarity on these issues can lead to a pretty profound growth in market opportunities, but mistiming it could also mean some pretty heavy losses,” Zoco warns.
Despite the risks and uncertainties, Henbest believes that all players in the energy economy reckon that the transition will happen and all are betting in the global marketplace in the hope that they have a winning strategy.
“They know that this huge shift is creating a big market opportunity,” he says. “It’s simply a matter of how fast it’s going to happen.”