TODAY’S STUDY: THE PROGRESS OF NEW ENERGY
Tracking Clean Energy Progress
April 2012 (International Energy Agency)
Recent environmental, economic and energy security trends point to major challenges: energy related CO2 emissions are at an historic high, the global economy remains in a fragile state, and energy demand continues to rise. The past two years (2010 and 2011) also saw the Deepwater Horizon oil spill off the Gulf of Mexico, the Fukushima nuclear accident in Japan, and the Arab Spring, which led to oil supply disruptions from North Africa. Taken together, these trends and events emphasise the need to rethink our global energy system. Whether the priority is to ensure energy security, rebuild national and regional economies, or address climate change and local pollution, the accelerated transition towards a lower-carbon energy system offers opportunities in all of these areas.
The Energy Technology Perspectives 2012 2OC Scenario (ETP 2DS)1 highlights that achieving this transition is technically feasible, if timely and significant government policy action is taken, and a range of clean energy technologies are developed and deployed globally. Based on current trends, are we on track to achieving this transition? Are clean energy technologies being deployed quickly enough? Are emerging technologies making the necessary progress to play an important role in the future energy mix? These are the key questions addressed in this report.
In summary, the following analysis finds that a few clean energy technologies are currently on track to meet the 2DS objectives. Cost reductions over the past decade and significant annual growth rates have been seen for onshore wind (27%) and solar photo-voltaic (PV) (42%). This is positive, but maintaining this progress will be challenging.
Government targets for electric vehicles stock (20 million by 2020) are ambitious, as are continued government nuclear expansion plans in many countries, in both of these cases, significant public and private sector efforts will be necessary to translate plans into reality.
The technologies with the greatest potential for energy and carbon dioxide (CO2) emissions savings, however, are making the slowest progress: carbon capture and storage (CCS) is not seeing the necessary rates of investment into full-scale demonstration projects and nearly one-half of new coal-fired power plants are still being built with inefficient technology; vehicle fuel-efficiency improvement is slow; and significant untapped energy-efficiency potential remains in the building and industry sectors.
The transition to a low-carbon energy sector is affordable and represents tremendous business opportunities, but investor confidence remains low due to policy frameworks that do not provide certainty and address key barriers to technology deployment. Private sector financing will only reach the levels required if governments create and maintain supportive business environments for low-carbon energy technologies.
Recommendations for Energy Ministers
Member governments of the Clean Energy Ministerial (CEM)2 process not only represent 80% of today’s global energy consumption, but also about two-thirds of projected global growth in energy demand over the next decade. If the 2DS objectives are achieved, CO2 emissions among CEM member countries would decrease by over 5 gigatonnes (Gt), and they would save 7 700 million tonnes of oil equivalent (Mtoe)3 through reduced fuel purchases. Globally, the near-term additional investment cost of achieving these objectives would amount to USD 5 trillion by 2020, but USD 4 trillion will be saved through lower fossil fuel use over this period. The net costs over the next decade are therefore estimated at over USD 1 trillion4. More impressively, by 2050, energy and emissions savings increase significantly as CO2 emissions peak, and begin to decline from 2015. In this timeframe, benefits of fuel savings are also expected to surpass additional investment requirements for decarbonising the energy sector. Potential savings among CEM countries in 2050 amount to over 29 Gt of CO2 emissions and about 160 000 Mtoe through reduced fuel purchases. This is equivalent to more than a 50% reduction in CO2 emissions from 2010 levels, and fuel purchase savings equivalent to twice total CEM country energy imports over the past 40 years. This combination of reduced energy demand and diversification of energy sources will result in far reaching energy security benefits.
Currently, CEM and governments around the world are not on track to realising these benefits. Few forums have as significant a potential to make a major impact on global clean energy deployment, and possess the operational flexibility to make it happen: this opportunity and momentum must be seized. Joint commitments taken at the third Clean Energy Ministerial can help overcome existing barriers to clean energy technology deployment, and scale-up action where it is most needed. This can be achieved by raising the ambition of Clean Energy Ministerial efforts to:
■■ Encourage national clean energy technology goals – supported by policy action and appropriate energy pricing – that send strong signals to the markets that governments are committed to clean energy technology deployment.
■■ Escalate the ambition of international collaboration – by building on the CEM Initiatives to take joint actionable commitments, and closely monitor progress against them.
With these two objectives in mind, if taken up by energy ministers, the following three key recommendations, and specific supporting actions, can help move clean energy technologies from fringe to main-stream markets.
1. Level the playing field for clean energy technologies…Price energy appropriately and encourage investment in clean energy technology…Develop policies to address energy systems as whole…Step-up to the CCS challenge…
2. Unlock the potential of energy efficiency…Implement energy efficiency policies and enhance efficiency standards…Leverage the role of energy providers in delivering energy efficiency…
3. Accelerate energy innovation and public RD&D…
Financing the Clean Energy Revolution
Part 1 concludes that most clean energy technologies are currently not on track to achieve the ETP 2DS objectives. Policy actions are required to scale-up the development and deployment of clean energy technologies, which will in part aim to shift capital from traditional fossil fuel technology investments, to clean energy alternatives. The power, transport, buildings and industry sectors will all require additional investments over the next decade to achieve the 2DS. This section reviews the scale of additional investments required, but also the fuel saving benefits from transitioning to a low-carbon energy sector. In addition, the potential sources of finance and tools to unleash this capital are highlighted.
Low-carbon energy investments to 2020
Over the next decade, an estimated USD 24 trillion will need to be invested in power, transport, buildings and industry sectors in the 2DS. Investments in the transport sector represent the largest share, accounting for 34% of total investments, and globally will exceed USD 8 trillion over the next decade. Over this period, a projected 1.7 billion new vehicles will be purchased globally. Building investments to 2020 will reach over USD 6 trillion of which just half is needed in OECD regions with significant investments for the retrofit of existing building envelopes and improvements in energy efficiency of HVAC systems, appliances and other equipment.
Investments in the power sector are estimated at USD 6.4 trillion under the 2DS, of which China will account for nearly 30% of investments – equal to the combined investments of the United States and Europe. China’s economic growth is expected to remain strong over the next decade resulting in increased investment needs across all sectors, but particularly in the power and transport sectors to meet growing demand for electricity and higher vehicle penetration rates. In OECD member country regions, investments are dominated by buildings and transport, which combined make up between 65% and 70% of total investments in the next decade.
Compared to the investment requirements over the next decade under the 6DS of USD 19 trillion, total additional investment needs to achieve the 2DS is projected to be USD 5 trillion or 25% above investments needed in the 6DS. OECD member countries represent over half (USD 2.5 trillion) of these total additional investments, with the European Union accounting for the largest share of any region at 22% or USD 1.1 trillion (Figure 2.1).
The largest share of additional investments needs in 2DS compared to 6DS over the next decade are required in the building sector, representing more than half at USD 2.9 trillion globally. On a regional basis, buildings represent by far the largest share of the additional investment needs for all countries, accounting for 70% (Other Developing Asia) to 40% (China) of the share of total additional investments. Early investments in low-carbon building options are critical to achieving the high share of energy efficiency outlined in the 2DS. Delays in implementing these investments will result in the need for additional investments for new power generation capacity, as well as higher fuel costs in buildings and an increase in the number of people without access to reliable and affordable energy.
The importance of implementing energy efficiency measures over the next decade cannot be over-emphasised. In many cases these options have short payback periods with low or negative abatement costs. Investments with longer payback periods (such as deeper renovations in buildings) will also be needed to avoid technology lock-in. For new buildings mandatory building codes with stringent minimum energy performance requirements (standards) aiming to zero-energy buildings need to be implemented. For existing buildings governments should implement mandatory annual renovation rates; and each time renovation undergoes energy requirements should be based on life cycle cost analysis. There is also a need to enforce building codes and energy requirement at the design, the construction and operation stage of the building; and stringent penalties in case of non-compliance should be defined and implemented by governments. New financing mechanisms will need to be explored.
The diverse nature and large number of individual transactions in the building sector means that transaction costs associated with investment in individual energy efficiency projects in buildings can be prohibitive. A mechanism to pool individual transactions into a portfolio of energy-efficiency projects could help to overcome this barrier and governments could play an important facilitation role.
Benefits of a low-carbon energy sector
The additional investment needed to transition to a low-carbon sector will have significant benefits, not only in terms of reduced environmental damage, but also improved global energy security, as dependence on fossil fuels is reduced. Improvements in energy efficiency will reduce the growth rate of energy consumption. The amount spent to purchase fuel will decline sharply with the switch from fossil fuels to renewables. For countries that import oil and gas, this will improve current account balances and allow foreign reserves for other uses. In addition, the transition to a low-carbon energy sector will also yield significant health and employment benefits.
The move away from traditional fossil-based energy technologies will result in significant fuel savings with reductions in the purchase of oil, gas and coal. An estimated USD 4 trillion will be saved in the 2DS from lower fossil fuel use and an additional USD 0.2 trillion will be spent on additional biomass for a net fuel savings of USD 3.8 trillion between 2010 and 2020. In energy terms, this represents a 10 600 Mtoe reduction in fuel purchases to 2020.
Over the longer term higher fuel savings will significantly offset the additional investment requirements in 2DS. An important challenge will be to shift investment patterns towards higher capital-intensive technologies with lower fuel inputs. In the buildings and transport sector, individual consumers often do not adequately value the benefits of reduced fuel costs in the future and focus more on the higher upfront costs (Figure 2.2).
Unlocking trillions from institutional investors
Of the USD 212 trillion in global capital markets, more than half are assets of the global fund management industry (McKinsey, 2011). The industry can be split into conventional fund assets, typically managed by pension, mutual and insurance funds, and unconventional fund assets comprised of wealthy individuals, sovereign wealth funds and hedge funds. These investors had combined assets of USD 117 trillion at the end of 2010, with conventional assets rising 10% to reach USD 79.3 trillion and unconventional assets rising 12% to USD 37.7 trillion (Figure 2.3). Since 2000, assets under management of conventional funds have risen at a compound annual growth rate (CAGR) of over 7%, while unconventional funds (including private wealth) have risen at a CAGR of 6%.
Conventional funds generally have low appetites for risk and invest primarily in liquid (e.g. exchange listed and freely tradeable) equities, fixed-income and other securities, seeking average annual returns of 4% to 8%. Pension and insurance funds invest pension contributions and insurance premiums to fund future long-term and statistically determinable liabilities. Pension funds and insurance companies have greater flexibility in making long-term, illiquid investments. Mutual funds invest capital for capital appreciation and their time horizons range from short to long-term. Because mutual funds must be ready to redeem shares on a daily basis, they have large cash reserves and are nearly fully weighted to listed equities and bonds. These investors are major shareholders in listed companies and hold significant positions in government and corporate debt. Public pension funds, like private pension funds, seek adequate risk-adjusted returns for their investments and require stable inflation-adjusted income streams.
Investments in low-carbon power generation technologies, which often offer stable income streams through long-term power purchase agreements, appear to offer a good fit for these investors with relatively low appetites for risk. The average returns which these investors target vary depending on the associated risks of the different investment vehicles (Figure 2.4). It is important to note that the expected average return is based on variable performance of different investments so the actual target investors will strive for will need to be higher to achieve the indicated average returns. For example an infrastructure fund which expects returns of 7% to 10% will generally invest at 10% to 15% as some returns will be lower then their expected target.
Allocation of pension funds to clean energy technologies is currently very low, at less than 1% (Della Croce R et al, 2011) with little data currently available on allocation by other investors. In contrast, fund holdings in traditional energy companies (most of which are primarily fossil fuel based) are estimated to be approximately 5% to 8%. Raising adequate financing for clean energy will require attracting a much greater portion of funds under management by pension funds, and other conventional and unconventional fund investors.
The increased allocation of pension funds and other institutional investors to clean energy investments will occur only if the investment opportunities in these sectors offer adequate risk-adjusted returns. Pension funds cannot and should not be expected to invest in clean energy simply because it is needed by society. Government policies can correct market failures through regulations and policies aimed at filling the gap between investment risks and market barriers. They can also ensure that adequate domestic frameworks covering energy, climate and investment policies are in place to attract sufficient capital to this sector.
Understanding investment risks
Prior to investing in any project, investors will undertake a risk assessment of the project. A number of different risks will be evaluated by investors and cover regulatory and policy risks through to construction and markets risks (Table 2.2). Investors seek conditions in which risks can be understood, managed and anticipated (Hamilton, 2009). Policies can help to address both investment risks and market barriers to create suitable environments for low-carbon energy technologies to attract private sector finance.
The ability to evaluate and manage the above risks will differ depending on the stakeholder and their experience and capabilities to properly support these risks. For example, in the case of offshore wind, one of the largest risks for these projects comes with construction. Offshore wind farms are still at a relatively early stage in development, and can face many different challenges during the construction and operational phases.
Companies that have significant experience in developing wind farms and, in particular, offshore wind farms, are particularly well placed to support the construction risk of developing offshore wind farms. Once the project construction is completed and operating, it can be sold (either in part or in its entirety) to a different actor that is equally adept at owning these assets and managing the market risks of projects in their operating phase.
Mechanisms and financing vehicles to leverage private-sector investment
A range of public finance mechanisms and financing vehicles has been identified that can be used to overcome these barriers (Table 2.3). Public finance should be used to underpin and develop early investment-grade projects to allow the private sector to move into new markets, thus helping build up the technical capacity of a country. Early public-private partnerships should be encouraged, as they can help demonstrate technologies and create new markets.
The current economic crisis has reduced the amount of public finance available to support low-carbon energy technologies. Public finance must be used as efficiently as possible and should be targted at mechanisms that can leverage high levels of private sector finance. Well-designed public finance mechanism can leverage between three and fifteen times their amount in private-sector investments (IIGCC, 2010).
Well-targeted public finance mechanisms will help create an investment track record and thereby offset some of the perceived investment risk that private investors are not currently willing to support. For certain less-mature technologies such as CCS or for those which are not currently cost effective (some building technologies), where there is a larger public good aspect to developing or deploying these technologies, the role of public finance and regulation will be particularly important.
Different financing models will emerge in different countries, depending on the market structure of the energy sector and maturity of the financial market. In many emerging countries, such as China and Brazil, the prevalence of state-owned development banks and state-owned enterprises will mean that the role of public finances will be much greater than in more liberalised energy markets and mature financial markets such as the United Kingdom and United States.
Green or climate bonds
Green bonds offer the largest potential to attract funding from institutional investors in the next decade. Bonds represent roughly 50% of holdings by institutional investors, making this asset class particularly attractive. With a value of USD 95 trillion, the global bond market offers plenty of opportunities to raise large amounts of finance for clean energy technologies.
The current market size of self-labelled climate change-related thematic bonds (labelled anything from green, climate to clean energy) is, at USD 16 billion (Table 2.4), far below what is needed to create a liquid asset class that institutional investors could easily access.
The largest green bond issuances to date have come from green or clean energy bond programmes by multilaterial development banks, such as the World Bank and European Investment Bank, totalling USD 7.2 billion. These bonds have received the highest AAA rating and have helped establish early confidence in the green bond market. The United States government has allocated USD 2.4 billion under a Clean Renewable Energy Bonds program to allow municipalities to finance public sector renewable energy projects22. In addition, a number of large bond issuances ranging from USD 500-850m in the United States have raised capital for wind and solar farm construction, and renewable energy manufacturers are increasingly turning to the bond markets in the absence of restricted bank lending.
An estimated USD 200 billion of bonds have been identified that could be classified as climate change investment-related bonds, once asset-backed and corporate bonds are included (CBI and HSBC, 2012). Climate bonds are defined as those issued to fund or refinance climate change mitigation, adaptation or resilence projects (Climate Bonds Initiative). Included investments would range from clean energy and grid development to water adaptation and flood defense.
Bonds can be issued by banks, governments or corporations. They can be asset-backed securities linked to a specific project or they can be treasury-style bonds issued to raise capital to fund a portfolio of projects. For a specific bond to have sufficient liquidity, it needs to be issued with a size of at least USD 300-400 million. Below this threshold, climate bonds will have difficulty attracting sufficient interest from mainstream markets. Institutional investor appetite for bonds is largely in the investment grade area and in large-scale issuance. A liquid market requires issuance upwards of USD 200-300 billion, made up of bonds rated BBB or higher.
Qualifying as investment grade is an issue for clean energy investments, with ratings agencies typically awarding BB or lower ratings for wind and solar project bonds. A focus on issuing bonds for refinancing rather than project funding is one way of addressing this, with established projects likely to achieve higher ratings than pre-development project bonds; this would involve banks maintaining current bank debt to bond ratios of 20:1, but securitising loans within two years of development in order to avoid liquidity ratio issues involved in long-term holding of lower grade debt.
Another strategy would be to bring rating agencies, investors and governments together to determine optimal means to overcome barriers. The lack of track record for large-scale climate change related bonds means that risk is seen as greater than with existing investments; this is compounded by policy being seen as the main (and volatile) sector risk by investors.
Governments can help bring institutional investors into the market by:
■■ Providing insurance and other guarantees in relation or policy risk. For example the German government currently provides guaratees for power purchase agreements in Germany and in some other European countries, such as Greece.
■■ Providing legislative or tax credit support for qualifying bonds. The United States for example provides tax credits for clean energy bonds and the United Kingdom derisks securitised energy efficiency loan portfolios through the legislated repayment collection mechanisms in its Green Deal legislation.
■■ Issuing government climate bonds, as Australia is doing for its Clean Energy Finance Corporation, to lend to intermediary banks to direct to energy developers.
The last option is also a means of addressing problems of lack of scale, with large sovereign or multilaterial bank bonds raising funds for distribution across a portfolio of projects (CBI, 2012).
Banks can issue asset-backed securities that effectively aggregate portfolios of smaller loans into institutional investor sized offerings. The market for asset-backed securities is still weak, but investment grade ratings can for the moment be achieved with partial or even full guarantees, all the while educating investors about the underlying projects in anticipation of the recovery of an asset-backed securities markets.
Like utilities, large corporations can do the same, contributing to developing an investment track record for underlying assets by linking their bond issuance to low-carbon projects, while providing full and later partial credit rating through the corporate balance sheet. Over time this will allow utilities to better focus their balance sheet on the need for development of new energy infrastructure.