Transition Finance Is Key To 2024 Climate Investing

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If you’re like so many people in the world, you’re concerned about the climate crisis. If you are also an investor, then you should keep your attention on transition finance.

“Transition finance” is a new term that’s being tossed around to describe industries and infrastructure that promote a net zero economy. You might be saying, it’s another way to discuss “green finance,” but that’s not necessarily so, as green finance looks to climate solutions like wind farms or battery plants.

The term “transition finance” emerged during Conference of the Parties (COP) 28 when 200 nations agreed to move away from fossil fuels in a nonbinding deal to contribute to a global energy transition. Transition finance is fluid — fossil fuel companies create their own strategic plans for transitioning to renewables, and investors with sustainable mandates feel headed in the right direction.

Mark Carney, the United Nations special envoy on climate action and finance, coined the term during a COP28 panel discussion. There’s a “whole world of transition finance being created as we speak,” he described.

Transition Finance is a Bridge to a Sustainable Future

Climate breakdown is a global existential crisis that has resulted from mass dependence on fossil fuel-generated energy consumption. Fossil fuels – coal, oil and gas – are by far the largest contributor to global climate change, accounting for over 75% of global greenhouse gas emissions and nearly 90% of all carbon dioxide emissions. Such traditional energy sources have contributed to more than 80% of total global energy usage.

To transition energy systems is a complex endeavor that is layered with environmental, technical, and economic aspects that combine to ensure a sustainable energy supply. Needless to say, transition finance is an approach that can be unsettling. It introduces the idea that investments can support both renewable energy companies as well as companies that emit high levels of climate pollution as long as they’re on a pathway toward fewer emissions. In this sense, the culprits who caused the problem are soothed as they admit culpability and swear off their evil ways — soon, very soon.

How can investors be confident they’ll decarbonize at the speed and scale envisioned? “If you’re investing in a firm that’s claiming to transition, it’s got to have a really robust plan,” Kate Levick, who leads E3G’s sustainable finance activities, told Bloomberg. “Regulatory expectations are firming up, but it’s a race to get there and also to converge so that we don’t get fragmented regulation gaps.”

Then again, moving towards energy transition is extremely challenging and is associated with 2 main barriers: higher costs of clean energy over fossil fuel-generation and the intermittent and volatile nature of renewable energy.

Transition finance is the result of increasingly complex global geopolitical situations, which are causing severe impacts on energy markets and which are making clear that renewables are the best energy options. For example, the Biden administration has allocated significant funds to support renewable energy infrastructure construction. It regards the promotion of renewable energy expansion as a critical measure to resist external risks and ensure energy security. Renewable energy lowers the negative effects of fossil fuel price uncertainties and geopolitical risk on economic growth and is expected to be the main source of electricity supply in the US by 2050.

Nonetheless, transition finance is a process, and, with the goal to obtain a low- to zero-emissions end result, it requires fossil fuel companies to diversify. In economics and finance, the term “diversification” has traditionally referred to a corporate strategy involving the distribution of financial assets and investments in favor of promising areas of business development that could ensure competitiveness and sustainable growth.

The energy transition to electrify everything necessarily must be a series of deep organizational and technical transformations in the production, transmission, and use of electricity to create a climatologically and environmentally safe power industry. The essence of this approach comes out of the Glasgow Financial Alliance for Net Zero (GFANZ), which has designed an investment strategy that embraces financing of traditional green activities, polluting companies that plan to decarbonize, and even coal plants on their way to decommissioning. “You’ve got to go where the emissions are and try to bring those down,” Curtis Ravenel, a senior adviser to GFANZ, advises.

GFANZ’s voluntary guidance for financial institutions and companies centers on 4 financing strategies to deliver a whole-of-economy transition:

1. Financing the development and scaling of climate solutions;
2. Financing assets or companies already aligned to a 1.5 degrees C pathway;
3. Financing assets or companies committed to transitioning in line with 1.5 degrees C-aligned pathways; and,
4. Financing the accelerated managed phaseout of high-emitting physical assets.

Looking Back to 2023 Investing, Envisioning 2024 Sustainable Strategies

Investing in 2023 turned out to be ​“a tale of two halves,” investor Zach Barasz, who previously worked at Kleiner Perkins’ Green Growth Fund, said in an interview with Canary Media. “The first half was slow in terms of investments and slower in terms of quality opportunities. In the second half of the year, that changed quite quickly, with many more high-quality opportunities. 2024 is going to be a very busy year for new investments.”

More deep-pocketed investors seeking out climate investments will be particularly vital for companies that make it past the early stages in 2024. As Canary Media outlines, there aren’t many climate-oriented venture firms dedicated to late-Series A through C rounds — when startups are looking for something in the range of $15 million to $50 million. Many companies have made progress toward unveiling a climatetech product, yet they don’t hold the substantive revenue that growth equity investors or mainstream venture-capital firms want to see.

Whether a startups or part of the long-established fossil fuel industry, credible transition plans will need to guide financial institutions and their stakeholders as they voluntarily transition their activities and portfolios in line with the goals of the Paris Agreement and domestic policies designed to help achieve them. As transition finance planning becomes a common practice, GFANZ predicts that more capital will flow to those companies that are providing solutions and driving progress. Understanding which companies are leading the way requires quality data and transparency, which GFANZ argues creates the underpinnings of successful markets.