Increasing deployment of transition finance is a vital part of meeting global climate goals, and the eagerly anticipated report from the UK’s Transition Finance Market Review (TFMR) is sure to bring renewed urgency to the discussion on how this is best achieved.
A successful transition relies on the ability of hard-to-abate sectors, such as steel, cement and aviation, to reduce their emissions, ideally in an orderly fashion and in line with accepted science. But that is often easier said than done. We expect TFMR to bring fresh insights on this difficult reality and present thoughtful recommendations for how we move forward.
The finance sector is hard at work with clients on how to extend financing that will enable progress.
From our vantage point, a post-TFMR debate should focus on the reality that the most effective way to deliver greater investment in the transition is to ensure that the required technological solutions present appropriate risk/return rewards for investors.
But for this to happen, policymakers must focus on enabling the real-economy drivers of the transition by using the best tools they have at hand – effective, targeted industrial policy and innovative use of public-private financing vehicles.
Public policy is needed to address economic barriers to the transition
Many transition-related technologies in harder-to-abate sectors are not currently commercially viable: the technology is not yet cost-competitive, demand for these technological solutions remains nascent, and consequently the risk/return trade-off is unattractive. It’s not a lack of capital preventing greater deployment of finance for the transition – it’s that the underlying project economics do not make sense.
The good news is that well-designed public policy can step in to help make project economics viable for providers of private capital.
Arguably the most successful example of public policy intervention is the US Inflation Reduction Act (IRA), which was designed to focus on addressing fundamental economic issues holding back investments in transition-related technologies.
Offering expanded tax credits, loans and grants, the IRA has provided the confidence for companies to invest in such technologies and consequently enhanced their investibility and bankability. Since the IRA was passed, investments in clean technology have surpassed $175 billion, with more anticipated.
Even better, experience shows that transition-related technologies supported by public policy interventions reach “tipping points” from which they self-perpetuate.
As outlined in a recent research paper by Exeter University, policies such as mandates can help reach tipping points when a new, clean technology becomes more cost-competitive than the existing one. What’s more, according to the research, policies to advance the transition in one sector tend to bring forward positive tipping points in others, given the reinforcing interactions between them.
So with time, system-wide decarbonisation should achieve self-propelling momentum and, while there is a clear need for policy intervention to make breakthroughs, such measures are unlikely to be needed on a permanent basis.
Public finance deployment can help to close the ‘missing middle’
The “missing middle” funding gap for lab-proven projects and companies that have matured out of early-stage financing but have not yet reached the maturity required to attract other forms of capital and investment is a key challenge preventing the scaling of early-stage transition technologies.
To close the gap, public and private finance will need to think differently about risk and about how capital is deployed. The steel sector provides a good example of this economic challenge and how public finance can help.
Steelmaking is a carbon-intensive activity and is the largest industrial emitter. The sector has a sprawling footprint given how many products rely on its production. Swedish steelmaker H2 Green Steel is addressing this issue by producing steel with 95 percent less CO2 emissions compared with traditional blast furnace technology.
H2 Green Steel has benefitted from public grants from the EU Innovation Fund and support from the European Investment Bank, which has helped attract bank financing. The company now has €4.2 billion in debt financing from major banks. This success story is as yet rare, but demonstrates the power of blended finance solutions.
Private capital can do its bit to help close the “missing middle” gap by thinking creatively about structuring solutions – for example, by investing both at the project level and corporate level to balance risk – and take a long-term approach to valuation. But in many first-of-its-kind projects and nascent technologies, catalytic public capital will be essential for success, and public and private finance will need to work in tandem, collaborating closely and learning from each other.
Transition plans alone will not inspire investor confidence
Central to the discussion on transition finance has been the question of mandating companies to produce transition plans which articulate a company’s strategy to decarbonise.
Corporate transition plans are helpful tools that can help provide useful information to the market on the risks and opportunities of corporate decarbonisation strategies. But on their own they will not unlock transition finance at the speed and scale required because they will not fundamentally shift the economic conditions that remain key barriers to transition financing.
In many cases, a strategy described in a transition plan can only be achieved where enabling policy is in place to create the economic conditions required to attract and scale up the required capital that can turn ambitions into reality.
As an example, without the latest UK government Contracts for Difference (CfD) scheme, which awarded 6.3 GW of new wind capacity, there would be lower investment in wind in the UK – regardless of corporate ambitions and investor pressure and engagement. The UK government was able to attract new investment thanks to the increased price ceiling included in the CfDs, which guaranteed an acceptable return to bidders.
Technologies required for the transition need public support. As these become increasingly commercially viable and mature over time, they will be able to compete against existing technologies even in the absence of public incentives. But until then, transition plans will need to exist in a world in which economic incentives are provided for plans to become actionable and investible.
As TFMR is released and policymakers around the globe consider how to support transition financing, it will be important to recognise that public-private collaboration focusing on cost-competitive routes for established companies to profitably evolve and for new disruptors to access the “missing” capital is how we’ll be able to collectively accelerate progress.
André Abadie is managing director for JPMorgan’s Centre for Carbon Transition. Luke Nelson is head of international sustainability at JPMorganChase.
