De-risking climate investments in energy transition

By Reg Fowler and Michael Putra

The world has sufficient capital and liquidity to be invested in climate change mitigation, but the money is simply not flowing where it is needed at scale and at pace. This was one of the key messages from the most recent report by the Intergovernmental Panel on Climate Change (IPCC), released on April 04 – along with mounting scientific evidence on the urgency to act.

The IPCC also emphasized that “limiting global warming will require major transitions in the energy sector”.

The problem of attracting sufficient investment for energy transition, however, is enormously complex. The global energy system comprises the largest and most expensive infrastructure built over centuries of investments across the chain, and we now only have a very short window to transform it. For this endeavor to succeed, investments in energy transition need to be significantly de-risked.

Climate change and energy transition bear all the hallmarks of a “wicked problem” where there is no silver bullet. Instead, wicked problems require a systemic change. With limited resources (and time), an important step toward such change is by establishing clear priorities. A way of prioritization in the efforts toward galvanizing investments for climate change mitigation is to identify which are the “carbon-critical countries” where climate-related investments need to be stepped up fast.

There are four important categories that could constitute a country to be critical to the global climate change mitigation efforts.

First, countries that are currently the top greenhouse gas (GHG) emitters. A percentage reduction in GHG emissions in these countries will bring far greater absolute reduction globally.

Second, countries that will account for the majority of the global population in 2030. Large emerging countries such as Nigeria, Pakistan, Brazil, Bangladesh and Ethiopia are projected to be home to more or less 50-250 million people each by 2030. A combination of population and the aspired economic growth in these countries means investment decisions made today will define their economies’ carbon intensity of the future, and thus define the trajectory of global energy transition.

Third, countries that hold significant resources of climate-critical minerals needed in the supply chain of cleaner energy systems. Investments in cleaner energy systems must be looked at holistically throughout the chain that enables them. Solar panels, wind turbines, batteries and electricity grids require more than just hard cash, good policies and engineers – they need critical minerals.

The International Energy Agency puts in its report, The Role of Critical Minerals in Clean Energy Transitions, that there are only a few dominant countries in the supply chain of copper, lithium, nickel, cobalt and rare earths.

Mining projects have significant lead times and a lack of capital investment in this sector means the supply crunch is intensifying.

Fourth, countries that hold significant opportunities for nature-based solutions. Although this is not directly related to the energy sector, it remains an important part of the suite of solutions that complement the ongoing efforts in the energy sector. These investments also need to be de-risked and protected.

When we look at the list of countries along these categories, there are about 30 countries. However, nine countries appear at least in two categories or more: China, India, Indonesia, Brazil, the United States, the Democratic Republic of Congo, Mexico, Canada and Japan.

Notwithstanding the different developmental stage of these countries, focusing efforts on de-risking climate-related investments in a list of nine (high-impact) countries seem to be a more manageable, albeit not easy, proposition compared with covering dozens of jurisdictions.

Investments naturally flow to places where risks and rewards are competitive compared with other potential destinations.

To achieve the United Nations Framework Convention on Climate Change (UNFCCC) goals though, climate-related investments need to be encouraged to flow much more to countries presenting higher investment risk because of a lack of basic governance qualities, policy consistency, supply chain certainty and labor market, etc.

On the reward part of the equation, a clear signal coming from a carbon price is a very important indicator – making Indonesia’s incoming carbon tax a step in the right direction. 

The risks and rewards of these investments rely heavily on stability in government policy in the respective country. This is especially the case with the regulation of carbon markets and carbon pricing. In the meantime, energy transition investments involve long-term, often low-margin infrastructure projects (renewable energy, grid upgrading, mining of climate-critical minerals), which depend upon stable demand and stable pricing.

Thus, a mechanism to facilitate private investment in carbon-critical countries needs to be found urgently, minimizing as far as possible the policy risks carried by the investor i.e. the risk that a host government will change its policies on which the value of the investment relies.

Fortunately, such a mechanism exists – kind of. Investment treaties are well-known tools to provide investment protection, and there are over 3,000 of them in effect today. However, apart from the Energy Charter Treaty, no existing investment treaty has yet been formulated exclusively for a particular type or scope of investment. Climate change justifies such an approach.

A novel “climate change investment treaty” could provide protection for investments that are recognized to contribute to climate change mitigation, primarily to the energy transition. It would grant investors the right to bring legal proceedings against a state that diverges from its UNFCCC Nationally Determined Commitments (NDCs), and materially damages the investment as a result. But protection under the treaty would be limited to investors who could demonstrate their investment contributed materially to delivering on those NDCs.

The state would be expected to publish a detailed time-bound plan for the implementation of its NDCs for the international community to scrutinize and for the investment finance market to treat as “an invitation to contract” across the country’s entire NDC activity. The terms of protection under the treaty would reflect a fair deal between state and investor; the state would carry responsibility for the consequences of any “backsliding” in its NDC commitments and the investor would take responsibility for failure to deliver on its commercial and technical promises to the state.

Most of the carbon-critical countries are members of the Group of 20 ( G20 ) advanced economies and the rest are hosts to investments coming from G20 countries.

As it holds the G20 presidency and is itself a carbon-critical country, Indonesia has an opportunity to display diplomatic excellence in the energy transition space by offering concrete solutions, such as a climate change investment treaty, that could unlock the flow of energy transition investments to where they are needed most.

 ***

Reg Fowler is senior energy lawyer and consultant in London and Michael Putra is a PhD candidate at Rotterdam School of Management, Erasmus University. These views are their own.

This article was published in thejakartapost.com on April 8, 2022 with the title “De-risking climate investments in energy transition”. Click to read: https://www.thejakartapost.com/paper/2022/04/07/de-risking-climate-investments-in-energy-transition.html.

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  • Byline

    Michael is a professional leader in the fields of energy investments, complex commercial deals, and sustainability with extensive international experience. His personal interests span from socio-political issues, history, and culture.

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