Comment & Analysis
The climate crisis is the most pressing issue of our generation. In a world where critical resources are becoming scarce and global decarbonisation is essential, investment into infrastructure, operations, and innovation is needed in abundance to mitigate and adapt to the effects of climate change. But where is the money coming from and is there enough of it?
Global estimates vary, but all point to a significant gap. A previous report by the Institution discusses the required global investment to deliver Net Zero. It highlights McKinsey’s estimate of $275 trillion by 2050 ($9.2 trillion per year on average), which is a $3.5 trillion increase in annual investment above current levels, aligning with the OECD’s view of a $3.8 trillion gap. [1] Climate Policy Initiative estimates nearly $200 trillion USD is needed by 2050; $6.2 trillion annually from now to 2030 and $7.3 trillion by 2050, which may indicate a slightly smaller gap. [2] However, projected global climate finance only reached 1.27 trillion in 2021/22. [3]
The transport and energy sectors look to be the most expensive. [4] The World Economic Forum’s 2023 study focused on carbon intensive parts of production, energy and transport, accounting for over 40% of global greenhouse gas emissions. [5] They put the required investment at around $13.5 trillion for clean power, clean hydrogen and fossil fuels abated by carbon capture, utilisation and storage to account for over 90% of the energy used in 2050. In the UK specifically, the National Energy System Operator suggests the pathway to clean power by 2030 requires up to £60 billion of network investment cumulatively for new onshore and offshore networks. [6]
Climate finance needs and access vary by nation with some more vulnerable to the adverse effects of climate change. The United Nations’ New Collective Quantified Goal on Climate Finance being discussed at COP29 aims to address the growing gap between the needs of developing countries and ongoing challenges in accessing climate finance. [7] The work proposes a minimum allocation amount and equitable distribution for developing countries, while urging developed countries and finance providers to improve access to bilateral (direct transfer to recipient) and multilateral (joint international response) mechanisms and reduce barriers, for example by simplifying application processes or supporting the capacity of developing countries.
Who’s really paying: Governments, businesses or households?
There are several key stakeholders to consider who each shoulder some of the cost of the Net Zero transition, with a view that upfront costs are higher, but this should alleviate over time as benefits materialise.
Governments play a major role by decarbonising public bodies and assets like infrastructure, while providing financial incentives and reducing risk for businesses and households to do the same. This includes through tax incentives, tariffs, cap and floor schemes, grants and subsidies, as well as creating a stable and competitive domestic policy and economic environment to attract private investment. Governments must also manage perceptions as cost increases felt without benefits can dampen public support. [8]
Examples of Government-led funding mechanisms include Canada’s Low Carbon Economy Fund for projects to reduce greenhouse gas emissions and generate growth or the UK’s Green Financing Programme, which sources finance from investors, via government bonds called ‘green gilts’, to fund sustainable initiatives. [9,10] The EU’s Carbon Border Adjustment Mechanism is a tariff on embedded carbon emissions from the production of imported goods to ensure they are equivalent to the carbon price paid domestically. [11]
Further down the line, Governments will likely play a role in maximising value from any ‘stranded assets’ as we shift away from high-emission resources, for example the estimated $2.1 trillion of power assets no longer needed by 2050 globally. [12]
Private investment, including household spending, dominates climate finance sources in the USA and Canada, Western Europe and South Asia compared to public finance. [13] Some forecast the share of private investment to be around 80% of the total investment needed. For the private sector this means equity and debt financing, which needs to be mobilised to reduce the finance gap. This includes pre-seed to late-stage funding like Australian company, Virescent Ventures, provides; solely investing in deep tech and business model innovations, software and hardware to achieve Net Zero. [14]
Research and development via education and research institutes support both the public and private sectors to produce the innovation required to reach Net Zero, heavily relying on engineering. In 2021, engineers from the University of Hong Kong received over HK$60 million in funding from the government’s Innovation and Technology Fund. [15]
In the short-term, households will bear some of the costs of complying with Net Zero requirements like additional upfront costs to update household technologies (e.g. switching to a heat pump) and potentially higher bills (e.g. electricity), which should reduce over time. [16] Cost increases disproportionately impact lower income households so careful consideration is needed to mitigate this to ensure an equitable transition.
Hardly any of the financial implications for governments, businesses and households are borne alone. Think about electric vehicle grants, R&D tax credits or green loans. These and other joint funding mechanisms are essential to the future of climate finance if all parties are to willingly stay on track with the goals of the Paris Agreement. [17]
Key principles for future finance
It seems appropriate that future finance should focus on three key principles to enable the necessary changes to achieve Net Zero: partnership, prioritisation and impact. Collaboration between the public and private sectors, universities, and households is vital and this will require joint funding models that function effectively for all partners. We also know that we cannot do it all at once so stakeholders will need to prioritise funding for the most critical projects in the first instance. Alignment between stakeholders who face similar challenges will help to accelerate solution deployment as stakeholders can mimic solutions prioritised, developed and tested elsewhere, while focusing resources on the unsolved problems. Finally, the overall impact on people must be evaluated and should ensure a positive impact on measures like income and employment, including retraining and upskilling, health, while mitigating inequitable outcomes.
[1] McKinsey & Company. (2022). The net-zero transition: What it would cost, what it could bring. https://www.mckinsey.com/capabilities/sustainability/our-insights/the-net-zero-transition-what-it-would-cost-what-it-could-bring
[2] Climate Policy Initiative. (2023). How big is the Net Zero financing gap? https://www.climatepolicyinitiative.org/wp-content/uploads/2023/09/How-big-is-the-Net-Zero-financing-gap-2023.pdf
[3] Climate Policy Initiative. (2023). Global Landscape of Climate Finance 2023. https://www.climatepolicyinitiative.org/wp-content/uploads/2023/11/Global-Landscape-of-Climate-Finance-2023.pdf
[4 ]Climate Policy Initiative (n 2).
[5] World Economic Forum. (2023). Net-Zero Industry Tracker 2023 Edition. https://www3.weforum.org/docs/WEF_Net_Zero_Tracker_2023_REPORT.pdf
[6] National Energy System Operator. (2024). Clean Power 2030. https://www.neso.energy/document/346651/download
[7] United Nations Framework Convention on Climate Change. (2024). Ad hoc work programme on the new collective quantified goal on climate finance. https://unfccc.int/documents/641326
[8] Varadhan, S. (2024, October 21). New Zealand, Cambodia cite political risks due to high energy transition costs. Reuters. https://www.reuters.com/business/energy/new-zealand-cambodia-cite-political-risks-due-high-energy-transition-costs-2024-10-21/
[9] Government of Canada. (n.d.). The Low Carbon Economy Fund. https://www.canada.ca/en/environment-climate-change/services/climate-change/low-carbon-economy-fund.html
[10] HM Treasury. (2024). UK Green Financing Allocation Report. https://www.gov.uk/government/publications/uk-government-green-financing-allocation-report-2024
[11] European Commission. (2024). Carbon Border Adjustment Mechanism. https://taxation-customs.ec.europa.eu/carbon-border-adjustment-mechanism_en
[12] McKinsey & Company (n 1).
[13] Climate Policy Initiative (n 3).
[14] Virescent Ventures. (n.d.). Climate Tech innovation meets commercial Ambition. https://www.virescent.vc/
[15] The University of Hong Kong. (2021, August 31). HKU Engineering scholars received over HK$60 million funding from Innovation and Technology Fund. https://engg.hku.hk/News-Events/Details/id/6785
[16] McKinsey & Company (n 1).
[17] United Nations. (2015). Paris Agreement. https://unfccc.int/sites/default/files/english_paris_agreement.pdf