It’s estimated that up to 90% of man-made emissions can be abated with existing climate technologies. However, 45% of these required abatements will need to come from technologies that haven’t yet been developed fully or deployed commercially.
To see these technologies scale in the short timeline we have left until 2050, financial services firms need to embrace the next stage of financing green.
There are challenges associated with this which may leave firms asking; ‘is it a viable investment’? This blog explores this question, and the need for a creative approach to financing the next wave of the climate transition.
Financing green to transition finance
Solutions like solar, wind and hydro are already commercially available and helping to decarbonise high-emitting sectors like built environment, energy and transport. This is thanks to funding from major banks and public equity, which allowed companies to move through the International Energy Agency’s (IEA) technology readiness levels (TRL) to reach the highest two categories (10 and 11).
Categories 10 and 11 are defined by IEA as “Integration needed at scale” and “Proof of stability reached” respectively, and greatly improve a company’s investability.
But these solutions cannot solve the climate crisis alone. Other technologies are needed to fully transition from fossil fuels to green or renewable energy; technologies like hydrogen, carbon capture, electric vehicles (EVs), and nuclear, as well as the infrastructure that supports them.
If we wish to decarbonise our primary services and accelerate net zero progress as a nation, then these technologies need to be financed. However, these technologies are still in transition themselves, which creates challenges when it comes to investment.
The financing gap
The cost-benefit analysis of transition finance for early TRL propositions is difficult to balance.
The risks
According to McKinsey, the “ticket size of major climate technologies in early-stage VC are fix to six times higher” than some other sectors, even before production. At the same time, the “break-even point is not immediately in view” and prices have yet to even be established. There also isn’t much return on remuneration, or it’s equally slow, so there is little appetite for this approach.
This isn’t helped by the fact that organisations in less mature sectors like hydrogen or carbon capture aren’t in a position to demonstrate historical evidence or contracted future revenues. This often rules out funding from big banks or major investment funds. On the other hand, they may have outgrown their series A/B status.
As a result, the companies developing these tools either can’t access funding or, when they can, their risk ratio sends their interest rates skyrocketing, pricing them out.
The benefits
That being said, the financial motivations are equally clear. These industries are expected to grow thanks to both regulation and necessity.
Hydrogen and nuclear will likely become significant enablers of clean energy; heat pumps will be in more homes; EVs adoption is expected to rise as prices become more accessible (cost being a primary barrier) and the used electric car market grows – not to mention that policies making EV infrastructure more accessible. For example, all new cars must, by law, be electric in the UK by 2035.
Plus, the success of more mature green energies is a reliable indicator of what’s to come. If these predictions occur, the cost of not investing on the ground floor could be much more in the long run than that of investing now.
This is not to mention that organisations are already building more sustainable portfolios to meet net zero targets, or simply because it’s the right thing to do.
Nevertheless, although investors know transition technology is a budding opportunity, they may not yet be convinced to take it on themselves due to the financial risks.
Deconstructing the risks
The ‘why’ isn’t the issue – it’s the how. In its current risk state, it’s going to take more than straightforward private investment to fund finance transition. So, what can finance firms do to help accelerate the companies stuck in TRL no-man’s land, and why should they?
McKinsey offers two approaches to this:
- De-risk the business case
There are ways to provide evidence of expected success when a company is too early in TRL to provide expected sales or customer contracts.
For instance, most technologies needed for climate transition are already mature, or proven at scale by other applications, even if the companies themselves are not. Processes are also based on well-founded studies. Finance firms should appreciate that these solutions are not as ‘black box’ as the evidence suggests.
“A circular chemical company combined five different steps where all but one were proved at scale—and the new production step was already being demonstrated at one plant.” McKinsey
Equally, many providers are partnering with their supply chain to share the risk. For example, if they can’t yet prove contracted revenue from customers, can they demonstrate purchase price agreements from the downstream side? Or can they demonstrate a clear strategic plan for partnerships that eliminate demand risk?
“One early-stage green-ammonia project developer negotiated a long-term baseload purchase price allocation from a renewable power source; the agreement included guarantees of origin for each project site.” McKinsey
- Creative financing options
Financial services organisations can also adapt their financing strategies to accommodate companies with the unique circumstances that many transition technologies now represent.
Blended finance: co-financing with public and private entities reduces the risk and private debt for banks by sharing it with larger, more robust quasi-government institutions. For example, UK Infrastructure Bank (UKIB) recently committed to co-finance cutting edge climate spin-out, start-up and scale-up companies alongside Greensphere Capital. Various other UK institutions offer similar funding, such as Scottish National Investment Bank (SNIB) whose strategy focuses on climate finance.
Transition financing arms: Santander is providing earmarked funds for climate and transition technology deals, such as with its Alternative Investments scheme or through Santander Asset Management. This means they can adapt their risk-reward calculation so that TRL needn’t impact an organisation’s viability for investment.
Debt and project financing: corporate debt and project financing are already established in more developed climate tech sectors, like solar and wind, but are being introduced to lower readiness level markets. Plus, funders other than the traditional ‘big bank’ are getting involved, such as asset managers or growth-lending facilities.
“While renewable energy still constitutes the largest share of transition project financing, project financing for other climate technologies—such as battery production, EV manufacturing plants, and hydrogen plants—has seen growth rates around 15 to 30 percent over the past years and now constitutes about 25 percent of total project financing volume.” – McKinsey
Finance firms are key to scaling climate transition
There are many ways firms can lower the risks involved in transition financing and build viability into the market, but mostly, they need to be bold and have patience. There’s no doubt that transition technologies will not show overnight return.
Nevertheless, if financial services firms can find a way to reduce their investment risks today, then they will be on the ground floor of a societally and legislatively essential, and fast-growing, industry. One that is certain to be a positive and impactful long-term investment.
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