Removing friction in climate finance
The climate finance problem is not a shortage of finance or of opportunity. The real problem is the friction that slows the flow of capital from investors to climate solutions. This friction, created by outdated and overbearing regulations, industry and market inexperience, and inertia, spans the globe.
When I began work in this area two decades ago, entrepreneurs (including me) complained that investors were uninterested in financing businesses addressing climate change. Conversely, investors complained that there were simply too few financeable businesses. Both were right. In the early 2000s, products designed to reduce greenhouse gas emissions, such as solar panels, were outrageously expensive, more than four times the cost of power from natural gas. Similarly, electric vehicles were costly and lacked the range to compete with gasoline-powered automobiles.
Today, that’s no longer the case. Renewable energy is cheaper than fossil fuels, with the International Energy Agency declaring solar “the cheapest source of electricity in history”. Electric vehicles perform better than gasoline-powered automobiles, have comparable range and refuel for a fraction of the cost. But just because low-carbon products are better, does not mean that climate change has been solved.
Avoiding catastrophic warming, defined by scientists as global warming more than 1.5 to 2 degrees Celsius, requires an entirely new global economy, reconfiguring our sources and uses of energy, transportation, existing building stock, agriculture and land use. And it needs to happen quickly. To put it another way, the global economy built in the 300 years since the Industrial Revolution must be rebuilt within 30 years. Investors met the unprecedented demand for capital to create the Industrial Revolution. They have the opportunity to do it again in the era of climate change.
Seizing this historic opportunity will require policymakers in every country to address three points of friction slowing the flow of investment capital required to alter the course of climate change:
Financing a transmission line to move clean hydropower from Canada to New York City has taken 17 years to clear regulatory approvals and is still pending final review.
The story in Europe is not much better. In Germany, a country with a history of leadership on climate change, construction of new wind farms has ground to a halt in the face of new state-level regulations. In many countries, outdated regulations thwart investment in energy efficiency in buildings, electric vehicle charging stations, sustainable meat substitutes and so many more climate-friendly businesses.
The solution to regulatory friction is both less government and more. Specifically, governments at every level need to remove or streamline regulations that hamper projects while imposing government authority to resolve disputes and limit NIMBYism (those who cry “not in my back yard”). The recently passed Inflation Reduction Act incentivizes low-carbon solutions, but even its political backers recognize the need to advance “permitting reforms” for the promise of this new law to be realized.
Investors rely heavily on experience, their own and that of market experts, when committing capital. This poses a problem for climate solutions that are relatively new to investors. For example, renewable energy projects have been slow to securitize because of an absence of standards and ratings, reducing the flow of capital to the sector.
Fortunately, investors are beginning to understand how to navigate this new terrain. As I outline in my new book, “Investing in the Era of Climate Change,” five climate-friendly investment strategies are broadening the participation of investors, not only individuals but also large institutional investors.
Investing in climate solutions in developing countries is made more challenging by volatile local currency exchange rates, economic and political instability. These additional frictions have created an inertia among investors.
While the UN calls for a six-fold increase in financing of climate solutions in developing countries, actual foreign direct investment has declined in recent years. Governments and multilateral institutions, such as the International Monetary Fund and the World Bank, need to address this inertia with sovereign risk insurance products to accelerate capital flows from investors to low-carbon solutions in developing countries.
These friction points appear minor against the massive challenge of climate change but addressing them will make a world of difference. Products to reduce nearly half of global emissions are already commercially competitive and appealing to many traditional investors. The technologies needed to reduce the remaining half are in development and attracting venture capital investors. While the total investment needed to remake the global economy is an estimated $100 trillion to 150 trillion over the next 30 years, an increase of five to eight times the current rate of $600 billion annually, it’s entirely feasible given the deep liquidity of the global capital markets and the shift underway in the investment community.
The capital exists, as do the business solutions, to avoid a climate catastrophe. Governments simply need to ensure they connect quickly enough.
Bruce Usher is the Elizabeth B. Strickler and Mark T. Gallogy faculty director of the Tamer Center for Social Enterprise and a Chazen Institute senior scholar at Columbia Business School. He is the author of “Investing in the Era of Climate Change.” Usher is an active investor in numerous public and private companies that provide climate solutions.
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