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Finance4Good: Financing the transition to a low carbon economy

In December a year will have passed since the celebration of COP21, a conference labeled a success as all 195 countries participating reached a global agreement, the so-called “Paris Agreement”. This aimed to reduce carbon emissions worldwide in order to bring down global warming below the 2°C threshold.

Finance4Good - low carbon economy

We are living in crucial times. As the environmental impact of human activities has grown exponentially since the industrial revolution, so has the need to reach a political consensus regarding the urgency of action. This appears to have been achieved.One of the key issues regarding the development of a decarbonized economy, or at least a low carbon economy, is electricity generation. Financing the transition from conventional energy sources clearly requires great commitment. In the EU alone it will be necessary to invest 270 billion euros more per year (roughly 1.5% of the EU's GDP) over the next 40 decades in order to bring down carbon emissions by 80% of the level reached in 1990. While we can agree on the goal, the means to achieving it seem source of conflict. Who should finance this transition? What energy sources will have to be promoted? Under what conditions? Is it financially feasible to promote such a change in an era of low commodities prices?

Such questions were debated at "Financing a Low Carbon Economy" session of Finance4Good conference moderated by Jean-Michel Gauthier, Affiliate Professor at HEC Paris and Executive Director of the Energy & Finance Chair. His remarks set the tone: “The situation in the energy market looks bleak if you look at the glut, excess of oil, gas, electricity. And very low energy prices do not encourage alternative investments.” 

Government Role

So far, markets have not been capable of fully assessing the price of climate change. Short term profit seeking has proven to be a barrier for further involvement in the transition to a new economy. However, governments are starting to take action in favor of a low-carbon economy through regulation. Last year, France became the first country to introduce mandatory climate change through Article 173 of the “energy transition for green growth” Law. Major world powers, such as China, are also taking a stand in favor of a “green economy” with it brings out its first domestic green bonds. In a matter of months, these have become its largest green bond market. 
Policymakers have exerted a key role in reducing the cost disadvantage that most clean energy technologies face in comparison with fossil fuels. SolarNet director Patrick Hubert gave the example of solar energy production which currently costs less than other energy resources. “The development of renewable capacity production in Europe,” Hubert stated, “has only been possible through subsidies and government schemes, and not on the basis of a market mechanism or even against the backdrop of a mere supply and demand situation.” 

Financial Markets

Changes towards a low-carbon economy can also be seen in the private sector. Investors are starting to realize that climate change is a factor that has to be included in the risk calculation of a portfolio. As mentioned by Frédéric Samama, new arguments are emerging stating that investing in polluting companies may even go against fiduciary duty, as it will represent a lower return on investment for shareholders in the long-term. That is why key actors such as AMUNDI, are currently offering decarbonized indexes, an approach that uses both divesting and engagement techniques. While obtaining similar returns to an average index, decarbonized indexes exclude the worst performers (30%) of every industry in terms of carbon footprint and pollution, creating a virtuous circle of encouragement for a continuous improvement in environmental practices. 

Large banks such as Société Générale have also experienced changes in their investment structure in the last three years. Currently, energy financing is almost exclusively reserved for renewable energy projects. Nevertheless, Allan Baker also acknowledges that the sector is facing liquidity limitation issues: the amount of money invested in energy financing is insufficient for a full energy transition. There is still a need to attract larger investments from institutional investors. 

In the microfinance sector crowdfunding is allowing the financing of smaller green projects, individual investors are able to invest in micro green bonds. As stated by Mathieu Dancre, these type of investors are not only looking for good levels of return on investment, but also transparency and trust. Although green crowdfunding has proved to be an efficient mechanism for the development of renewable energy projects, the competitiveness between renewable and nonrenewable energy sources is still so high that it makes it difficult for green projects to succeed. 

We can acknowledge that transitioning into a low carbon economy is a goal that will require the cooperation and coordination of all key actors: governments, establishing the right incentives; investors, taking into account the impact of their transactions; asset managers, formulating innovative ways to achieve profitability and accountability; and consumers who will have to invest in goods compatible with this new economy. Are we up for this challenge?

Written by Alicia Ruiz Huidobro & Raimundo Miralles, HEC Paris students

Finance3Good - financing a low carbon economy

The panel was made up of Allan Baker, Managing Director, Global Head Power Advisory & Project Finance, Société Générale; Mr. Mathieu Dancre, Founder and President, Green Channel; Mr. Patrick Hubert, co-founder and Executive director of SolarNet; and Mr. Frédéric Samama, Deputy Global Head of Institutional & Sovereign Clients and founder of SWF RI, Amundi. All four specialists looked at the challenges posed by the  financing of a low carbon economy.