Category: Investing in the Energy Transition

Continued Growth in Companies Using Internal Carbon Pricing in 2022

Exhibit: Companies Using or Planning to Implement an Internal Carbon Price, 2015-2022

Source: CDP and World Bank Group

Key Points: The number of companies using Internal Carbon Pricing (ICP) rose again in 2022 (to 1,200 of 8,400 surveyed). Most ICPs are too low to reflect accepted views of the societal cost of carbon, but having the mechanism is an important step — it drives developing the ability to assess carbon footprints and it can drive significant behavioral change.

An incremental 12% of companies surveyed using an internal carbon price in 2022. The World Bank Group, in its latest annual State and Trends of Carbon Pricing report, released in late May, includes information about companies’ Internal Carbon Pricing (ICP) policies and intentions in 2022. The World Bank gets this ICP information from an annual survey conducted by CDP (formerly the Carbon Disclosure Project). (The CDP’s last report on its survey was published in 2021 and assessed its 2020 survey results.) Of the 8,402 companies responding to CDP’s latest survey, 1,203 have ICP, up 12% from the year ago survey and up 40% from 2020. Further, another ~1,500 companies responded that they intend to implement ICP within the next two years. See Exhibit. Based on CDP’s earlier surveys, ~1/2 of the world’s 500 largest companies (by market capitalization) are putting a price on carbon.

Companies seeking to use ICP to change behavior and drive low carbon investment. The survey respondents indicated that the primary reason for having ICP is to spur low carbon investment and energy efficiency measures. A smaller number of respondents indicated that it was to help them navigate regulations at a business-unit level; approximately ½ of the companies with ICP are already subject to either a carbon tax or ETS and another 15% expect to be so within the next three years. In its earlier report, CDP cites that its data finds correlation between a company having ICP and “taking other strategic actions to integrate climate change issues into their business strategy.”

The ICP companies are using tends to be low, however. Although average or median ICP were not provided with this year’s results, in prior years’ reports, CDP has indicated the median ICP reported was $25-30/ton of CO2-equivalent. With that said, the reported ICP range is wide, with ~16% of reporting companies using an ICP below $10/ton (and some ICPs are pennies/ton) and ~10% reporting over $100/ton. As the World Bank report notes in its State and Trends report, it has been recommended that a carbon price of at least $40/ton be used to encourage behavior more consistent with limiting global warming to below 2º Celsius. This allows for the concern that the pricing isn’t motivating adequate behavioral change, although having an IPC at all brings an important awareness to companies’ investment and operating decisions.

The financial services sector leads in the number of companies with ICP; power and fossil fuel companies lead in the proportion of their sector having ICP. The World Bank report notes that the services industry leads sector groups with ICP in place, with >1/4 of total companies (i.e., >300 services companies surveyed have ICP), followed by the manufacturing sector and then materials. Within the services industry, the report notes the financial services is particularly well represented. This is consistent with anecdotal information, for example, of asset managers using carbon pricing as part of assessing risk of various portfolios.

As a proportion of the number of survey respondents within a given sector that have an ICP, the power and fossil fuel sectors have historically led. In the CDP’s last published results from its 2020 survey, for example, 71% of companies in the power sector had ICP, followed by 67% of companies in the fossil fuel sector and 52% of respondents in the financial services sector.

June 8, 2023

CDR Portfolio Option Introduced​

Exhibit: The NextGen CDR “Ecosystem”

Source: Mitsui O.S.K. Lines

Key Points: NextGen CDR hopes to progress CO₂ removals at scale by offering (1) vetting, oversight and portfolio construction services to buyers and (2) advanced market purchases, i.e., revenue visibility, to sellers. NextGen launched in late April with five buyers committing to ~200K tons; it is targeting selling 1MM tons by 2030 at an average price of $200/ton.

NextGen CDR Facility introduced. Sponsors South Pole and Mitsubishi have launched the NextGen CDR Facility. The facility is designed to pool multiple large-scale sources of technology-based Carbon Dioxide removal (CDR). NextGen is facilitating the purchase and sale of CDR credits, ensuring compliance with industry best practice for credit issuance and CDR performance. Its ambitions are to contract for 1 Million (MM) tons worth of offsets at an average price of $200/ton by 2030.

Three initial sources of credits. See Exhibit. Although other technologies are expected to be added to the available portfolio, the initial sellers of CDR credits into the facility are:

• 1PointFive’s Direct Air Capture facility under construction in Texas. The facility targets removing 500 thousand (K) tons per year and is expected to be operational in 2025.
• Summit Carbon Solutions’ biomass carbon removal and storage project in the U.S. upper Midwest. The project envisions partnering with 30 ethanol plants across five midwestern states to capture CO2 emitted during the fermentation process and send it to a sequestration site in North Dakota via pipeline. The project targets 9MM tons per year. Sales to NextGen from this project may reach $30 Million.
• Carbo Culture’s biochar project in Finland. The company targets storing 2.5MM tons by 2030. Carbo Culture had previously signed advanced market purchase agreements with Zendesk and Rothschild & Co. Construction of its first commercial facility is underway; the company envisions several operating facilities by 2026.

Five founding buyers committed to buy 193K tons starting in 2025. Mitsui O.S.K. Lines, BCG, LGT, Swiss Re and UBS have committed to buy CDR credits as the sources scale up operations.

Creating a technology portfolio for buyers. NextGen is seeking to provide large CDR buyers an option to buy a portfolio, enabling them to invest in several technologies with less effort than having to source, perform due diligence, and contract each on their own. Buyers may be attracted to the portfolio as a way to help sponsor several technologies or to hedge against the risk that a particular technology does not pan out as envisioned. Buyers also get the benefit of yet another source of vetting for project integrity — NextGen is sourcing its credits that have been vouched for by the International Carbon Reduction and Offset Alliance (ICROA, an integrity body) but will also continue to provide independent monitoring services.

NextGen is funding technologies just as they are scaling up; April also saw earlier stage CDR funding support. NextGen is slotting into the development lifecycle as technologies are scaling/commercializing. This stands in contrast to, for example, Frontier Climate, which is supporting a wide(r) array of CDR technologies earlier in their development, although also through advanced market commitments (Frontier has accordingly assumed thought leadership responsibilities regarding valuing technology uncertainty). Also in April, Frontier received commitments for $100MM from another four buyers, bringing its total advanced market commitments to over $1 Billion.

May 3, 2023

Insight Into the Higher Cost of Capital in Emerging Economies

Exhibit: WACCs in Select East Asian Countries, Onshore Wind and Utility Scale Solar

Source: Imperial College and IEA, Payne Institute

Key Points: A recent IEA/Imperial College report compares financing costs of renewable energy (RE) across the ASEAN. The differences stem from perceived country/currency risk, electric power policy, (contractual) relationship with the utility/buyer and “depth” of financing options. The report is part of a broader initiative to lower obstacles to RE development.

A strikingly large range in cost of capital (i.e., cost of financing) across countries. The authors derived Weighted Average Cost of Capital (WACC, see below for more detail) ranges for each country by renewable energy (RE) technology. The WACCs range from approximately 6.5-8% for utility-scale solar projects in Malaysia to approximately 10-13.5% for utility-scale solar in Vietnam. See Exhibit. The high WACCs create a significant, although not the only, obstacle to RE deployment at scale in those countries.

The WACCs for all the countries studied include some risk premium vis-à-vis developed economies. This is reflected, for example, in currency exchange risk vs. the US Dollar; the report suggests this adds ~1-3 percentage points, with Malaysia at the low end and Vietnam and Indonesia at the high end.

Challenges in Vietnam and Indonesia. The higher WACC in Vietnam and Indonesia reflects, per the interviewees, greater perceived business and financing risks from:

• integration challenges (of tying in newly constructed electricity generation into the grid)
• power curtailment risk (by the state-owned utility that is to buy the power)
• contractual risk (with the state-owned utility)
• underdeveloped banking systems (tends to result in higher interest rates; this may be due in part to a more limited track record, at least in Indonesia)

Report Background. The International Energy Agency (IEA) and the Imperial College London recently published a joint report on the financing costs and challenges of developing new RE sources in the ASEAN region (the Association of Southeastern Asian member states). It offers interviewees’ assessments of the WACC and issues/challenges for different RE projects. The report gathered cost of capital data from representatives in these countries via interviews with private and public investors and industry sources.

The report is part of a larger effort to increase transparency of the components of the cost of capital for RE in emerging economies; that effort is a World Economic Forum/IEA initiative called the Cost of Capital Observatory, of which the Payne Institute’s Sustainable Finance Lab is a working group member. It is hoped that greater transparency can help spur development of concessional support and policy changes to lower perceived risks and thus lower the cost of financing.

The Cost of Capital Observatory’s efforts have included a survey of (different) professionals conducted in the Summer of 2022. A follow up survey is to be released in May. Some of the original survey data was integrated into the IEA/Imperial report’s cost of capital estimates (our thoughts on the original survey results are here).

 WACC defined. The WACC of a project is determined by its cost of debt and its cost of equity (otherwise known as the expected return on an equity investment), weighted based on how much each (debt and equity) comprises of the total financing. To illustrate, if a project is financed with 70% debt that has a 7% interest rate and 30% equity with a 12% expected return, the WACC would be (.7*.07)+(.3*.12) = 8.5%. The cost of equity is estimated by adding a risk-based estimate of the returns to that of a risk-free rate of return. The WACC is lowered by having lower costs of debt and equity — and these are lowered when investors perceive lower risks in the project — and/or, generally, with more of the financing coming from debt vs. equity.

4/26/2023

Credit Suisse Demise Opens Another Hole in Climate Financing

Exhibit: Blue Bonds Principles

Source: The Nature Conservancy

Key Points: Climate finance is more vulnerable than other sectors to a banking crisis because fewer banks engage with emerging companies/newer financial products. We discussed SVB in a separate article; here we note Bloomberg reporting of a Credit Suisse niche in “nature” bonds — blended finance vehicles that lower debt costs in exchange for nature action.

SVB’s bankruptcy looks set to slow startups’ development. Silicon Valley Bank’s (SVB) outsized role in providing banking services (including specifically venture-related loans) to startups included a dominant presence in some segments of “climate tech,” new technologies directed at producing carbon-free energy or in some form of decarbonization. The bank’s demise thus threatens to slow climate tech companies’ commercialization and growth, which, in turn, suggests a slower pace of energy transition (although calibrating how much of a delay or impact might be impossible). A silver lining, as we discussed in in an opinion piece in The Hill, it is that one would hope for a diffusion (of people in the climate venture capital ecosystem and of knowledge of emerging technologies) to many banks that can lead to much more financial support over time.

Credit Suisse’s fall may slow novel environmental bond issuance. In what admittedly is a smaller example than SVB, the investment bank played a key role as a facilitator in issuing some novel nature-protection related bonds. The largest category of these is “Blue bonds” (see description below). Per Bloomberg, Credit Suisse was the sole arranger of the largest blue bond issued to date, $364 Million (MM) to Belize in 2021, and of a $150MM issuance to Barbados last year. Blue bonds appeared poised to grow, with Bloomberg reporting that Gabon ($700MM), Ecuador ($800MM) and Sri Lanka ($1 Billion) all working towards issuance.

Credit Suisse was also the sole structurer and joint book runner on the World Bank’s $150MM “Rhino bond,” designed to fund the protection of black rhinos in South Africa.

Blue bonds offer a chance for a country to lower its debt burden in exchange for protecting ocean areas. A relatively new product, blue bonds are loans with two purposes: 1) to refinance a country’s outstanding debt and therefore offer some relief and 2) to allocate some of the newly borrowed funds to a program to preserve and protect ocean areas (see Exhibit). Blue bonds are thus an extension of debt-for-nature swaps first conceived in the 1980s.

Blue bonds have been orchestrated and managed by The Nature Conservancy (TNC). Grant funding (sourced in part from TNC as one of the recipients of The Audacious Project) helps initiate projects. Loan insurance provided by the U.S. International Development Finance Corporation (i.e. public support) helps private investors accept lower returns and so the new loan carries a lower interest rate. Also, for at least the Belize debt, the proceeds were used in part to buy back existing bonds that were trading a steep discount, thereby lowering the country’s outstanding loan balance.

3/22/2023

The Recent Reshaping of Renewable Energy Investment

Exhibit: % of Renewable Energy by Finance Source, 2013-2020

Source: CPI

Key Points: Renewable energy (RE) investment shifted to commercial lending/securities from project finance in the 2010s, reflecting growing comfort with solar/wind technologies as well as a China industrial policy tool. The shift likely helped RE growth in 2021-22 in the OECD. “Direct” institutional investment is seen as a key enabler in developing economies.

A detailed study of renewable energy finance trends. In late February, the Climate Policy Initiative (CPI) and International Renewable Energy Agency (IRENA) published their third biannual report of investments in Renewable Energy, segmenting by region, technology, source of financing and grid/off-grid. The data and analysis concentrate on 2013-2020, although there is some data available through 2022.

No significant growth in RE investment in 2014-2020… The value of investment in RE from 2014 through 2020 was relatively unchanged, fluctuating between $260 Billion (B) and $350B (see figures at the top of the Exhibit for annual detail). A step-up in RE investment began in 2021 and reached $500B in 2022 (please see this recent Payne blog for discussion).

…But there was a change in where the money came from to make the investments. The composition of the financing sources, however, shifted considerably, to a mix of 56% debt/44% equity in 2020 vs. 23% debt/77% equity in 2013. The shift occurred largely as project-level (project financed) equity was replaced by balance sheet (i.e. corporate) debt. Project-level equity fell to 10% of total sources by 2017 from 30-40% in 2013-2016; balance sheet financing, in which a company borrows from commercial lenders or securities markets, grew to 30% of total sources by 2020 from 0% in 2014 (see Exhibit).

The maturation of solar and wind technologies allowed for the shift.  The growth in commercial lending and marketable securities, which are less expensive and much more broadly available than project financing, reflects increased comfort with solar and onshore wind technology. The growth in lending was, however, not all driven by market forces. It also reflected policy decisions — the most important example being in China, which established a Feed-in Tariff to encourage wind development and directed Chinese state-owned financial institutions to lend to wind projects.

Institutional investor direct project investment is well below 1% of total financing. The study notes the very limited role institutional investors, including pension funds, insurance companies, sovereign wealth funds and endowments and foundations, play in directly funding RE investment. These entities combined to invest in a range of $300 Million to $1.3B per annum over 2013-2020.

These institutions do provide capital support, investing through established capital markets (i.e., they buy listed stocks and bonds). But with their collective tens of $Trillions of assets under management, their direct participation in projects is seen as a powerful tool in fostering significantly more RE development in developing economies. It is perceived that direct investment is required for developing economies given relatively immature capital markets and lending institutions in these countries.

The argument that this group might be interested in making these direct investments is based on the idea that they have:

1. longer investment time horizons,
2. stated goals to decarbonize their investment portfolios, and
3. (arguably) some willingness to earn more modest rates of return (as long as the risk profile is commensurately lower).

Spurring more direct investment from these entities, however, involves overcoming a number of hurdles, including providing local knowledge and country- and project-specific risk amelioration; it likely also requires them making specific changes in their investment mandate to include more tolerance for longer term, less liquid holdings (i.e. to be willing to hold onto their investments for a long time).

3/6/2023

Energy Transition Investment Tops $1 Trillion in 2022

Total Investment in Low Carbon by Category, 2022 ($Billions)

Source: BloombergNEF

Key Points: Global spend on energy transition hardware was US$1.1 Trillion in 2022, up 31% from 2021, per BloombergNEF. Another $350 Billion went towards power grids and manufacturing capacity. China continues to dominate, reflecting its ambition but also highlighting geopolitical/supply chain risk. Net Zero investment modeling suggests far more spend is needed.

BloombergNEF cites US$1.6 Trillion put or raised toward the energy transition in 2022. In its latest annual study of energy transition investment, BloombergNEF tallied $1.1 Trillion (T) of spending globally on specific hardware related to the supply and demand for low carbon power (with a sliver of spending on carbon capture); $274 Billion (B) on power grids to support growth in electrification; and $79B in Supply Chain & Manufacturing (=investments in factories/capacity to build low carbon equipment). See Exhibit.

It also counted $119B of equity capital raise (public and private) for companies in the energy transition space. This category is a bit of an orphan. It does not jive with the other figures, which are of spending, and it doesn’t reflect equity raised by, say, legacy firms that also engage in non-climate tech activity but that have raised money to invest in low carbon energy. It can, however, offer some perspective on spending capacity and prospects for new technology development and trends over multiple years may be telling.

Just under 90% of the $1.1 Trillion in energy deployment spend on renewables or electrified transportation. Renewable energy comprised $495B (45%) of the $1.1T spent; electrified transport (which includes EVs and charging infrastructure) spend was $466B (42%). See Exhibit.

China accounts for ½ of the $1.1 Trillion; India is the only other non-OECD country in the top 10. BloombergNEF tallies $546B in energy transition spending by China in 2022, or 49% of its global total (excludes the grid and the supply chain spending categories described above). The U.S. ranked second with $141B and Germany third with $55B. Of the rest of the top 10, only India (8^th place with $17B) was not in the OECD.

Supply Chain & Manufacturing spend dominated by China; skewed to batteries. Global Supply Chain & Manufacturing spend rose 44% in 2022 to $79B. By target, $45B (58%) of the total was directed at batteries followed by $24B (30%) at solar. China accounted for over 90% of the spend, up from ~70% in 2021; the mix was impacted by year-over-year decline in Europe after strong spending on battery manufacturing in 2021 partially offset by growth in the U.S.

Net Zero Studies have estimated that far more needs to be spent per annum. BloombergNEF notes in this current study that the approximately $1.4T spent in 2022 (hardware plus grid) pales in comparison to the average $6.4T in annual spend that it has calculated separately will be required for the world to achieve Net Zero emissions by 2050. Its estimate is in the ballpark with McKinsey’s estimate, made ~one year ago, of $5.5T of required annual spend on mobility and power to achieve the same. Such estimates suggest dramatically higher spending will be required for much of the world outside of China.

1/30/2023

Environmental Debt Issuance’s Very Strong 2022

Exhibit: Annual “Impact” Bond Issuance by Type (US$ Billions), 2018-2022

Source: Intercontinental Exchange (ICE)

Key Points: Green bond issuance fell 1% year-over-year in 2022 to US$487B, a stark contrast to overall debt issuance’s 20% drop to $52 Trillion. Sustainability bonds fell 25% to $152B. Sustainability-Linked Bonds appeared to fall around 25% as well, suggesting that integrity concerns did not weigh meaningfully on this segment, despite financial outlet narratives.

ESG bond issuance fell 13% year-over-year (yoy) in 2022 vs. total issuance down 20%. Per statistics from the Intercontinental Exchange (ICE), Impact bond issuance fell 13% yoy to US$771 Billion (B) in 2022. On a percentage basis, declines were led by lower issuance of Social bonds (-32% to $132B) on lower pandemic-support. See Exhibit.

Green bond issuance was most resilient (-1% to $487B), supported in part by growth in China and Germany, but also by relative resilience among corporates (corporate Green bond issuance fell by only 4% yoy to $289B).

Per Bloomberg data, total global bond issuance fell 20% to US$52 Trillion (T). The decline was driven by the dominant government sector, which fell 21% to $39T. (US Dollar strength no doubt aggravated declines in 2022; there is no attempt made herein to adjust for currency when comparing Impact bond issuance with the overall market.)

Evidence mixed on whether Sustainability-Linked bond (SLB) issuance was affected by integrity concerns. Issuance of SLBs appears to have fallen in line with Sustainability bonds. Assessments varied across different financial outlets but arguably coalesce around a 25% decline — e.g., a tally by Bloomberg suggested SLB issuance fell 17% to $86B in 2022 from $103B a year earlier while Environmental Finance reported that it had fallen 26% to $70B in 2022 from $94B a year earlier. (ICE did not report data for this SLB segment.)

These outlets and others wove into their commentaries that SLB issuance was weighed down in 2022 by integrity concerns (both inadequately ambitious targets for decarbonization and weak penalties for missing targets). EF noted in the same report that corporate SLB issuance fell 32% (to US$62B) and so governments (e.g. Chile, Uruguay) partially offset. And given the dramatic growth in SLB issuance in 2021 — roughly 10x from 2020 — one might have expected continued growth simply from annualizing or from having more entities get up to speed on the tool. Yet SLB’s relatively comparable decline with the overall debt market suggests that the impact of additional scrutiny was likely modest; perhaps it will have more of an impact (either in issuance volume or the Key Performance Indicators in the bonds) going forward.

January 23, 2023

A Global Public Good Push for the World Bank

Key Points: The World Bank Evolution Roadmap includes expanding focus to include climate change and pandemic response and changing operations to mobilize more private capital. Ideas for the latter, most being revisited, include expanding what can be considered WBG equity capital, diversifying from providing senior debt and selling off loans to recycle capital.

The World Bank issues Evolution Roadmap Paper to broaden its mandate. In early January, the press reported seeing a leaked World Bank Group (WBG) document called the Evolution Roadmap Paper. This strategic and operations review, which was prompted by its government shareholders, considers (more formally) including in its mandate (1) broader poverty alleviation (beyond extreme levels) and (2) funding investment in “Global Public Goods” including climate change and pandemic preparedness and response.

Multilateral Development Bank (MDB) watchers appear to generally agree with the strategic shift to include these global challenges. On climate funding, however, some have raised concerns about the WBG’s historical inefficiency, i.e., greenhouse gas reduction per dollar spent, and that climate-related financing to middle income countries might “win out” over poverty eradication in poorer countries. Regardless, changing incentives for MDBs to provide more (and more effective) climate finance, which can include being measured on transformation (and climate impact), is a critical starting point.

Operationally, much of the emphasis is on mobilizing more private capital. The WBG paper points to a shortcoming in legacy MBD concessional lending in terms of attracting private capital (i.e., catalyzing or mobilizing private investment). This shortcoming has been recognized for years, including by the MDBs themselves.

The Evolution Roadmap offers several ideas to mobilize more private investment without spreading WBG capital too thinly and thus sacrificing its strong credit ratings. Suggestions include giving explicit value to contingency capital that is callable from shareholder governments, innovation in mechanisms to provide concessional support (e.g. issuing debt that is subordinated to private lenders, greater use of guarantees, etc.), mechanisms to bring in private capital into MDBs and selling off/syndicating loans (for more on these last two, see below).

Multilateral Development Banks (MDBs) mobilize capital indirectly and directly. The late-2022 announcements of JET partnerships illustrate the potential indirect impact of public/MDB funds: if they support local government institutions, it can unlock private capital. This can involve technical education/support — for example assistance in loosening power market regulations that might give new renewable energy (RE) generation more commercial opportunities. Or it might be infrastructure-related — such as helping to fund a national utility expand transmission and distribution capacity to accommodate new RE generation.

MDBs can also have a direct catalytic impact through co-financing: with an MDB providing a tranche of lower cost debt and perhaps some form of risk assumption (e.g., taking losses first), it supports private entities co-financing the project at (reasonable) market rates.

Selected ideas include new types of investment opportunities for private capital. We note three ideas, which include recommendations of an Expert Panel tasked by the G20 to boost MDBs’ investment capacity, that explicitly involve deploying private capital. The first two allow MDBs to do more of what they do today; the third ties with an indirect/facilitator role.

• Introducing non-voting capital. This is envisioned as equity or perhaps hybrid/interest-bearing instruments provided to WBG (and so is not project-specific) by private investors. Such investments could help these private actors boost/meet ESG or sustainability commitments in their portfolios.
• Selling off loan portfolios/securitization. WBG would continue to originate and administer loan portfolios but would either sell off parts of the loans or engage in some form of (synthetic) securitization. This has been trialed successfully by the African Development Bank.
• Support development of VCM, including being a “trusted intermediary.” WBG is currently sponsoring a blockchain-based ecosystem for warehousing credits registered in various markets and is supporting development of a centralized, digital infrastructure that connects various registries’ systems.

January 17, 2023