A major focus of this year’s COP26 event centres around the question, ‘How can the energy transition be adequately financed?’. Classification society DNV recently released a report entitled, ’Financing the Energy Transition’, summarised briefly by gasworld here. Following up on the report, gasworld spoke with report authors Jeremy Parkes, Global Business Lead, Electric Vehicles, Energy Systems, DNV, and Christian Parker, Content Manager, Energy Systems, DNV.

To achieve goals set out by the Paris Agreement, such as a 50% reduction in harmful emissions by 2030, the report stated that a ‘massive redirection’ of spending from carbon-heavy investment into clean energy is required.

DNV forecasted that the current budget for a ‘1.5C future’ will be exhausted in 2029 with an emission reduction of just 9%. This implies that financial barriers are going to have to be faced and overcome.

When asked about the main obstacle standing in the way of redirecting funds into clean energy, Parkes mentioned that a particular concern was the ‘significant upfront investment’ in addition to supportive policies that are costly in the short term.

He added that unabated fossil fuel assets must be scaled down, which would cause companies to take a financial hit.

World energy expenditure as a fraction of world GDP.

World energy expenditure as a fraction of world GDP.

Source: DNV.

Elaborating on the requirements of policies, he said, “To enable the massive redirection of capital required for the energy transition, policies will need not only to support clean-energy projects, but also to disincentivise fossil fuels and the status quo.”

This mirrors the view of the Organisation for Economic Co-operation and Development (OECD) and the International Energy Agency (IEA) which recently said that – during periods of high energy prices - more focus needs to be shifted to investing in sustainable energy infrastructure, rather than encouraging further fossil fuel subsidies.

Parkes added, “In 2020, governments globally provided more than $180bn of fossil fuels subsidies, according to IEA estimates. However, with the right policies these can be redirected into clean energy solutions.”

How can existing policy change to help financial markets accelerate the transition?

The authors stated that the challenge is to create the correct conditions for capital to flow into clean-energy projects, as well as enabling the redirection of capital required for the energy transition.

Parker explained, “Tools such as the EU taxonomy could go some way to addressing this. An effective price on carbon would be the next step. By effective we mean properly pricing the damage caused by emissions, and pricing at a level that makes technologies to remove carbon from fossil fuels commercially viable, such as hydrogen and carbon capture and storage (CCS).”

“The fact that most carbon-emitting industries, from generation through to industrial processes, do not pay enough or at all for the cost of carbon is itself a subsidy.”

To incentivise further investment in clean energy, policies need to create a level of certainty and risk reduction. By using subsidies, early-stage investment, and measures to get greater certainty from the demand side, Parker believes the profitability of clean energy opportunities that are currently high-risk, low-return, long-term investments can be improved.

Such measures include corporate PPA agreements for renewable electricity generation and consumption or for joint investment in industrial clusters for hydrogen and CCS.

Conditions can also be created to reduce further investment in oil and gas projects by introducing policies and regulations that can increase the risk. With investors fearing stranded assets with long-term multi-decade projects, the risk is brought forward, a phenomenon already occurring.

“Policy is key not just in setting out the path to decarbonise, but also in deciding how quickly regions and world move down that path. The quicker that governments incentivise industry to adopt technology, the quicker the technology progresses along the cost learning curve and becomes independently financially viable,” Parker said.

How vital is it to focus on hydrogen and CCS?

A faster transition to a decarbonised energy system is required to meet Paris Agreement targets, according to DNV. This will require a greater focus on renewable power generation and electrification, in addition to the pre-combustion removal of carbon from fossil fuels by using hydrogen or at points of ‘major combustion’ with CCS.

Parkes said that hard-to-abate sectors such as heavy industry and aviation are slow to decarbonise and that emissions from those areas will increase over the next 15 years according to DNV forecasts. Although the utilisation of hydrogen, CCS, and biofuels for aviation can and will contribute to decarbonisation, they are all at early stages in their development and more methods will have to be taken to fully embrace the transition.

“They are likely to require government intervention – incentive schemes, innovation funding, and mandates – to accelerate decarbonisation of these sectors,” said Parkes.

Meeting the Paris Agreement, affordable or not?

Calling it ‘a question of mindset’, the authors stated that, while it is affordable in GDP terms, the question is whether the upfront investment required to accelerate the energy transition will be prioritised. Parker referenced a quote by Daniel Wong, Global Co-Head, Macquarie Capital, “If something becomes of increasing importance, which clearly climate change is, then the priorities become reordered and we will afford it.”

An important question to raise is, who should pay for the transition? Although perhaps a political question, the authors see it as something that everyone must pay for.

“The question is whether we pay now or pay later and also to accept the costs and impacts of failing to secure a Paris-compliant future. The balance is that everyone should then also see the benefits from an accelerated energy transition, making it essential to ensure a just transition,” they said.

Assuring that capital flows to the right areas…

With a significant focus at COP26 on governments of developed countries pledging funding for developing countries, there are still very few countries currently on track to meet their own carbon reduction goals. This is exacerbated by the constant struggle to provide affordable, reliable energy while also researching and developing ways to decarbonise.

World hydrogen energy demand by sector, as forecasted by DNV.

World hydrogen energy demand by sector, as forecasted by DNV.

Source: DNV.

Unlocking private sector funding is a major factor in assuring the correct flow of capital, said Parker. Elaborating, he said that government funds should be used to drive policy change, de-risk projects and get capital flowing into developing countries. This creates the conditions that will incentivise private capital investment.

“Developed countries need to go first in scaling clean energy technologies to bring down their cost to then be feasibly deployed in developing economies,” he said.

This is apparent with wind and solar, both of which are quite often cheaper than fossil fuels for power generation. To mirror this with hydrogen, CCS and energy storage a greater emphasis needs to be placed on scaling.

What exactly is a ‘just transition’?

DNV frequently alludes to a ‘just transition’ in its literature. The organisation believes that this is an integral part of the Paris Agreement and essentially involves balancing sustainability priorities, such as the Sustainable Development Goals (SDGs), across regions and sectors.

“Crucially, it focuses beyond industries and financial markets to the societies and people affected by them. A just transition is both a risk and enabler of an accelerated transition,” said the authors.

DNV state that there are three main priorities around providing a just global transition: the provision of clean, affordable, and reliable energy, the balance between return on investment and reduction in emissions, and making sure that emerging economies maintain the right to the economic benefits of fossil fuels versus the need to accelerate the transition globally.

“For governments, enabling a just transition is a prerequisite for achieving policy targets: transition initiatives will fail in the absence of sustained support from most of society,” said Parkes.

Concluding, the authors emphasised the necessity for climate resilience to ensure a just transition, “Mitigation alone will not stop the impact of global warming on people and societies. Adaptation and resilience must be built into systems and infrastructure to moderate harm from the climate crisis. This becomes more critical as the cost of natural disasters keeps rising.”

The full report by DNV is available to read here.