Access to energy finance can improve international equity for the green transition

Policies helping the cost of capital of the energy sector converge internationally can play a significant role in greening the electricity generation, lowering the cost of mitigation, and improving equity in developing countries. That is the key takeaway of a Nature Energy publication by a team of researchers from several European universities, including Spinoza-prize laureate and environmental modeler Detlef van Vuuren and economist Friedemann Polzin of Utrecht University. This topic is critical in terms of policy relevance, financial fairness and energy justice. Energy is fundamental for sustainable social and economic development. How can we make renewable energy that is sometimes available abundantly, more widely accessible, particularly to low-income populations?

If African countries would ‘energize’ like the Western economies and many emerging economies did in the past, we will not be able to stay below 1.5 degrees global warming, says Friedemann Polzin.

As highlighted in the Intergovernmental Panel on Climate Change (IPCC) Sixth Assessment Report, finance is one of the critical enablers for accelerating climate action. However, access to finance is fundamentally unequal across countries and, as a result, it can be a barrier to mitigation and adaptation investment. Developing countries and renewable energy sources (RES) in particular face high investment risks that are reflected in a high cost of capital (CoC) for projects. Managing such costs is thus a key challenge in mobilizing (private) funding for the energy transition in the developing world.

Ensuring access to capital through low-cost finance and financial de-risking

This is a critical topic in terms of policy relevance, financial fairness and energy justice. Indeed, a key issue raised by the clean energy transition is how to make renewable energy more widely accessible, particularly to low-income populations, as energy is fundamental for social and economic development. Therefore, suitable public support is required, which can be achieved by ensuring access to capital through low-cost finance and financial de-risking. This problem is particularly acute, given the recent global rise in interest rates, which is putting developing countries’ finances under pressure, and the high capital intensity of clean energy technologies. Despite their evident relevance, the CoC and appropriate de-risking policies are currently not well represented in the models generating the scenarios reviewed by the IPCC. In their paper, the research team shows that they are a key tool for ensuring a just climate transition.

Climate finance gap

Friedemann Polzin: In the COP29 conference in Baku, negotiators agreed that by 2035 at least 300 USDbn from the ‘Global North’ will flow as public investments into developing countries. But to reach the reasonable demands from these countries of at least 1.3 USDtn annually, and therefore close the ‘climate finance gap’, more finance needs to be mobilized from all sources, including the private sector. De-risking those investments as we did in our simulations would result in a much cheaper and faster energy transition in countries with high costs of capital, especially in the absence of more stringent climate policies.

Reconsidering investment ‘risks’

Climate stabilization requires the mobilization of substantial investments in low- and zero-carbon technologies, especially in emerging and developing economies. However, access to stable and affordable finance varies dramatically across countries. Models used to evaluate the energy transition do not differentiate regional financing costs and therefore cannot study risk-sharing mechanisms for renewable electricity generation.

When the CoC of developing countries converges to that of developed countries, demand for renewable energy would increase by 10%.

In this study, the researchers incorporated the empirically estimated cost of capital differentiated by country and technology into an ensemble of five climate–energy–economy models. They quantified the additional financing cost of decarbonization borne by developing regions and explored policies of risk premium convergence across countries. Results indicate when the CoC of developing countries converges to that of developed countries, demand for renewable energy would increase by 10%. A reduction in CoC could also partly mitigate the climate finance gap, namely the difference between finance needed to achieve 1.5-degree pathway and the current pledges.

Conclusion? Alleviating financial constraints benefits both climate and equity as a result of more renewable and affordable energy in the developing world. This highlights the importance of fair finance for energy availability, affordability and sustainability, as well as the need to include financial considerations in model-based assessments.

Research team

The research team included 17 researchers from Germany, Greece, the Netherlands (PBL Netherlands Environmental Assessment Agency, Utrecht University and University of Maastricht), Italy, Switzerland, the USA and the United Kingdom.

More information

Read the paper ‘Reducing the cost of capital to finance the energy transition in developing countries’ by Calcaterra et al. (2024) in Nature Energy (Open access):

Or contact Friedemann Polzin: f.h.j.polzin@uu.nl