Investment in the energy transition is rising rapidly. The annual flow of investment funds into clean energy is now 70 percent larger than the flow into fossil fuels. The capital going into certain sectors, like the roll-out of renewable energy, is encouraging, and so are the capital flows into certain technology-driven, asset-light businesses that are aligned with the goals of a clean economy. However, the flows of capital are still not large enough overall, nor are they going everywhere they need to go.
Figure 47: Clean vs dirty
The gains since 2019 are certainly encouraging. And yet — this will be a familiar refrain by now — they are not enough. The International Energy Agency calculates that by 2030, clean-tech investment will need to approach USD 5 trillion a year if the most ambitious goals of the Paris climate agreement are to be met. This means the annual sums invested in clean-tech need to rise much faster than they are doing.
Figure 48: Historical and required investments
Source: IEA, Generation analysis
A major part of the problem is that the energy transition is still largely confined to a handful of markets: the United States, the European Union and China, primarily, with a notable role for solar power in India, Australia and a handful of other countries. The transition must broaden to encompass the entire world. In the next section, we will discuss the problem of developing countries and the risk that many of them will be left behind as the clean economy takes off.
Given the urgency of the situation, the pipeline of investment funds flowing into the transition is still too constrained. Unfortunately, a new political development in the United States is compounding the challenge. For years, investors had increasingly been embracing a money-management approach that promised to take environmental, social and corporate-governance factors — so-called ESG factors — into careful account. But state and federal politicians are now attacking this movement, and in some cases have passed laws ordering pension funds under their control not to invest in ESG funds. We believe the ESG trend certainly warranted some criticism: people were using conflicting definitions of the concept, the terminology was often confusing, there was an over-reliance on checklists and the field has been plagued by a lack of rigour and accountability. But these valid criticisms do not mean that sustainable investing and the ESG approach are failed concepts. Instead the criticism, where valid, will help to ensure that sustainable investing and ESG concepts are carefully defined, clearly understood and effectively practised.
The American political attacks, motivated by far-right ideology, have gone beyond any reasonable criticism. Climate change is having, and will continue to have, devastating effects on people and nature. Investors who do not consider the physical realities with which we are living are putting their clients’ capital at risk and failing to fulfil their fiduciary duties. You only have to look at the recent fires in Canada and California, and their implications for insurers as far away as Zurich, to realise that the climate crisis has large consequences for business, and those will continue to grow.
The ESG backlash has not been the only setback of recent years. Generation has long been concerned about subsidies for fossil fuels, a category of government spending so perverse that we refer to it as anti-climate finance. The Organization for Economic Cooperation and Development, the club made up of 38 rich countries, has been pushing since 2009 to reduce these subsidies. And for several years they did fall, but the energy crisis that followed the Ukraine war has seen a dramatic reversal. Western governments, in particular, opened the floodgates and spent immense sums to shield their consumers from higher energy bills. Remarkably, direct energy subsidies have nearly tripled in two years, as the chart below demonstrates.
The political impulse that led to this sudden jump was certainly understandable, given the public outcry that followed a tripling or quadrupling of household energy bills in some European countries. The smarter way to have done it would have been to concentrate the subsidies on households too poor to bear the increased costs, while exposing those who could afford to pay to the real market realities of fossil fuels, encouraging conservation, home retrofits and smaller cars. But this would have required considerable political courage and it is not what happened. Now governments have a lot of work to do to peel back these subsidies and get back to where they were only a few years ago.
Figure 49: Global fossil-fuel subsidies
Perhaps the most worrisome aspect of the investment situation is that the flow of funds into clean alternatives remains constricted for entire sectors of the economy. The industrial sector, the buildings sector and the land sector must undergo transformations in the coming decades that are just as dramatic as those already taking hold in power and transportation. But we are not seeing capital flows remotely commensurate with the scale of the task.
We will not attain a sustainable economy unless the stewards of capital consciously allocate the funds to help create it. If the investment industry is to deliver against its climate commitments, it will need to seriously reconsider how and where capital and engagement efforts are needed. Investors should adopt a new framework for capital allocation that expands what capital markets value. A good example is an approach that we call climate-led investing.
The idea is to identify climate solutions with the highest potential impact, defined as avoidance or removal of greenhouse emissions at scale, in a way that is timely, as well as consistent with a just economic transition and a sustainable end state. Climate-led investing then seeks to allocate capital to climate solutions that can both address these emissions while also generating attractive risk-adjusted financial returns for investors.
These will be difficult goals to meet. Governments have yet to pass the necessary laws, adopt the right rules or establish the right conditions for the clean economy to flourish. They are still too much under the influence of fossil-fuel interests, it is true, but the sheer power of human inertia may be just as important. One of the roles investors must play is to help governmental leaders see that change can no longer wait.