A recent study titled “How Big is the Net Zero Financing Gap”, conducted by the Allen & Overy and Climate Policy Initiative (CPI) in September 2023, estimates that $6.2 trillion will be required an­nually until 2030, and $7.3 trillion by 2050, totalling $200 trillion, to achieve net zero goals outlined in the Paris Agree­me­nt. In 2022, the total spending on climate acti­on was about $1 trillion, highlighting a ma­jor gap between the desired climate action and the actual commitments globally.

The study has evaluated the current spen­ding trends and investment requirements in various climate action sectors such as energy systems, industry, building and in­fra­structure, transport, water and wastewater, agriculture, forestry and other land uses, and fisheries.

According to CPI’s estimates, the global climate finance flows in 2021 reached about $850 billion, a 28 per cent year-on-year increase from 2020. The investment continued to rise, reaching $1 trillion in 2022. The rate of climate investment is lower than expected as these flows need to increase by 625 per cent by 2030 to meet the Paris Agreement goals.

According to the report, with each year of inaction, this gap will continue to widen, leading to increased physical, financial and social risks. The report estimates the negative economic consequences of climate change, primarily due to infrastructure damage globally, at about $300 billion per year. If the additional costs associated with the health effects of increased pollution are also considered, this figure will increase significantly. While the cost of decarbonisation is substantial, it will benefit the global economy in the long term by adding nearly $1 trillion annually, which is equivalent to a 3.8 per cent increase in the global GDP by 2070.

Climate investments need sectoral and geographical diversification

According to the report, global climate investments have been dominated by the renewable energy (52 per cent) and low carbon transport (23 per cent) sectors. In­vestment in decarbonising other sectors, such as buildings, industry and agriculture, has remained relatively low despite the­se sectors contributing to over half of all emissions globally. This is largely be­cau­se either the decarbonisation process is difficult and cost-intensive in these sectors or the necessary technologies have not reached a maturity level comparable to energy and transport systems.

The financing gap between technologies also varies significantly. For example, the annual investment in solar power needs to increase by 2.2 times to an average of $298.5 billion through 2050, while the annual wind power (onshore and offshore) investment needs to increase by 3.3 times to $508.8 billion over the same period. In comparison, investment in battery EVs needs to increase by almost 14 times, from $78.2 billion per year in 2019-20 to $1.1 trillion annually through 2050.

The largest projected financing gaps are associated with technologies that have not reached commercial maturity such as carbon capture, utilisation and storage (CCUS) and hydrogen projects, requiring $125.6 billion and $287.7 billion respectively. An additional challenge with CCUS technology is that, for a storage project to be viable, the developer must have invested in carbon capture technologies and vice versa.

In terms of the regional distribution of climate finance, 75 per cent of the total global spend in 2019-20 was directed towards East Asia and the Pacific, Europe and North America. It is essential to ensure th­at investments are scaled up equitably acro­ss regions as no region in the world is close to delivering the capital required to achieve net zero. However, the relative gap is particularly large for regions with a hi­gher concentration of developing ­eco­no­mies, such as Latin America and the Caribbean, South Asia, Africa and the Middle East.

Public finance and policies must play a catalytic role

To secure the substantial amount of in­vest­ments required for achieving net-zero emi­s­sions, private investments must be mobi­lised by effectively deploying public capital, policies and frameworks. Up to 2020, public finance, which inclu­d­es funding from governments, development financial institutions, and state-owned institutions, grew at a rate of 9.1 per cent per year compared to 2011, whi­ch was more than double the growth in private fi­nance at 4.3 per cent. However, the share of public finance in the total climate finan­ce varies significantly across regions, ac­c­ounting for 86 per cent of the total in Af­rica over the past decade but just 4 per cent in North America.

The report suggests that multilateral development banks and bilaterals should redirect grants and concessional finance away from mature technologies and to­wards less mature technologies to help de­velop innovative technologies and re­du­ce the risk for investors. Further, the re­gions and economies with a higher cost of capital should be prioritised to mobilise private sector investment in these areas.

Opportunity for the private sector to fill the financing gap

Currently, climate finance is mainly provided by private corporations, commercial financial institutions and individuals, with limited direct contribution from funds and institutional investors. Over 90 per cent of this funding supports renewable energy and low-carbon transportation. The report emphasises the need to redirect a significant portion of annual investments in future low-carbon solutions towards ad­dressing immediate climate issues. For instance, while approximately $3.5 trillion is spent annually on vehicles, only $280 billion was allocated to electric vehicles (EVs) in 2021.

Thirty of the largest banks have committed around $870 billion annually to climate actions, indicating the potential for future growth. However, further commitments are necessary from these institutions to bridge the gap in financing for achieving net-zero goals. While the venture capital and asset management sectors have witnessed noticeable growth, the sustainability of this growth is uncertain, particularly given the possibility of higher interest rates, which may lead investors to prioritise short-term gains.

Outlook and potential solutions

There remains a significant funding gap of several trillion dollars between the current flow of climate finance and the estimated investment required to achieve net zero. Specific sectors will require policy measures and direct public assistance to reach the required scale. Technologies that are already commercially viable, such as on­shore and offshore wind, solar and EVs, mi­g­ht need policy interventions to add­re­ss challenges like long permission pro­cesses, slow grid upgrades, and the need for additional transmission lines.

Meanwhile, emerging solutions such as floating offshore wind, next-generation nuclear infrastructure, CCUS as well as technologies designed to reduce emissions from air travel and heavy industries, will depend on a diverse range of public policies and direct government support to achieve the required scale. The report suggests three key steps as potential solutions to bridge the financing gap:

First, stakeholder alignment is deemed crucial, as achieving net zero will require the collaborative efforts of the majority of businesses, investors, governments and development finance agencies. Policy measures must create an environment conducive to fostering private investment in net zero, involving a mix of price support mechanisms, targeted financial incentives, simplified permitting systems, and international frameworks to discourage high-carbon activities.

Second, critical decarbonisation technologies that are not yet commercially viable, including carbon capture, nuclear and green hydrogen, and industrial sectors such as steel and cement, will require policy and financial support to achieve net zero. These sectors and technologies are projected to transition from minimal in­vest­ment in actual projects in 2020 to annual investments of hundreds of billions of dollars up to 2050.

Third, the report suggests that amplifying engagement and reframing public discourse will be necessary for achieving net zero. This may involve large-scale behavioural changes, necessitating customised strategies for different markets, regions and sectors, as well as close collaboration with the private sector to understand the investment incentives and the challenges associated with scaling up technologies.