Higher cost of finance exacerbates a climate investment trap in developing economies
Non-technical summary: Higher cost of finance exacerbates a climate investment trap in developing economies
6 July 2021
- Title: Higher cost of finance exacerbates a climate investment trap in developing economies
- Publication/funder: This research was made possible by support from two European Union’s Horizon 2020 projects, namely the COP21 RIPPLES (Grant Agreement No 730427) and GREEN-WIN (Grant Agreement No 642018); and the EPSRC as a Standard Research Studentship (Grant number: EP/M507970/1). H.C. acknowledges the support of the Chair Energy and Prosperity, under the aegis of the Risk Foundation.
- Date accepted: 30/06/2021
- Authors: Dr Julia Tomei UCL ISR; Nadia Ameli UCL ISR, Olivier Dessens UCL ISR/EI, Matthew Winning UCL ISR/EI, Jennifer Cronin UCL EI, Hugues Chenet UCL ISR, Paul Drummond UCL ISR, Alvaro Calzadilla UCL ISR, Gabrial Anandarajah UCL EI &Michael Grubb UCL ISR.
Access to finance (credit) is vital for the green energy transition needed to reduce global greenhouse gas emissions, as laid out in the Paris Agreement. But access to low-cost finance is uneven, with the cost of securing capital to help reach net zero differing substantially between regions. This study shows the road to decarbonisation for developing economies is disproportionately impacted by differences in the weighted average cost of capital (WACC). This is a financial ratio used to calculate how much a company or organisation pays to finance its operations, whether through debt, equity or both. The lower the value, the easier the company or government can access funds. In the case of Africa, and a scenario where global warming this century is kept at 2°C, we calculated that current unfavourable WACC values will stunt the region’s green electricity production by 35%. We also make the case for policy interventions to lower WACC values for low-carbon technologies by 2050. This would allow Africa to reach net-zero emissions approximately 10 years earlier than if reductions in the cost of capital are not considered. We also describe the ‘climate investment trap’ that developing economies are faced with when climate-related investments remain chronically insufficient. These regions of the world already pay a high cost of finance for low-carbon investments, delaying the energy system transition and the reduction of emissions. Yet, unchecked climate change would lead to greater impacts in these regions, raising the cost of capital and discouraging investment even further. The trap is so binding in itself that poorer countries will struggle to escape it – especially in the aftermath of COVID-19 and its impact on their economies. Radical changes are needed such as helping to underwrite the perceived greater risks of low carbon investments in such regions. So that capital is more equitably distributed and all regions, not just those in the global north, can afford to work towards net zero at the rate needed to tackle climate change for the benefit of everyone. International organisations such as the IMF, investors and policymakers can all take responsibility for lowering the costs of capital in Africa.