Right now leaders from both the private and public sectors are gathering at COP29 in Baku, Azerbaijan—where one of the leading topics is how to finance the pursuit of net-zero. Reaching that goal will require investing in a range of decarbonization solutions: renewables, green hydrogen, energy storage, electrification, carbon capture—to name a few. And while these solutions are critical, many are perceived by investors as more—more capital-intensive, more costly, more nascent—than their fossil fuel counterparts. In short, more risk.
Governments have a pivotal role to play in addressing that risk—but they can’t do it alone. It will take cooperation across a range of players outside the sphere of government, including the private sector, development finance institutions, and international organizations to set up the right conditions to finance the green energy transition. Even more, government action that encourages and supports private sector funding can be the impetus for investment and can help drive the journey to net-zero.
Exploring blended finance to mitigate cost and risk
It’s estimated that it could take anywhere from US$5 trillion to more than US$7 trillion globally per year to achieve net-zero greenhouse gas emissions by 2050. Right now, less than US$2 trillion is being invested on a yearly basis. This is due to the elevated cost of underlying investment risks—which can discourage private capital investments in green energy projects. There are political and regulatory risks that stem from a lack of political visibility and stability or incomplete or inadequate regulatory frameworks. Market risks can include uncertainty about a project’s viability in terms of revenue, liquidity, and competitiveness. And then there are risks such as a lack of infrastructure, construction delays, and cost overruns.
Innovative financing can help overcome these risks, de-risking partly or fully green energy projects and reducing the cost of capital and investment needs. Two examples are offtake agreements—a contract to purchase the energy produced over an agreed-upon period—or guarantee mechanisms, which can guard against political, performance, or infrastructure-related uncertainties. Other options include tax incentives or lower-cost loans or grants.
Typically, more than one of these de-risking mechanisms are needed to get a green energy project off the ground. This “blended finance” approach relies on cooperation between private risk-averse capital providers and public entities that can assume higher risks. For instance, governments can do their part by developing more attractive tax packages while development finance institutions can offer low-interest loans or grants. And with these mechanisms in place, the private sector can more confidently invest in projects that support the energy transition.
Laying the groundwork through collaboration
To advance these types of blended finance agreements, the right starting conditions need to be in place. As summarized below, governments, development finance institutions, and international organizations all have a role to play in de-risking green energy projects:
- Governments and policymakers should work to develop clear climate and energy strategies. These strategies often form the basis of a country’s green energy development, providing a direction to aim toward, common targets to rally behind, and a shared rulebook to follow. They should be transparent and encompass a well-defined regulatory framework. Governments can also take such actions as reducing administrative obstacles and developing the infrastructure needed to build out green energy projects. And countries should work together to harmonize the many conflicting definitions of what is considered “green,” establishing a common language for investors.
- Development finance institutions, when providing loans or grants to green energy projects, should try to tailor blended finance instruments to specific contexts and projects. The cost-efficiency, effectiveness, and indirect effects of financial instrument combinations vary with the location, technology, and maturity level of the underlying markets. And by deepening their analysis of green project de-risking tools, these institutions can enhance their role as risk-absorbers to help facilitate investment. Private investors’ risk perception decreases when reputable institutions like multilateral development finance institutions make visible investments or loans to a project.
- International organizations should champion the energy transition, helping to establish the diplomatic ties that can facilitate the global trade of green technologies. International organizations can also help harmonize climate and energy regulatory frameworks around the globe as well as taxonomies and definitions. Unified standards are necessary to help enable the global trade of clean energy technologies and raw materials. For instance, the economic health of the future global green hydrogen market largely depends on establishing common rules and open trade routes. In a world where the trade of green hydrogen is limited by tensions or legal disharmony, market costs can increase by as much as 25% on average.
Although all of the above players will be needed to help finance the green energy transition, governments do have a unique role to play. Through their actions to create a low-risk environment, governments can signal to other key participants—private investors, development finance institutions, international organizations—that the time is now to fully commit to positive climate impact projects. Making a first wave of clean projects bankable and successful can help improve overall risk perception, creating a virtuous cycle where the energy transition not only is ignited but maintains momentum.
Learn more about Deloitte’s sustainability activities at COP29 or check out our report, Financing the Green Energy Transition: Innovative financing for a just transition on our Deloitte Global Public Services & Government pages.