Financing the energy transition

Achieving the Paris Climate Agreement goals requires trillions of dollars in investments in sustainable energy infrastructure globally in the coming decades. This paper explores the important role that institutional investors can play in providing these required investments, and thus in the transition to a clean energy system. Through a series of semi-structured interviews with pension delivery organisations, asset managers and Dutch pension funds, the paper highlights key topics that need to be addressed to help institutional investors become the driving force behind scaling up and accelerating investments in the energy transition in the Netherlands.

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Financing the energy transition in the Netherlands: the important role of institutional investors

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The landmark International Panel on Climate Change (IPCC) Special Report on Global Warming of 1.5°C, published in 2018, states that the world must reach net zero emissions by 2050 at the latest to achieve the Paris Agreement goal of keeping average global surface temperature rise to below 1.5°C. The parties to the Paris Agreement have pledged their commitments to cutting greenhouse gas (GHG) emissions by submitting their Nationally Determined Contributions (NDCs) to the United Nations Framework Convention on Climate Change (UNFCCC). The European Union (EU) has committed to reducing GHG emissions by at least 40% below pre-1990 levels by 2030. At the national level, the Netherlands has passed legislation that sets climate goals of 49% emission reductions by 2030 and 95% by 2050, compared to 1990 levels.

The energy sector is the largest source of GHGs by sector globally, being responsible for around 35% of total anthropogenic GHG emissions (IPCC, 2014). Approximately 90% of energy-related emissions are derived from CO2 from burning fossil fuels (IPCC, 2014). Clearly, emission reductions in the energy sector is critical for achieving the world’s climate change mitigation ambitions. This is reflected in the EU targets for renewable energy of at least a 32% share of total energy use and a minimum of 32.5% improvement in energy efficiency by 2030. At the national level, the Netherlands has set increasing targets for energy use from renewable sources: 14% by 2020, 16% by 2023, and 27-35% by 2030 (NECP, 2018). To meet the world’s climate goals, transitioning to a clean energy system needs to happen, and it needs to happen fast.

Implementing climate and energy targets will require coordinated global action in many domains, including capacity building, institutional strengthening, and arguably most importantly financing. Transitioning to clean energy will require cumulative investments of trillions of US dollars globally (IEA, 2014, 2017; IFC, 2016; NCE, 2016). Average annual additional investments in the EU alone are expected to be roughly €38 billion between 2011 and 2030 to achieve the EU’s stated climate and energy goals (EC, 2018). Planbureau voor de Leefomgeving (PBL) has estimated that around €200-300 billion of investment will be needed between 2020 to 2040 in the Netherlands to achieve emission reductions of 80-95% from 1990 levels by 2050. These financing requirements are substantial, and research clearly shows that current investment levels are insufficient to meet the Climate Goals (Energy and MFF, 2018).

Problem definition

Given the scale of investment required to achieve global, EU and national climate and energy targets, it is clear that limited public budgets will not be enough, especially taking into account the competing uses of these funds to address other economic and societal challenges. A large proportion of the required investment levels must come from the private sector in the form of companies and institutions. In particular, institutional investors such as pension funds, insurance companies, and investment banks, that have trillions of euros in Assets Under Management (AUM) could play a critical role in providing the amount of capital needed for a successful energy transition. Although these institutions have vast amounts of capital at their disposal, finance is currently not flowing towards the energy transition at the rate and scale that is needed.

This paper explores the factors that could influence the scale and speed of flow of capital from institutional investors to the energy transition. In a set of semi-structured interviews undertaken with pension delivery organisations, asset managers and Dutch pension funds about their clean energy investment strategies, and the challenges they are facing in scaling up investment in this domain, six key takeaways are identified. These all point to the following conclusion:

Companies, clients of investors and investors themselves all have a key role to play if institutional investors are to become the driving force behind scaling up and accelerating investment in the Energy Transition in the Netherlands.

Observations

  • Money talks: Dutch institutional investors have the financial means to scale up and accelerate investment to the levels necessary for a successful energy transition.
  • It's a two-way street: asset managers and their clients both have important roles to play in changing the status quo of how asset allocation decisions in investment portfolio management are made.
  • Direct investment can have the largest impact: institutional investors can scale up and accelerate capital flows to the energy transition by injecting more equity into unlisted companies and projects.
  • Regulation is key: appropriate government regulation can steer investor behaviour towards scaling up investment in the energy transition.
  • Standardised Environmental, Social and Governance (ESG) criteria and reporting can be the trigger: ESG investment criteria need to be clarified and standardized to help investors better assess sustainable and responsible investment.
  • Stewardship & Engagement can change the behaviour of companies: investors can influence the strategy and decisions of companies to ensure that their investments are future-proof, including from the energy transition perspective.

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Towards broad support for the energy transition
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Matthew Halstead

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