Zeroing In: Financing the green transition

DNV's Niki Hutson, Zohrah Yaqub and Astrid Helene Rusås Kristoffersen explain the findings from its latest Energy Transition Outlook and consider what steps can be taken to keep the transition on track

DNV's 2024 Energy Transition Outlook (ETO) reveals that the global energy transition has truly begun, with energy-related emissions expected to peak this year.

However, emissions will not fall rapidly enough, and at the current trajectory, the world is most likely to see a 2.2°C temperature rise by the century's end, far exceeding the Paris Agreement's 1.5°C goal.

Our research suggests that achieving 'net zero by 2050' is infeasible at the current pace, but accelerating the green transition is more important than ever if we are to maintain the target. Early action on emissions reduction is far more effective than delaying efforts. Moreover, as our ETO findings indicate, an energy system dominated by renewably generated electricity is considerably more efficient and affordable than the current energy mix. It also provides an economic justification for boosting investment in a Paris-compliant energy transition, even before considering the incalculable costs of mounting climate damage.

So, how can we fast-track progress to reach our climate goals? With COP29 approaching and insights from DNV's 2024 ETO, we explore how sustainable finance can be leveraged to channel investments into initiatives that accelerate the green transition.

Redirecting capital flows

While capital is largely flowing in the right direction, funding continues to support the continuation of fossil fuel projects over the next decade. Shockingly, in 2023, three-quarters of total world energy expenditure ($6.1 trillion) was dedicated to fossil fuels.

Despite challenges of transitioning to a low-carbon economy, there are glimmers of hope – we have seen investment in renewables, particularly solar photovoltaic, reach a record $570.5 billion in 2023, surpassing other new generation technologies. This underscores the need for policies and financial incentives to redirect capital to support cleaner energy.

Directing investments toward green activities can accelerate change, but country differences pose challenges. Wealthier nations, such as those in Europe and North America have established financial markets with easy capital access, reasonable levels of liquidity, and diversity of financial instruments. However, emerging markets and economies may be more fossil fuel-dependent, slowing their transition.

Governments should utilise a range of policy tools to support the transition effectively and foster an environment that accelerates the shift to green energy. This should include both tools that promote technological innovation, e.g. infrastructure investments in grids (technology-push), and tools that stimulate demand for green energy, e.g. renewable energy use targets (demand-pull).

Harmonisation, not uniformity

While policies can reduce investment barriers for the green transition, developing countries still face intrinsic challenges – such as limited resources, high costs, vulnerability to climate impacts, and technological gaps. To address this, COP29 will focus on the climate financing bottleneck.

Harmonising sustainability taxonomies will be instrumental in unlocking capital and addressing regional financing gaps. These taxonomies prove to be a powerful tool for the sustainable finance market, as they enable companies to identify eligible sustainable activities that are taxonomy compliant and contribute to wider sustainability objectives, such as Climate Mitigation and Adaptation, as demonstrated by the EU Sustainable Taxonomy.

With around 47 taxonomies in effect or under development (such as Canada, Japan, France, The Netherlands, and south-east Asia), this demonstrates clear climate action commitments across regions. However, a globally fragmented approach combined with the proliferation of sustainable taxonomies, further exacerbates the issue of a geographically uneven transition. As referenced in DNV's ETO, divergent requirements and reporting obligations create market confusion, especially for cross-border investors (Spaans et al., 2024).

Balancing the need for interoperability of national taxonomies whilst accommodating regional nuances, is paramount in achieving a collective net-zero goal.

Tackling this widely acknowledged and complex issue is fortunately already underway, as the UN Environment Programme Finance Initiative (UNEP FI), Principles for Responsible Investment (PRI), and the Climate Bonds Initiative (CBI), recently announced a collaboration to develop a platform to support global taxonomy interoperability.

Overcoming barriers – fossil fuels & hard-to-abate sectors

Though sustainable taxonomies are valuable for defining green and sustainable activities, they are still perceived as limited in scope in relation to hard-to-abate sectors. These challenges are further exacerbated in economies that rely heavily on revenue from such sectors, including shipping and agriculture. In tandem, these issues spark investor uncertainty and reluctance in making sustainable financing commitments, serving as additional barriers to the green transition.

Alongside calls for global taxonomy interoperability and applicability, it also necessitates dedicated climate finance pathways to be created specifically for these countries. These should especially prioritise clean energy initiatives and the rapid phase-out of fossil fuel plants to meet global climate objectives.

DNV's ETO insights indicate that these pathways are needed, now more than ever. The research found that over the period 2016–2021, multilateral finance institutions such as the African Development Bank (AfDB) and the World Bank, provided most of the fossil-fuel finance to sub-Saharan Africa (Climate Analytics, 2022). The research highlights that emerging economies are lagging behind high-income nations.

The challenge of delayed transitions, particularly in hard-to-abate sectors within emerging economies, has intensified following COP28. As highlighted in our ETO, the Industrial Deep Decarbonisation Initiative introduced the Green Public Procurement (GPP) pledge. This aims to accelerate decarbonisation in hard-to-abate industries such as steel, cement, and concrete. This initiative is a crucial step toward fostering sustainable practices in these sectors.

While the GPP pledge is supported by governments of countries, including Canada, Germany, the UK, the US, Japan, Austria, and the UAE, not all emerging economies have joined the initiative. Notably, India has opted not to sign the GPP pledge but has made some efforts elsewhere, focusing instead on promoting the use of low-carbon industrial materials to stimulate market growth in that area.

Unfortunately, current efforts are falling short of achieving meaningful progress toward the global net-zero target. To achieve meaningful progress, it is essential for all countries to make stronger commitments to sustainability. This effort should be supported by enhanced assistance from wealthier nations through sustainable financing practices and initiatives.

Despite this, all is not lost; whilst recent science indicates we are unlikely to meet the objectives of the Paris Agreement, ongoing positive developments and initiatives globally provide a beacon of hope. We eagerly anticipate that the upcoming COP29 in Baku will prioritise an accelerated, practical, and solutions-oriented approach, particularly regarding climate finance – a main theme.

To download the latest Energy Transition Outlook, click here.