Comment: Building climate-driven energy demand growth into transition finance

Climate change and energy are closely entwined. Much of the focus – in transition finance narratives and beyond – has been on how reaching net-zero climate targets will require unprecedented efforts to decouple energy supply from carbon emissions.

This includes decarbonising and electrifying high-emitting sectors and increasing energy efficiency. But less attention is being paid to how climate change will drive rapid growth in energy demand, and change how we ensure reliable, accessible energy in the future.

Last year, extreme weather events caused large-scale power outages in almost every region of the world. This spring, demand for cooling and refrigeration surged as parts of Asia sweltered in an early and record-breaking heatwave. Air-conditioned malls have become urban oases. Climate change is accelerating global energy demand far faster than business-as-usual.

The energy system of the future will need to be larger, cleaner and more reliable than today. While rising demand likely can and should be increasingly met by building out cheap renewable energy, transition finance to simultaneously decarbonise hard-to-abate sectors, prevent methane leakage, and ensure diversified, accessible energy systems can help minimise the negative feedback loops between climate and energy that could upend financial, energy and societal systems.

Climate change is expanding energy demand

Much of the debate around the clean energy transition focuses on how carbon dioxide, methane and other greenhouse gases from our fossil-based energy system are responsible for climate impacts.

It is also important to look at the other side of the coin. The impact of physical climate change on energy demand is not widely or systematically acknowledged. Physical and transition risks are often viewed separately, and energy-demand narratives are dominated by other factors such as emerging market access and the surging demand from the tech sector.

We see a global paradigm shift in energy demand evolving as a result of climate change.

Rising global temperatures will bring more floods and droughts, record heat, migration and infectious disease. These climate-driven impacts will require energy to pump water, cool air, refrigerate vaccines, rebuild infrastructure and move people.

The world will need much more energy. And quickly. Studies find that in the US alone, the electricity used per square foot to cool buildings will increase by nearly 14 percent for every degree of global warming. This is before we factor in the growing demand from efforts to decarbonise core parts of the economy through electrification.

Mounting climate disruption will also require massive back-up power systems to keep the lights on and machines operating when extreme weather events hit. Energy redundancy and diversification will increasingly be a necessity, especially for the most affluent global citizens who find energy shortages inconvenient and costly.

Energy access narratives that focus on population and industrial growth in developing and emerging markets miss the growing and diversifying energy demands worldwide in response to changing climate realities.

New energy demand should be met with renewable energy

If new gas, oil or coal supplies come online to meet growing energy demands, this could trigger climate tipping points that upend financial markets. It will be far easier and cheaper to invest and build out renewable systems at the start of this growth than to retrofit away from fossil sources later.

The good news is that the renewable revolution is advancing at remarkable  speed. In fact, the speed of the revolution has defied many leading energy commentators who have continuously  underestimated  its actual trajectory. Renewables are the cheapest form of new energy in many parts of the world.

But building out a clean energy system at the scale and reliability needed will not happen automatically or overnight. Finance and investment will be needed to use every tool in the renewable energy toolbox: clean technologies,  battery storage, transmission  and distributed resources, including energy efficiency, demand flexibility and distributed generation.

Even with more renewables, transition finance is needed for industrial decarbonisation.

Ensuring that new demand is met by renewable energy, decarbonisation, methane abatement and fossil fuel phase-out is imperative, but still not enough to prevent climate change.

Letting existing industry go on emitting unabated will lead to continued extreme weather, accelerated energy demand, and make it harder and harder to maintain a functioning economic and social system. Not all industrial processes can be electrified and solved by growth in renewable energy. Reliability will continue to be an issue, especially as extreme weather disrupts energy supply and economic supply chains.

Transition finance – especially for hard-to-abate sectors – can help fill financing gaps to sustainably meet growing demand, support an economy-wide transition and avoid carbon lock-in. The sooner this capital is invested in high-emitting sectors, the more effective it will be in helping to short-circuit future negative feedback loops.

A systems view of financing for the energy transition

The exact dollar amount needed for the energy transition depends on many variables, and reports regularly have different answers.

In the new net-zero pathway, IEA estimates that global clean energy expenditures need to increase to $4.5 trillion annually by the early 2030s.

In a sectoral analysis of the financing gap, Absolute Strategy Research (ASR) found that decarbonising the energy system will account for a big piece of the puzzle. Financing for the energy sector will need to grow $747 billion a year on average – an increase of more than 60 percent from 2023 levels.

If climate change continues and energy demand accelerates, this spending need will only grow.

Beyond the energy sector itself, a systems view of climate-energy feedbacks will be critical to understanding the transition-related financing gap, risks and opportunities in other parts of the economy. Each sector will be impacted by climate change – and face challenges. This will be compounded by rising energy demand from climate shocks and changing weather patterns, which will be material to lowering absolute carbon emissions and meeting net-zero targets.

Financing for the net-zero transition increasingly needs to reflect the realities of physical climate change, including the burgeoning impact on global energy demand. In addition to decarbonising existing energy demand and supply, transition finance must be available to ensure that surging new demand can be met by clean energy solutions to escape a potentially vicious cycle.

Deborah Gordon is senior principal for climate intelligence at RMI.

Elizabeth Harnett is research and impact expert for climate-aligned finance at RMI.