BiGS Actionable Intelligence:
BOSTON — Financing capital-intensive climate-related initiatives necessary to lowering emissions by 2050 will cost trillions of dollars, highlighting the need for innovative financing solutions, Peter Tufano, a professor at Harvard Business School, said, citing recent estimates.
In response, Tufano and colleagues are working on a “whole-system” approach to finance, which combines public and private organizations, along with risk and return engineering, to provide efficient and effective financial solutions to climate change.
“We have to direct more private and public money to generate a huge climate ‘dividend,’ some in the form of social benefits and some in the form of private benefits,” Tufano told an audience during Harvard Climate Action Week in June. Tufano moderated a panel with finance leaders from BlackRock, ArcelorMittal, and the International Finance Corporation (IFC).
Climate finance more than tripled globally during the last decade, from about $364 billion in 2012 to almost $1.3 trillion in 2022, according to data from the nonprofit Climate Policy Institute. Much of that growth took place in the last four years.
Yet the global economy still needs about $275 trillion in cumulative spending between 2021 and 2050 to meet emission goals, according to data from McKinsey & Co. That’s an average of about 7.5% of global GDP each year.
What that means is that, while nearly $1.3 trillion was spent in 2022 to finance climate-related projects worldwide, global economies need to spend a great deal more each year moving forward. And no single sector can handle it alone.
Decarbonizing economies globally, Tufano said, requires developing new strategies, including more public-private financing partnerships and capital structures that facilitate whole-system financing between government and private firms.
“We're going to have to transform both risks and returns so that both private and public parties can find ways to work together,” Tufano said.
The keys to ‘whole system’ financing
In addition to Tufano, the panel included Anmay Dittman, a managing director at BlackRock, the world’s largest asset manager; Lana Graf, global lead for artificial intelligence (AI) and deep tech venture capital at IFC, a member of the World Bank Group that focuses on the private sector in emerging markets; and Irina Gorbounova, vice president or mergers and acquisitions and head of the XCarb Innovation Fund at steel company ArcelorMittal.
The experts discussed how the “capital stack” will become more sophisticated as climate change continues and financing decarbonization projects becomes more costly. Some companies are themselves taking a diversified approach.
ArcelorMittal, for example, has been decarbonizing its steel by using hydrogen and other sources that emit less carbon, but has also acquired four recycling centers that cost roughly $1 billion. In addition, the company’s venture fund has spent almost $300 million in community allocated funding.
“We launched three years ago with the intention to invest roughly $100 million a year, then on top of that, of course, you’ve got projects,” Gorbounova told the audience. “We are also developing our own renewable energy.”
BlackRock’s assets under management include both pure-play climate funds, which total about $11 billion, and some diversified funds that also invest in climate work, Dittman said. Blended finance (combining both public and private investors) can work, she said, if investors with varying objectives all believe their goals are being met.
“At the end of the day, if you want the blending to work, you really need to understand exactly what each mission set is for the investors,” she said.
Spreading risk exposure
Investors must also trust that asset managers are mitigating the amount of risk properly, Dittman said.
“To really resonate in the private markets, you need to understand what they're looking for and then you need to earn the trust that you're managing their capital in a way that is risk-aware and that is delivering on their goals,” Dittman told the audience.
Blended financing often involves different parties taking on different pieces of a project and diverse financing instruments, because each party’s individual risk preferences can differ. Deals in blended finance often involve parties that are unwilling to hold certain kinds of instruments or types of risk, she noted.
The result is that gaps remain in financing decarbonization projects. Some investors have smaller funds and lack the capital to work with larger, more complex projects. But investors with deeper pockets want less risk and sometimes avoid financing almost mature, but not fully mature, technologies. Fully mature technologies often do not fit some of the funds’ investment criteria because of the potential for lower returns.
“Every investment we make is not just a passive investment so that we invest and see if it's going to work out,” said Gorbounova at XCarb Innovation Fund, which debuted in March 2021. “It's always a strategic lens. We are looking to decarbonize and still make the value chain regardless of the technology pathway we take.”
ArcelorMittal’s strategy is different, Gorbounova said, because the company’s needs are energy-intensive, requiring a lot of clean energy to produce decarbonized steel. This led XCarb Innovation Fund to invest $25 million in nuclear power company TerraPower, which was founded by billionaire investor Bill Gates in 2008.
Investing in long-term storage is also vital when companies are using renewable energy. The XCarb Innovation Fund, for instance, made an investment in Form Energy — led by CEO and former Tesla executive Mateo Jaramillo — in 2022, which provides multi-day energy storage capacity, and the fund signed a joint development agreement with Form. The fund will provide direct reduced iron (DRI) for Form Energy’s battery technology, which is now undergoing large-scale production trials, she said.
Providing the capital to fund these decarbonization projects is not the only solution, Gorbounova said. “What I'm trying to say is that it's not just pure financing, it's really this package of the equity investment coupled up with a strategic agreement that hopefully will get them to bridge some of this gap,” she said.
Some traditional lenders are willing to fund solar and other renewable technologies, but she said interest in mature technologies is not universal. “We see some of the mega shops like BlackRock, Brookfield, and Temasek raising the funds, so I see movement in the space,” she said. “But it's still insufficient to fully bridge this gap.”
Some organizations are watching to see how traditional lenders operate. IFC, for example, seeks to lower risk by examining whether organizations like BlackRock invest in a project, according to Graf.
“That would be almost a mutual mandate in the risk appetite, so it means that we would be quite comfortable there,” she said.
Finding projects that could be replicated in other countries is also important to IFC. “We're trying to understand if the markets might be repeatable and that's fascinating,” Graf said. “When you can develop one solution for a country and then repeat it — fantastic.”