Driving Investment toward Low Carbon Energy in the Global South

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It is crucial that climate policy addresses the global investment challenge as a transition to a low carbon society will require a substantial financial investment. The International Energy Agency estimates that to meet the rising global energy demand an infrastructure investment of US$37 trillion is required by 2035. This translates to an annual investment of roughly US$ 1.5 trillion. Current rates are far off this target as the annual investment in renewable energy was US$270 billion in 2014 globally which is only 16% of the total energy sector investments, totalling US$1.6 trillion. However, some optimism can be taken as the total investment in Renewable Energy in 2004 was only US$45 billion, representing a significant increase in market share. Furthermore, the total spend of US$1.6 Trillion means there is an appetite and market for investment in the energy sector, allowing for substantial future market share gains for renewable energy. While as Mazzucato & Semieniuk (2018: 8) explain that the future success of financing renewable energy requires “a better understanding of the relationship between different types of finance and their willingness to invest in renewable energy”. 

Schwerhoff & Mouhamadou (2016) recognise that climate funds are limited in their capacity to invest in renewable energy projects at the scale required. They describe the “obvious approach” would be “providing a reliable investment framework” and to promote the active involvement of the private sector in order to increase the international financing volume. Thus, the inclusion of private financiers could act as a catalyst to accelerate widespread adoption of new technologies. While one of the main barriers for entry include high costs for deployment for low-carbon technologies making it more capital-intensive than the high-carbon alternatives, whose costs are mainly dictated by the cost of fuels. Due to the magnitude of investment required to fund low-carbon power generation the availability and cost of debt is crucial for successful energy transitions. This means that they are much more sensitive to the increase in financing costs such as the cost of debt or interest rates. Which creates an unattractive risk/return profile associated with low carbon investments and is one of the fundamental reasons preventing larger flows of credit to these sectors. One of the factors leading to higher financing costs is due to a lack of information and knowledge around renewable energy, financiers do not have the knowledge to effectively valuate the risks and returns for investments in renewable energy technology opposed to older and established & proven fossil fuel technologies. This perpetuates an industry which is prone to lock-ins, because renewable energy is exposed to the cost of debt due to high initial investment costs. The result is that governments, investors and utilities companies are then more inclined to invest in fossil fuel because of the lower financial costs. 

As Eberhard & Gratwick (2013) acknowledge, one of the fundamental issues facing a transition to renewable energy for African counties is that most African governments are not able to fund their power needs. Entities such as national utility companies lack an investment-grade rating and therefore are unable to raise sufficient debt at an affordable rate. Similarly, Schwerhoff & Mouhamadou (2016) identify that African countries and their governments need to take crucial actions in improving their governance with the objective of achieving a better credit rating which would ultimately reduce the cost of financing. Additionally, the overall quality of the continents’ financial markets needs to be improved or maintained at a standard which can aid domestic funding. While this may still be difficult for many counties as the market for domestic funding is still developing, international funding agencies would also need to increase their volume of investment in order to fund a shift to renewable energy. Furthermore, by eliminating barriers in the investment environment and improving local institutions the overall market risk is reduced. Additionally, Schmidt (2014) recognises the need for a global database on financing costs, as despite large differences in risk profiles across various countries, most energy models and reports used to calculate project feasibilities assume universal financing costs which is simply not the case. As discussed, financing costs in the global south are expected to be higher than that of the north due to perceived risks, but until such a database is created the variance of this is unclear. Mapping out financing costs through a global database could be hugely beneficial, increasing competitiveness in the global market by creating a universal pricing structure.

Polzin (2017) explains that technological barriers can be removed through technology-policy, as the most significant barrier to a low carbon transition are lock-ins and a subsequent dependency on out dated technologies. Aligning environmental targets with energy policies could act to support redirecting funding towards low carbon technologies. In order to prevent lock-ins, it is important to appreciate that when designing policies which promote investment, it can ultimately create directions and path dependencies for certain technologies, whether planned by policy makers or not. As private and public financial actors can affect the direction of change and innovation as well as setting path-dependence in innovation, the role of feedback has an effect in creating lock-ins. While the opposite can also be true, poor policies can create path dependencies and ultimately lock-ins, impeding innovation for new technologies.

Further encouragement can be provided to private investors by implementing a regulatory framework such as emission taxes for pollution, which would effectively make fossil fuel more expensive and renewable energies the more attractive investment option. Additionally, new market opportunities and incentives can be introduced through governments initiatives such as Power Purchase Agreements (PPA), Feed-in Tariffs or the removal of subsidies for Fossil Fuels can drive a response from market players and change behaviours. Though on its own this may not be sufficient due to the inherent market failure associated with the fact that private banks operate with relative autonomy while allocating large portions of global credit. However, this could have a better chance of success in emerging economies where central banks and governments have a higher level of control over the private sector.

References/Further Reading

Campiglio, E. (2016). Beyond carbon pricing: The role of banking and monetary policy in financing the transition to a low-carbon economy. Ecological Economics, 121: 220-230.

Eberhard, A. & Gratwick, K. (2013). Investment power in Africa: where from and where to?. Journal of International Affairs, (14): 39–46.

Eberhard, A. & Kåberger, T. (2016). Renewable energy auctions in South Africa outshine feed-in tariffs. Energy Science & Engineering, 4(3): 190–193.

Eberhard, A., Gratwick, K., Morella, E. & Antmann, P. (2017). Independent Power Projects in Sub-Saharan Africa: Investment trends and policy lessons. Energy Policy, 108(1): 390-424.

Mazzucato, M.  & Semieniuk, G. (2018). Financing renewable energy: Who is financing what and why it matters. Technological Forecasting & Social Change, 127: 8-22. [online] Available from: http://dx.doi.org/10.1016/j.techfore.2017.05.021

Polzin, F. (2017). Mobilizing private finance for low-carbon innovation – A systematic review of barriers and solutions. Renewable and Sustainable Energy Reviews 77: 525-535.

Schmidt, T., S. (2014). Low-carbon investment risks and de-risking. Nature Climate Change, 4:237-239.

Schmidt, T.  S., Matsuo, T. & Michaelowa, A. (2017). Renewable energy policy as an enabler of fossil fuel subsidy reform? Applying a socio-technical perspective to the cases of South Africa and Tunisia. Global Environmental Change, 45: 99-110. [online] Available from: https://doi.org/10.1016/j.gloenvcha.2017.05.004

Schwerhoff, G.  & Mouhamadou, S. (2016). Financing renewable energy in Africa – Key challenge of the sustainable development goals. Renewable and Sustainable Energy Reviews, 75: 393–401. [online] Available from: http://dx.doi.org/10.1016/j.rser.2016.11.004

Steffen, B. (2018). The importance of project finance for renewable energy projects. Energy Economics, 69: 280–294. [online] Available from:  https://doi.org/10.1016/j.eneco.2017.11.006

Walwyn, D. R. & Brent A. C. (2015). Renewable energy gathers steam in South Africa. Renewable and Sustainable Energy Reviews, 41: 390–401. Available from: http://dx.doi.org/10.1016/j.rser.2014.08.049

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