By Daniel Ogbonna, Dario Traum, Richard Abel and Stephen Moir
Achieving the greenhouse gas emissions reductions needed to avoid catastrophic levels of climate change requires a rapid and just transition in emerging markets and developing economies (EM&DEs). Yet at a time when global action to deliver the transition should be accelerating, sustainable investment flows into these countries have been stalling. Promises of international government support have been made and missed, damaging the goodwill that is vital for progress, whilst insufficient uptake of enabling policies by countries continues to stifle the emergence of a steady and sufficiently large pipeline of investable projects. The ongoing deterioration in global macroeconomic conditions is exacerbating these challenges with many investors taking a more conservative approach to investment in EM&DEs.
However, a review of the impact and achievements of some trailblazing governments, corporates, investors, and civil society across EM&DEs over the last decade also reveals the opportunities that transitioning to a low-carbon economy can generate. In this piece, the authors provide Macquarie’s perspective on why supporting decarbonisation in EM&DEs is central to global climate change mitigation efforts and share their view on some of the key priorities, opportunities, and solutions in closing the gap in climate finance mobilisation.
Emerging markets and developing economies are critical to meeting the Paris goals
Inevitably, economic growth and development are the overarching priority across EM&DEs, but without a major and rapid shift in their emissions trajectories to enable lower carbon growth, the world will miss the Paris Agreement goal of keeping global warming within 1.5 degrees Celsius of pre-industrial levels.
Two out of every three people in the world live in EM&DEs, they represent a large – and the fastest growing – segment of the global population and economy. From 2000 to 2019, the GDP of these countries more than tripled in real terms while greenhouse gas emissions rose by 56 per cent. This growth is set to continue as industrialisation and demographic shifts drive increasing demand for energy, infrastructure, food and other products and services.
The chart above shows that EM&DEs are in the early stages of the archetypal development pathway followed by most advanced economies over the 20th century. Many are still in the process of providing universal access to energy and transportation to their population or expanding investment in energy intensive industries. However, they can leverage technological progress, including access to increasingly affordable solar, wind energy and e-mobility, to deliver lower carbon growth than the historical norm. If EM&DE emissions continue to grow on the trajectory experienced over 2000 to 2019, by 2038 they alone will have exhausted the remaining global carbon budget to keep warming at or below 1.5C.
The energy transition is the linchpin of global decarbonisation efforts but EM&DEs are falling behind
Energy transition asset finance in EM&DEs rose steadily from $US45 billion in 2012 to a peak of $US73 billion in 2018 before declining to $US67 billion in 20215. Adding in grids, nuclear, hydropower and other clean energy investment, this figure was $US210 billion6. This is far below the over $US1 trillion annual clean energy transition investment needed across EM&DEs by 2030 to deliver emissions reduction in line with the Paris Agreement and over $US1 trillion of clean energy investment reached across advanced economies (including China) in 2021.
Share of global greenhouse gas emissions and energy transition asset finance, 2010 – 2019 (per cent)
The financing disparity is starkest when considering countries across the World Bank’s four income groups. Lower-middle and low-income countries, over half the world’s population, accounted for over 20 per cent of global emissions and just 6 per cent of energy transition asset finance between 2010 and 20192,3. This trend is particularly concerning given that the lower-middle income countries group includes large and rapidly growing economies like India, Indonesia, the Philippines, Egypt, and Vietnam.
Accelerating decarbonisation requires more ambitious policy action everywhere, especially in emerging markets and developing economies
Trailblazing EM&DEs have demonstrated that effective policy can catalyse significant capital for their transition, even in challenging investment environments – but the replication of these best practices remains insufficient. Whilst most countries have set net zero targets aiming for 2050, or shortly after, none of the world’s large economies are currently decarbonising fast enough to be on a sustainable trajectory towards these goals. More ambitious policy action is needed across most geographies and sectors. This is especially true in EM&DEs, where investment activity is often constrained by higher prevalence of risks such as currency volatility, unstable regulation, and uncertain access to and impartiality in arbitration. Despite these challenges, a growing number of EM&DEs are ranking among the most attractive investment destinations for energy transition investors, demonstrating that clear targets and supportive policies can help overcome most investment barriers.
Of all the climate and energy transition policy success stories to date, clean energy auctions have been the most prominent and impactful in EM&DEs. Brazil was among the first countries globally to use large, repeated auction programs to award fixed power purchasing agreements (PPAs) to onshore wind project developers, inspiring many others to follow suit. Auctions enabled Brazil to procure clean electricity at record low prices and to attract significant investment to its domestic onshore wind supply chain. Auctions are now by far the most popular clean energy policy, with over 100 countries using them to procure over 600 GW of capacity as of August 2022.
However, the adoption and successful implementation of tried and tested policy mechanisms such as auctions remains insufficient across EM&DEs. 8 in 10 EM&DE governments have adopted a clean energy target, but less than two thirds have complemented these targets with active investment incentives such as auctions or feed-in tariffs. In many cases, fossil fuel subsidies and regulation continue to distort competition or favour incumbent energy companies, delaying the switch to clean energy alternatives which could lower energy costs and reliance on imports.
The ongoing surge in fossil fuel prices and extreme climate events reinforces the need for an urgent acceleration in sustainable energy, infrastructure and adaptation investments
The maturity, competitiveness and global reach of the renewable energy industry creates opportunities for all nations to tap into their natural resources, create employment and scale zero-carbon energy supply affordably.
A heavy reliance on fossil fuels to meet growing energy demand in EM&DEs would be a major global climate risk. Fortunately, renewables are now the cheapest new build source of energy in most of these countries after steep cost declines over the past decade and these economics are reinforced by the current context of high fossil fuel prices.
International project developers and investors have already been instrumental in the build out of renewables across EM&DEs. Their financing and technical expertise played a significant role in solar and wind capacity growing across these markets at an annual average rate of 29 per cent from 2010 to 2020.
Greater deployment experience and climate ambition combined with improving enabling environments are helping EM&DEs create good conditions for investment in complex but high potential technologies like green hydrogen and offshore wind. The latter of which is being explored in a growing list of countries with windy coastlines and high energy demand.
As corporate sustainability ambitions rise, providing access to plentiful and competitively priced clean energy has become a competitive advantage in attracting and retaining supply chain investments from international actors
EM&DEs are critical to global supply chains, exporting important commodities, manufactured goods, and essential services. Attracting supply chain investment will boost their export revenue and employment, furthering development ambitions, but increased industrial activity can fuel a surge in emissions if supported by a carbon intensive energy mix.
As more multinational corporations and governments are committing to emissions reductions and some major markets consider carbon taxes on imports to protect local industry, EM&DEs face a challenge and an opportunity. Countries that offer access to plentiful low-carbon energy are likely to attract more long-term international supply chain investments, whilst those slow to decarbonise will see their attractiveness deteriorate.
Commercial and Industrial (C&I) renewable PPAs are a key tool in this context and can be a strong driver of capital to EM&DEs as, beyond emissions reduction, they allow corporates to fix long-term energy costs, reducing exposure to commodity price fluctuations and, in some cases, unreliable grid electricity. Many industrial leaders across EM&DEs are credit-worthy counterparties, making industrial decarbonisation a high-impact, lower-risk opportunity for mobilising climate finance.
The increasing intensity and frequency of extreme climate events reinforces the need for urgent investment in the resilience and adaption of critical infrastructure across EM&DEs
The need for infrastructure investment across EM&DEs will be unprecedented over the coming decades as countries look to meet the demands of growing economies and population. Private finance can play a central role in supporting this infrastructure rollout. The asset class has a track record of attracting patient, commercial investors interested in supporting activities that deliver high societal value while generating stable returns.
Parallel to rolling out more infrastructure is an urgent need for investment in the adaptation and resilience of new and existing projects against increasingly frequent and intense climate disasters such as flooding, droughts, and extreme heat. Progress on creating the enabling environment to incentivise this investment has been slow, but greater assessment and disclosure of climate risk data is enabling investors and asset managers to better price climate risk and the value of investing in protection against it.
Partnerships and innovation are needed to accelerate decarbonisation across EM&DEs
Climate action tends to be driven at a country level, and country partnerships have an essential role to play in coordinating private and public stakeholders working to accelerate the transition in EM&DEs. Bridging the climate financing gap will require new approaches for coordinating private and public action to tackle some of the larger challenges of the transition and avoid inefficiencies such as public finance being deployed to sectors where it risks crowding out private capital ready to be invested on commercial terms. Country partnerships or platforms are an emerging engagement model that aims to enhance and structure collaboration amongst the various stakeholders working on the transition in EM&DEs, including host governments and regulatory bodies, local and international private businesses and financial institutions, and public and development finance institutions such as multi-lateral development banks.
Country platforms can help stakeholders reach a consensus on the actions and financing needed to decarbonise each sector of the economy, on the set of climate solutions ready to be supported by private finance if policy signals are in place, and which solutions may still require significant capacity building or public finance support. The first climate-focused country platform is the Just Energy Transition Partnership (JETP) for South Africa, which was announced at COP26. With more government-led country partnerships under development, the private sector is showing its readiness to support these initiatives, notably through the launch of the Glasgow Finance Alliance for Net Zero statement on Country Platforms and a series of private sector-led country pilots.
Blended finance and close public-private collaboration are needed to accelerate the deployment of newer climate solutions such as e-mobility, which can address rapid emissions growth in road transport
Private finance cannot substitute for public finance. In many markets, engagement with governments and development finance institutions is needed to determine where public finance can complement enabling policies in mobilising private capital flows. Public finance can play a key role in de-risking sectors for early movers, for example through subordinated debt provision, credit guarantees and blended capital solutions. This is especially true for less mature clean technologies and in riskier countries.
Blended finance lowers the risk profile of projects, bringing down the barrier to entry for private capital and helping mobilise follow on private investment. Through blended finance arrangements, private sector institutions can also benefit from the local market experience, know-how and government relations of public institutions, building their confidence to establish long-term exposure in EM&DEs.
Financial innovation can play a significant role in accelerating climate finance deployment in sectors and countries that have struggled to make progress
A major challenge to closing the EM&DE climate finance gap is catalysing finance into the geographies and sectors that are harder to reach for regular international commercial investors. Most international sustainable infrastructure finance today flows to large projects and markets where investors expect repeated capital deployment opportunities in the future, with the opportunity cost of entering new countries hampering investor appetite for many smaller markets.
Multi-lateral public finance institutions and domestic financial institutions have a major role to play in mobilising climate finance in smaller markets and more challenging sectors given their footprint in these countries and lower exposure to certain risks, such as foreign exchange volatility. This is especially the case for sectors with more complex revenue and counterparty risk structures – such as energy access and home energy efficiency. In recent years, a growing number of development finance initiatives have been launched with a focus on stimulating commercial sustainable investment activity and financial innovation in less developed economies.
Funds available for sustainable investment globally outstrip investment opportunities, but solutions are needed to channel more of this demand towards sustainable project developers in EM&DEs
Taxonomies are expected to play a major role in helping investors direct their investment strategies towards assets and businesses that make a positive contribution to the transition to a low-carbon economy. Europe, China, Chile, but also EM&DEs including Georgia, Mongolia, Indonesia, and South Africa are some of the countries and regions that have introduced or plan to introduce taxonomies that use labels to guide and measure investment in the transition.
Labels can also play an important role in accelerating climate finance across EM&DEs. The use of standardised project assessment criteria in the awarding of label can help developers and financiers to design their project in a way that maximises visibility and attractiveness for international investors. For investors, robust labels with transparent criteria, backed by reputable entities with a strong technical know-how, can significantly reduce due diligence costs and channel funds to projects in EM&DEs that would typically go to sustainable projects in advanced economies.
Looking ahead to COP27
The turbulent period since COP26 in Glasgow has reinforced the urgency of rallying around the low-carbon transition and the importance of investing in sustainable and resilient infrastructure globally. As we approach COP27 in Egypt, there will be a heightened focus on addressing the climate finance mobilisation challenge to ensure that EM&DEs are not left behind in the transition. Meaningful progress is possible but requires immediate action and collaboration from stakeholders across the public and private sector – both international and domestic – to propose solutions to current barriers and identify investment opportunities.
This article has been sourced from Macquarie and can be accessed here
