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The low carbon transition is bound to be a watershed for financial institutions

The low carbon transition is bound to be a watershed for financial institutions

14-12-2021 | Stunning statistics

The private sector lending needed for the energy transition could reach USD 2 trillion annually over the 2021-2030 period.

  • Patrick  Lemmens
    Patrick
    Lemmens
    Portfolio Manager
  • Koos  Burema
    Koos
    Burema
    Portfolio Manager
  • Michiel  van Voorst
    Michiel
    van Voorst
    Fund Manager Equities

Speed read

  • Public and private entities must cooperate to achieve the energy transition
  • Climate risk represents a challenge for banks and other lenders to the private sector
  • But it could also present a tremendous business opportunity

What has happened?

Recent estimates1 by the International Renewable Energy Agency (IRENA) suggest that in its ‘1.5°C Scenario’,2 total global funding requirements for the energy transition could reach USD 5.7 trillion per year, over the 2021-2030 period, of which close to USD 2 trillion would come from private lenders (see Figure 1).

Figure 1: Total average yearly investment by source and type of financing (2019, 2021-2030 and 2031-2050)

Source: IRENA, June 2021, “World Energy Transitions Outlook: 1.5°C Pathway” report. In USD billion.

Beyond 2030, funding needs could reach USD 3.7 trillion per year between 2031 and 2050, of which more than USD 1 trillion would come from private lenders. These figures highlight the vast financing opportunity the green energy transition represents for the banking sector, especially over the coming decade.

Even in its less optimistic ‘Planned Energy Scenario’, which is based on governments’ current energy plans and other planned targets and policies, IRENA estimates still reach USD 3.5 trillion per year between 2021 and 2030, of which over USD 740 billion is expected to come from private lenders.

Why is it important?

Achieving net zero emissions and mitigating climate risk require colossal funding, both from public and private lenders and investors. Estimates of how much the net zero ambition will cost range from around USD 100 to 150 trillion, over the next three decades. IRENA’s recent projections fall within this range, with an expected USD 131 billion in funding needs between 2021 and 2050.

In this context, commercial banks and other financial institutions of the private sector can play a fundamental role in supporting this transition. They can have an impact both through their own actions to reduce greenhouse gas emissions and their lending practices. Funding the renewables revolution is one way, helping incumbent fossil fuel-dependent utility companies to restructure is another.

Many banks across the world have already taken steps towards aligning their lending and investment portfolios with net zero emissions by 2050. For instance, the Net-Zero Banking Alliance – an industry-led, UN-convened organization launched in April 2021 – brings together 95 banks from 39 countries, representing USD 66 trillion in assets, or over 43% of all global banking assets.

What does it mean for investors?

The transition towards a low carbon economy clearly represents a serious challenge for commercial banks and other lenders to the private sector, as well as their shareholders. For some banks with considerable loan book exposure to carbon-intensive industries such as oil & gas, transportation or manufacturing, the transition will likely be painful.

But the transition could also present a tremendous business opportunity. Monitoring these risks and opportunities as they unfold has become a key focus for our New World Financials equity investment strategy, in particular through our ESG integration process and active engagements. The climate transition of financial institutions is our latest engagement theme.

1 IRENA, June 2021, “World Energy Transitions Outlook: 1.5°C Pathway” report.
2 IRENA’s ‘1.5°C Scenario’ describes an energy transition pathway aligned with the 1.5°C climate ambition of the 2015 Paris Agreement on climate change. The aim is to limit the global average temperature increase by the end of the current century to 1.5° Celsius, relative to pre-industrial levels.

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