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How to finance industry's net-zero transition

 How can we mitigate the risks of financing a net-zero future for heavy industrial and mobility sectors?

How can we mitigate the risks of financing a net-zero future for heavy industrial and mobility sectors? Image: Ant Rozetzky / Unsplash

Derek Baraldi
Head of Sustainable Finance, World Economic Forum LLC
John Colas
Partner; Vice-Chairman, Financial Services, Americas, Oliver Wyman Group (MMC)
Ilya Khaykin
Partner, Financial Services, Oliver Wyman
Matthew Aks
Project Fellow, Financial and Monetary Systems, World Economic Forum
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Long-Term Investing, Infrastructure and Development

This article is part of: The Davos Agenda
  • The global energy transition will require huge levels of investment - but the sizeable risks involved make this a complex undertaking.
  • We have been working with the Forum to design financing solutions that can accelerate the mobilization of capital.
  • Several lessons have already become clear; here's what we found.

Trillions of dollars in investment will be required to transition the global economy to net-zero emissions and avert a climate catastrophe. This represents a massive opportunity for capital providers. However, many of the investments that need to be made are large and risky, especially in emissions-intensive heavy industrial and mobility sectors. Financing large and risky projects in these sectors is a complex undertaking – but with the right coordination and cooperation, it can be done.

For sectors that must transition to net zero – steel, chemicals, aviation and shipping, to name a few – transforming today’s carbon-generating asset base is an expensive proposition. Companies in these sectors rely on billions of dollars’ worth of property, plant and equipment, as well as extensive supporting infrastructure. Just financing the first net-zero deep-sea shipping lane (fuelled by green ammonia or methanol) will require approximately $700 million in up-front capital investment on its own.

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Retooling or replacing existing industrial assets isn’t just expensive; it is also still seen as risky by many would-be investors. Carbon-intensive industries have optimized existing operations over decades to achieve maximum efficiency. New zero-carbon technologies and processes introduce additional uncertainties and potential near-term competitive disadvantages.

So who among the traditional providers of capital should take the lead? The answer is not immediately clear. Venture capital funds are very open to new technologies and business models. But they would not typically invest hundreds of millions in a single venture. Large-scale project investors may be comfortable with the price tag but are understandably very conservative when it comes to technology risk. Consequently, new energy technologies often face a market failure known as the 'valley of death' – an inability of businesses to secure financing for the initial commercial-scale deployment of a new technology (see Figure 1, below).

Figure 1: The “valley of death” in financing clean energy technology
Figure 1: The “valley of death” in financing clean energy technology Image: Ghosh & Nanda, 'Venture Capital Investment in the Clean Energy Sector'

Last year, we began to examine this challenge as part of the World Economic Forum’s initiative on Financing the Transition to a Net Zero Future. We convened leading financial institutions to engage with executives from heavy industrial and mobility sectors who are part of the Forum’s Mission Possible Platform. Through a series of dialogues between finance and industry, we aligned on the financing needs and barriers. Moreover, given the 'valley of death' and other potential market failures hindering the transition, we also engaged with key sources of public financing. Over the coming months, we will build on this foundation to design financing solutions that can accelerate the mobilization of capital.

Already, several lessons are clear.

First: the public sector has a critical role to play in incentivizing private capital, but more work needs to be done to identify the most effective public interventions. Setting a carbon price is of course one major way to spur transition-related investments. The public sector can also take steps to de-risk specific projects and technologies. For example, governments can co-invest alongside private investors; provide tax credits or loan guarantees to private project developers; subsidize consumers buying higher-cost green products; or even commit to buying green products themselves with public procurement budgets. In the months ahead, we will aim to identify precisely which public sector interventions will make the difference in mobilizing capital for the industry transition.

Second: no single type of financial institution can shoulder the entire burden – a multi-stakeholder financing ecosystem is needed. To bring large-scale industrial projects from development to operation, a mix of capital providers with different risk appetites should invest at different stages of the lifecycle. Banks, asset owners, asset managers, insurers, venture capitalists and private equity funds will all need to play a role – in coordination with the public sector. The financing ecosystem that supports the solar industry provides one example (see Figure 2, below). As we identify solutions for specific sectors and technologies, we will also aim to foster an overall financing ecosystem that can enable the transition in heavy industrial and mobility sectors.

Figure 2: Evolution of US solar financing
Figure 2: Evolution of US solar financing Image: Fulton & Capalino (2014) / Ceres / BNEF

Third: we cannot afford to wait years for the financing ecosystem around industrial decarbonization to develop naturally – coordination and cooperation is urgently needed. The financing ecosystem supporting the solar industry evolved gradually over several decades. Today, the world no longer has the luxury of taking its time. If the world is to achieve net zero by 2050, industry must demonstrate viable zero-carbon operating models during this decade. To quote one top banking executive: “We should aim to do in five years what took the solar industry 30 years.” The Forum’s initiative on Financing the Transition to a Net Zero Future will serve as a venue for collaboration towards accelerated progress.

Addressing climate change is our society’s ultimate collective action problem. Bringing together all the relevant players to ensure a smooth transition to a low-carbon economy is no simple task. But it is feasible. For proof of what is possible, consider the rapid development of the COVID-19 vaccines. In the race for a vaccine, major breakthroughs were achieved on the basis of scientific ingenuity, public-private cooperation and singularity of purpose. Now, we must bring those same factors to the fight against climate change.

Learn more during the Davos Agenda session “Financing the 'Net-Zero' Transition

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