The Paris Agreement: What it Means for Climate Finance

The historic climate change agreement forged at COP21 in Paris late last year has sparked a lot of optimism. Not just for the obvious — the greater likelihood that climate change can be moderated — but also for the business opportunities that that moderation will bring.

Transitioning away from fossil fuels and toward clean energy and other technologies will require governments and companies to spend trillions of dollars over the next few decades. And that will bring a sea change to how those institutions approach their energy needs and their investments.

Indeed, the Paris Agreement should “send a very strong signal to investors and to the business community that the trend in emissions is now downward, and that the energy transition that we are already in is irreversible,” Stephanie Pfeifer, CEO of the Institutional Investors Group on Climate Change, said on an MSCI-hosted webinar not long after the Paris talks wrapped up

The Paris Agreement was reached by 195 nations who set a goal of holding the increase in the Earth’s temperature to well below 2 degrees Celsius. The agreement requires all nations to submit revised climate action plans every five years, and for those plans be more ambitious than the prior ones. The agreement also calls for increasing financial flows to support low carbon projects to at least $100 billion per year.

Some key “wins” of the agreement, according to experts, was that the commitments apply to both developed and developing countries, as developing countries such as India and China are now some of the world’s top carbon polluters. Another key win is that there is now a more transparent system in place to monitor progress being made around climate initiatives for all countries. The biggest complaint about the Paris Agreement, according to some experts, was that the commitments are voluntary, not binding.

To limit climate change to 2 degrees — or even to just 1.5 degrees — will require global spending of more than $12 trillion in clean energy investments over the next 25 years, Bloomberg New Energy Finance estimates. That comes out to about $485 billion a year.

If not for the agreement — if everything continued as is, under what BNEF calls the business-as-usual scenario — we’d still need to see $6.9 trillion of new energy investments annually. That means the 2 degree goal presents a funding ‘gap’ of $5.2 trillion, or $208 billion per year, according to Mapping the Gap: The Road from Paris, a report that BNEF released with CERES in late January. It was co-authored by Impax Asset Management director Ken Locklin.

Can that gap be bridged? Absolutely.

“While the scale of this new investment opportunity is massive, it is dwarfed by the capacity of global financial markets to unleash the needed investment capital, creating extensive new opportunities for commercial financiers, institutional investors and others,” the report says.

Those opportunities include new asset classes to invest in, new financing vehicles that will allow clean energy projects greater access to global capital markets, and new attitudes by the planet’s wealthiest investors. Yet experts temper all that optimism by noting that a lot needs to happen — at the governmental and the corporate levels — for those investment opportunities to really bear fruit.

CleanTechIQ spoke to many of those experts, and compiled numerous reports and white papers, to find out the best thinking on what the Paris Agreement means, and how COP21 will impact climate change finance in years to come. Here’s some of what they had to say.

Goldman Sachs on New Asset Classes to Invest In

The Paris Agreement will mean good things for a range of “key low carbon technologies, including solar PV, onshore wind, LEDs and hybrid and electric vehicles,” says a Dec. 15 report from Goldman Sachs’ GS Sustain division.

The report, The Low Carbon Economy: Key Takeaways from the Paris Agreement, says those specific technologies will benefit because they combined market scale with “a consistent track record of volume growth,” the report says (download the report.)

And the firm expects that growth to continue, or even accelerate, in the next 10 years. LEDs will increase their market share of global lighting from 28% today to 69% by 2020; wind and solar PV’s combined market share for new power generation will jump from 20% today to 51% by 2025; and hybrid/electric vehicles will soar from just 3% market share today to 22% by a decade from now, according to the report.

Those expected growth levels will create “not only significant emissions savings but also new commercial opportunities,” Goldman says. “Solar and wind installations are now a $200 billion [per year] market, and our analysts project grid-connected vehicle sales growing from about $12 billion in 2015 to $244 billion by 2025.”

More broadly, the report notes that the Paris Agreement “reaffirms the existing goal for advanced economies to increase climate finance to $100 billion per year by 2020.” And it “also adds new commitments to continue to provide the same level of finance to 2025 and for countries to negotiate a post-2025 climate finance target ‘from a floor of’ $100 billion,” the report reads.

But some vagaries should be noted. “However, the level of commitment is not mentioned in the agreement and what constitutes such climate finance remains only loosely defined in the document, although advanced economies have committed to more detailed and transparent reporting on such financing as part of the enhanced transparency framework,” the report adds. “There is also no formal requirement for emerging economies to contribute to climate finance, as had been discussed during the negotiations.”

RBC’s Tom Van Dyck on Financial Laggards

The transition away from fossil fuels and toward a low-carbon economy will represent “the largest wealth generation opportunity of this generation,” says Van Dyck, managing director of Royal Bank of Canada’s SRI Wealth Management Group. The agreement will impact everything, he says: “Buildings, transportation, agriculture, water, wastewater systems — it’s the entire economy that’s shifting. I think the reality of that is finally coming to bear.”

Financial firms likely won’t be at the forefront of that transition, he says. “I think one of the industry laggards would be the financial companies in dealing with clean tech. They are not the ones who are leading the way in deploying capital,” Van Dyck says. “Who is leading the way, and who were also represented in Paris, are groups like the technology companies and the major retailers, who have huge capital costs in the electrical areas.”

Van Dyck sees a lot of growth potential in batteries, a field which he says got a lot of attention from COP21 attendees. “Because once you get battery storage, it’s game over — you don’t need base load power anymore, because you can use batteries. The uncertainty in battery storage is, what is it going to look like?”

He’s also bullish on sustainable cities, as urban leaders push to become both more sustainable and less reliant on fossil fuels. “I’ve talked to mayors from all over the place, and they are all trying to ‘out-green’ each other. It’s incredible,” Van Dyck says. Cities are embracing sustainability projects because they are the ones bearing the cost of climate change, he points out.

Indeed, Michael Bloomberg, the former mayor of New York, published a column during the Paris talks in which he lauded the more than 400 cities who had signed the Compact of Mayors. That agreement, Bloomberg wrote, “requires them to set bold climate goals, adopt a common measurement system for emissions, and publicly report their progress.” Bloomberg called the Compact “the best insurance we have against backsliding by central governments, and it’s the best hope we have — along with technological innovation — for accelerating the pace of change in every region of the world over the next five years.”

The upshot, according to Van Dyck: “So now you have both cities and companies pushing to go 100% renewable and deal with climate change,” he says. “If you are a finance person, you have to be thinking that there will be a lot of financial opportunities here. It will provide opportunities. If you are not thinking that, you are going to miss the boat.”

To that end, he urges finance companies to change their outlooks and start investing in these new areas.

“The people that embrace it will lead the charge and be the innovators, and the spoils will go to them… If the banks can actually figure out how to finance these ideas and come together with innovative solutions to help cities, counties and states deal with it on a grass-roots level, they are the ones that will benefit the most versus someone who doesn’t,” Van Dyck says. “Finance in growing industries rather than contracting industries has always been a better game in the finance field.”

It’s really a no-brainer, he believes. “It’s cleaner, it’s more efficient, there’s less cost, there’s less waste, it is the best business decision out there,” he says. “And the cheaper it becomes the more overwhelming the argument becomes. You can deny the science, like you can deny the economics, but you will miss the major wealth generation event of this generation.”

Bloomberg New Energy Finance on Where the Money Will Go

The January report from BNEF and CERES takes a deep dive into investment opportunities, including a detailed look at what finance vehicles investors will favor in the coming years. “As clean energy continues to scale, the industry will expand the variety of sources of capital it taps to grow, with expanding investment opportunities in virtually every new renewable asset class,” the report says.

Until now, “the majority of clean energy power generation has been financed through direct loans,” according to the report. That’s set to change: “But other industries raise similar volumes in more diverse ways, often at lower cost. As clean energy continues to scale, the industry will expand the variety of equity and debt sources it taps.”

BNEF thinks that, as the “low-risk/reliable-return opportunity [of clean energy] becomes more apparent,” equity will be more appealing. That will likely lead to more investments in public market vehicles like U.S. yieldcos, master limited partnerships (MLPs) and real estate investment trusts. And the investor set should increase too: “As clean energy becomes a de facto infrastructure play, it should find a far more expansive home in large institutional infrastructure investors’ portfolios,” the report says.

Ken Lockin, the report’s co-author, tells CleanTechIQ in a separate interview that yieldcos have “really big potential” to attract new capital into the clean energy and energy efficiency markets. He believes that financial innovations, such as green bonds and yieldcos, are having a big impact on CO2 emissions reductions, by increasing the amount of capital available to clean energy projects

Bank debt and, in the U.S., tax equity providers will continue to be a “vital” source for clean energy financing, BNEF says, though bank debt’s share of overall debt may drop from 64% today to about a third by 2040 “as the sector matures and seeks alternative debt sources.”

By that time, institutional infrastructure investors “could provide up to 15% of overall debt financing,” BNEF estimates. “On-balance sheet financing is also poised to rise substantially as utilities develop more projects. Finally, the opportunity to refinance portfolios through asset- backed securities could rise.”

The space will need new players as well as new regulations and laws, BNEF thinks, especially in developing markets, where the majority of the new clean energy investments will take place. “Multilateral development banks and other public funding resources will have an expanding role to play in arbitraging risks and facilitating capital flows,” the report says. “Some new policies would be implemented to more accurately internalize relevant costs, making new fossil fuel generation less economic.”

As for specific types of power generation, BNEF sees continued strong growth for wind and solar. “These changes in market penetration levels are due to anticipated cost shifts, augmented by the potential for distributed solar to be highly cost-competitive as it offsets power consumed at the retail level,” the report says.

Project Finance Opportunities

Locklin tells CleanTechIQ that there’s lots of product development and support for project finance opportunities in the renewable and energy efficiency spaces.

He’s seeing an expanding number of players and a greater level of interest in clean energy financing, and says he has been surprised at the number of new faces he’s seen at recent industry events. The market is developing new approaches to make financing of clean energy projects and activities more efficient and more widely available and lower cost financing is helping to expand the market, Locklin says.

This all means the confidence levels of both investors and suppliers are on the rise, Locklin says, while policy developments are as less important now that the cost of clean energy has come down.

Locklin sees strong appetite from investors for financing distributed energy assets, particularly in solar, where the technology risk is low and the potential to do large scale securitizations is strong. Locklin cites SolarCity and SunRun as examples of strong distributed energy financing players.

Sindicatum’s Razzouk on the Need for Investment Signals

The Paris Agreement will indeed mean significant capital flows into clean energy. But, says Assaad Razzouk, CEO of Sindicatum Sustainable Resources, it will take some time before the money really starts flowing.

“It’s going to take six months to two years for the investment signals coming out of COP21 to trickle down to the financial markets,” says Razzouk, whose Singapore-based company develops and operates clean energy projects. “For them to trickle down, we need more concerted messaging and efforts and actions by a whole range of stakeholders, including all those who were at COP21.”

Razzouk stresses that it’s not that he’s pessimistic about the outcome of COP21. “This is just a timing issue,” he says. “There is an investment signal, yes, but it will take time to trickle down to the financial markets.” He says those markets likely won’t start to pick up that signal until at least 2017.

“To bridge the implementation gap, we need three things to happen,” he says. “One, the Paris Agreement has to tighten over time. There’s a lot of work to be done there by the 195 governments. Two, we need a financial-grade regulatory environment for clean energy. People have to stop flip-flopping on policy and putting in retroactive changes. And three, we need a carbon price embedded in the terms of trade between nations.

“Obviously we won’t get all three by next year,” Razzouk says. “But to the extent that we start to get some of that, it will send a clearer investment signal. At the moment it’s a bit of a muddle.”

Some of the current hurdles facing clean tech financing relate to basic economics.

“Fundamentally, it’s about the cost of capital,” Razzouk says. Right now, “the cost of anything green is higher than anything brown.” For example, he says, if a developer is seeking financing for, say, a new coal-fired power plant in the Philippines, “There’s a lot of excitement from the banks. They know the assets, and they will price it in a certain way, ignoring the fact that it may not function in 25 years,” he says. On the other hand, according to Razzouk. “For a new solar plant, the banks will add a risk premium on top. We would say that it should be the other way around, but it’s not right now.”

That needs to change, and it will, Razzouk says. “The financial analysts who are analyzing cash flows haven’t yet shifted the risk premium to where it belongs,” he says. “If we can stop risk premiums being applied to clean energy, and instead have risk premiums applied to oil, gas and coal investments, that would open up vast flows.”

On Green Bonds

Locklin is seeing significant interest from institutional investors for bonds supporting low carbon scenarios, as well as the emergence of new debt in the market.

The corporate sector is the fastest issuer of green bonds, he says. Large corporations are investing in renewable energy to lock in long-term energy rates and becoming more energy efficient, in order to reduce their energy costs, which they see as giving them a competitive advantage.

Locklin believes having better metrics and more disclosures regarding the impact these bonds are having on reducing carbon emissions is an inevitable part of their evolution and will accelerate the green bond market.

Green bonds, which increasingly being seen as a key financing mechanism for clean tech projects, were a hot topic at COP21. In fact, 27 global investors representing over $11.2 trillion of assets issued the “Paris Green Bonds Statement,” pushing for further green bond disclosures and a structured regulatory platform.

Increased standards are crucial, according to Sindicatum’s Razzouk, who says green bonds are not a great indicator of clean energy investments because there’s no standard for what constitutes a green bond. “You can issue an allegedly green bond and invest it in shale gas,” he says. “There’s no rigorous checking of what people are doing with their green bond proceeds.”

“The only thing that matters is equity,” he says. “The question is how much equity capital is going into clean energy, and will there be enough in 2017, 2018, 2019 etc., to get the job done as far as COP21 is concerned.” As of right now, he says, there’s not enough. “But the situation may improve.”

Goldman’s Park: Markets Move Faster than Policy

While the policy agreements reached in Paris were both welcome and much needed, it’s the markets that will really force change. “Despite policy moving in the right direction, what is moving even faster is markets and business,” said Kyung-Ah Park, the head of Goldman’s Environmental Market Opportunities Group, at a panel discussion hosted by Columbia University’s Center on Global Energy Policy in late January.

Indeed, investors care much more about concrete actions than goals and agreements. U.S. solar company stocks rose about 5% after the Paris Agreement was announced, Park said. Later in December, when Congress extended solar tax credits, Solar City’s stock price jumped some 30%, she noted. “Markets and investor react much better to tangible outcomes and specific actions,” she said.

And the changing economics around clean energy technologies helped the agreement come to fruition. “Leading up to Paris, the business case became much more compelling,” Park said. “Prices are going down, and the technology becoming affordable. The trade-off to a low carbon energy future is not as big as it used to be. It’s absolutely critical, and that going to continue to accelerate.”

Key to that is finding way to “incentivize private sector capital” to invest more into clean energy, especially in developing economies, Park said. That will require those economies to have policies and markets “that are conducive to private sector capital flows,” she said.

“The good news is that there is ample capital out there that wants to put money to work into climate mitigation solutions — renewable energy solutions in particular,” Park said. “The future of low carbon solutions is incredibly bright in terms of growth prospects, and we have policy winds behind our back.”

Park said it is “absolutely important” that industry leaders and policy makers “continue to drive the economic case and make it profitable for us to invest and mobilize capital towards low carbon solutions.” Crucial for this year, she added, is continued progress on “driving down further the cost of renewable energy, making energy efficiency much more compelling, and also catalyzing new technology investment into areas we need to continue to invest in such as energy storage… I’m very optimistic we will continue to do that.”

Carbon Tracker’s Campanale on the Divest-Invest Movement

Institutional investors are providing a massive help to pushing clean energy investments, says Mark Campanale, founder and executive director of Carbon Tracker, the London-based financial think tank. Indeed, the group announced at the Paris conference that investors with a combined $3.4 trillion in assets — including pensions, foundations, family offices and individuals — have pledged to divest, either partially or completely, from fossil fuels.

The movement is growing, says Campanale, who cites a recent event with “25 large pension funds from around the world, talking about climate risks to their fossil fuel investments. A number of them were moving from understanding the risks to understanding the opportunity.” He says he’s seeing pensions award mandates, worth hundreds of millions of dollars, for clean energy investments, and mentions companies like Bank of America, which recently announced it will invest or otherwise finance more than $100 billion in clean energy.

“You’ve got all types of supporting initiatives to deploy capital in the clean energy space,” he says.

Indeed, many of the investors who are divesting their portfolios of coal, oil and gas companies, will reinvest that cash into clean energy. “Some of the foundations are not just looking at wind farms in the U.S. or Canada, or solar projects in Germany,” Campanale says. “They are going much further than that. They are looking at clean energy opportunities in places like Asia and Africa.”

Consumer demand bodes well for electric vehicles, and poorly for the future of the oil and gas industry, he says. “I think consumers are assuming and expecting a switch to hybrid and electrical vehicle fleets,” Campanale says. “If that’s true, you only need to have a 1% decline in demand for oil to be compounded over the next decade or two and really undermine the fragile place of the oil industry in the S&P or the Dow. So, we perceive a long term trend down in demand for oil and coal.”

Meanwhile, clean energy “is becoming so much more competitive — whether it’s a rise in new technologies such as battery storage, or just more efficient solar panels,” he adds. “I think the transition is well under way. Solar businesses are beating coal just on cost grounds.”

Overall, Campanale says, the climate risk caused by fossil fuels “is ever more real and something that investors are taking very seriously.”

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