Andlinger Center Speaks: Bridging the gap between climate commitments and clean energy funding

By Colton Poore

Growing concern over the climate crisis has spurred international action to reduce carbon emissions, unleashing a tidal wave of high-profile net-zero pledges and public commitments to ramp up investment in clean energy projects.

But despite lofty ambitions and strong claims, evidence suggests that actual investments in clean energy projects have lagged far behind the trillions of dollars needed to execute the energy transition.

Chris Greig, the Theodora D. ’78 and William H. Walton III ’74 Senior Research Scientist at the Andlinger Center for Energy and the Environment, explained the deficit between decarbonization targets and the speed and scale of capital deployment needed to meet those targets in a commentary published Feb. 2 in Joule.

Along with fellow co-authors, including Scott Hobart, chief investment officer at Mercator Partners, a member of the Princeton E-ffiliates Partnership program, Greig highlighted where investments are falling short and presented suggestions to help both private and public sectors speed up capital allocation for clean energy projects.

What follows is a discussion with Greig and Hobart about the obstacles and opportunities for governments and financial institutions to make good on their decarbonization targets.

Achieving net-zero goals requires deploying massive amounts of capital, but in a recent commentary, you argue that we are not deploying funds quickly enough. How far short are we falling on those commitments?

Chris Greig: At the global scale, the gap is enormous. Groups like the International Energy Agency (IEA) and the Climate Policy Initiative indicate that the current allocation of clean capital is only around 20% of the amount needed to meet ambitious climate goals like those set out under the Paris Agreement. In the U.S., our Net-Zero America study suggests we have been running at less than half the capital allocation rate we need to reach both the 2030 goals set out by the Biden administration and the nation’s 2050 net-zero commitment. In that study, we showed that net-zero energy pathways are around 2.5 to 4 times more capital intensive on the supply side than the energy systems we have traditionally relied on. And at present, we simply aren’t investing capital into the clean energy and industrial sectors quickly enough to meet those requirements.

What are some reasons why the world is falling behind on its commitments?

Greig: It really stems from how project developers and investors manage capital-at-risk. Unlike in many energy systems models, investors in the real world have limited foresight, visibility, and influence across the energy ecosystem. They can’t predict future costs and performance of alternative technologies, when supply chain bottlenecks might arise, whether local communities will support certain projects and infrastructure, or how fast the market will shift to advancements like electric vehicles and low-carbon materials. All these uncertainties, which are especially high during initial project development stages, are sources of risk to the investor.

And as a defense against uncertainty, investors often take a cautious, risk-mitigating approach to allocating capital. While helpful for resolving investment uncertainty, this capital discipline often acts as a brake on the energy transition and encourages financiers to stick by well-established and well-defined projects and technologies. Capital discipline also explains why allegedly net-zero-aligned financial institutions and oil and gas majors continue to invest in expanding fossil fuel operations rather than ramp up clean energy investments. The combination of a longer history of delivering returns compared with renewable energy projects, coupled with recent windfall profits, is likely too compelling for them to resist.

Scott Hobart: There is abundant capital for projects offering de-risked economics and familiar technologies. For example, if you have an onshore wind project in Texas that has been fully permitted with a well-defined returns profile, then a large amount of capital will happily step in to fund that project.

But when you move beyond well-defined projects and technologies into some of the other emerging industries that are perhaps even more pivotal in the pursuit of medium- and long-term decarbonization targets, there is a huge void of capital. Show me the balance sheet that’s willing to commit the equity required to fund the development of a green hydrogen project in Iowa. In an industry like green hydrogen that is still in its absolute infancy, you don’t have 20+ years of projects to look back on when undertaking diligence for a new proposal like you can with onshore wind and solar. From that standpoint, it would take a lot more effort to build up an asset manager’s understanding and confidence in order to begin deploying finances for that type of project.

What changes should the private sector make to help speed up clean energy investments?

Greig: The financial services sector must confront the obstacles to capital deployment for clean energy projects, particularly in the early and riskier project development stages. Asset managers need to adopt a strategy to push portfolio companies to increase the level of development risk they accept. Additionally, the finance sector could establish large net-zero development capital funds to support emerging technologies and energy projects in developed and developing countries. Overall, the sector needs to rethink the criteria for acceptable project finance risk so that capital can be deployed more flexibly and efficiently. For example, by viewing net-zero financing on a portfolio basis rather than a project-by-project basis, the risk of investing in early-stage projects and emerging technologies could be mitigated by making up only a small portion of a larger clean energy portfolio. 

Hobart: The private sector has to change the rigidity with which it has traditionally approached capital deployment. It won’t be an overnight transformation, but given the urgency with which society needs to address the climate crisis, there is a case to be made that it at least needs to be happening at the margin. There is an argument, for instance, that maybe 10-15% of the clean energy capital being deployed should be disbursed under a far more flexible mandate than the current rigid, formulaic approach. That would allow investors to deploy capital much faster than they are at present, especially for emerging technology projects or ones that are seen as too risky under current criteria.

And what role might the public sector play in accelerating clean energy investments?

Greig: If the transition were able to play out gradually over several asset lifecycles, then I would say leave things completely in the hands of the private sector. The problem is that 2050, the target for countries like the United States to reach net-zero, is less than the typical life of most energy and industrial assets. It’s also a monumental coordination challenge. We need to synchronize this massive and rapid deployment of capital to simultaneously expand clean energy supplies, demands and connecting infrastructure. Therefore, while the private sector should ultimately lead on the transition, the required speed at which everything needs to happen means that governments have to play a major role in helping to minimize uncertainty and backstop investment risk in a number of sectors, at least until there is sufficient momentum for the clean energy markets to establish themselves.

One important role of the government could be to directly invest or underwrite private investment in shared enabling infrastructure, such as transmission lines, storage capacity, and pipelines to service both carbon capture and clean hydrogen production. This kind of intervention can help connect and ‘crowd-in’ investors on the supply side and demand sides, thereby accelerating the transition.

Hobart: I think the public sector will have to play an important role. As emerging sectors such as carbon capture and sequestration begin to scale, the economic framework for building out new capacity will have to lean heavily on government subsidies and incentives. A good example of how the public sector can help is the tax credit for clean hydrogen that was established in the Inflation Reduction Act. Governments must do something to backstop the economics of these emerging technologies and sectors to make them more attractive and less risky to investors.

Is there still time to change our current practices and meet emissions targets?

Greig: I don’t know whether all or even most countries can reach their announced net-zero target dates. For sure, many well-meaning government and business leaders are stepping up to the task. And there appears to be an abundance of capital looking to invest in so-called Paris-compliant, climate-safe assets. However, this capital is currently not being put to work in a manner consistent with ambitious net-zero goals. There still appears to be a disconnect between net-zero leadership signaling and the real challenge of pushing investable clean energy and industrial assets through the development pipeline and into service at the speed necessary to satisfy their net-zero commitments.

Hobart: I am optimistic but cognizant of the fact that the window of opportunity is quickly closing. Unless we see a material shift in perspective and the parameters under which the private sector approaches clean energy capital deployment in the next few years, I think there will be cause for a far more dire outlook as we approach the end of the decade.

The article, “Speeding up risk capital allocation to deliver net-zero ambitions,” was published on February 2 in Joule. In addition to Greig and Hobart, authors include David Keto (’77) of SRI Group, as well as undergraduate seniors Benjamin Finch and Ryan Winkler of Princeton University.