The Paris Agreement has the ambitious target of limiting temperatures to well below 2℃ above pre-industrial levels, through achieving net-zero emissions across the world by 2050. Huge capital investments are needed for the complex transition to sustainable energy technologies, which must be global in scale and not limited to rich, developed countries.
A detailed analysis by KAPSARC researchers has shown that nearly all countries need to accelerate their efforts in meeting sustainable investment goals in the energy sector. Most worryingly, the biggest investment gaps are seen in developing countries.
Totalling up the challenge
Recent estimates suggest a total decarbonization investment of between $103 trillion and $243 trillion is required for all countries to reach net zero by 2050. This would take an annual investment of $4 to $8 trillion worldwide, yet the highest annual investment to date was just $1.7 trillion in 2023.
“The global investment gap has been at the forefront of global climate discussions,” says Fatih Yilmaz, an economics researcher at KAPSARC. “What is less clear is the breakdown of this gap in major countries and regions, and how well the current distribution of global sustainable investment flows align with these gaps.”
“There will always be disagreement on each country’s ‘fair share’ of global mitigation or climate finance – be it on the providing or the receiving end. However, effective policymaking requires data.”
Mari Luomi
For this project, Yilmaz worked with a diverse team including economics researchers Fateh Belaid and Salaheddine Soummane, climate policy expert Mari Luomi, and two fellow researchers with expertise in climate and energy modelling: Mohamad Hejazi and Fahad Alswaina.
The multidisciplinary nature of the study was key. “This was the most diverse group of researchers I have ever worked with on one paper,” says Yilmaz. “It was absolutely crucial for this type of work given the diverse requirements of the analysis, which could simply not be done by economists alone.”
Taking stock
“There will always be disagreement on each country’s ‘fair share’ of global mitigation or climate finance, be it on the providing or the receiving end. However, effective policymaking requires data,” says Luomi. “Our study aims to estimate what levels of climate finance different countries might need if we are to stay within the temperature targets of the Paris Agreement. We then compared this to current levels of climate finance, and provided more in-depth details regarding the investment gap.”
One key part of the Paris Agreement is the Global Stocktake (GST), which provides a mechanism to ensure countries do not lose track of the wider Agreement goals and the time-sensitive nature of the climate emergency.
“Countries must submit their national climate change plans to the GST every five years, and this is followed by a global-level exercise to see how everything adds up and compares to the Paris Agreement targets,” says Luomi. “The GST includes data on human-made greenhouse gas emissions, countries’ resilience to climate impacts, and the support provided to developing countries to reduce their emissions and adapt to climate change.”
Models for change
To contribute to the first GST for COP28 in Dubai in 2023, the KAPSARC team analyzed investment gaps across different countries and regions around the world. They used the global change analysis model (GCAM), which is widely used in assessments of climate and economics.
GCAM simulates the interactions of multiple factors including energy, agriculture, climate, water and land use, providing projections up to the year 2100. Crucially, it includes a detailed model of energy and technology with representations of supply and demand, which enabled the KAPSARC team to focus on changes in the power sector.
The model assumes each power plant either runs until the end of its lifetime or is retired if its operating costs exceed the electricity market price. This builds a picture of future installations, which depends on policy choices. The team chose four scenarios, ranging from a world with no climate policies to one with greatly increased ambitions to meet the Paris Agreement goals.
Identifying the gaps
The team’s analysis demonstrates that current levels of investment from all countries are substantially below the requirements needed to meet the Paris Agreement targets. Even more critically, annual investments in developing countries are considerably lower than in developed countries. Investment in clean energy and carbon management technologies in the Global South will need to grow to four to fourteen times the existing levels in order to achieve decarbonization in the power sector alone.
Sub-Saharan Africa has the highest investment gap: its investment needs must reach almost 15 times current levels to meet decarbonization targets. The Middle East/North Africa region exhibits the second-largest gap requiring almost 11 times current investment, followed closely by India. China stands out as a leader, spending $116 billion of the $138.4 billion required annually to transition to net zero.
Quoting positive developments in other developing countries, Yilmaz notes that Brazil and South Africa are regional leaders in accessing sustainable private finance and achieving decarbonization investments. “Among lower-middle-income countries, Laos shows an interesting case with significantly improved access to sustainable investment in recent years,” he adds.
Sustainable finance
The distribution of sustainable finance, a form of private finance dedicated to energy transition investments, will play a pivotal role in realizing the Paris Agreement goals. These packages should, in theory, be available to all countries, with priority given to developing nations. However, the reality remains far removed from these aims, with developed countries securing considerably more sustainable finance than the Global South.
Countries with more developed financial systems have a comparative advantage in adopting these emerging norms and are therefore better positioned to attract sustainable funding for their decarbonization projects.”
Fateh Yilmaz
“Sustainable finance includes demanding requirements in terms of continuous measurement, verification, and periodical reporting,” says Yilmaz. “To serve these requirements, the host country must have strong institutional capacity and a robust legal infrastructure, helping to provide a certain level of ‘financial development’. We use the International Monetary Fund’s financial development index, which accounts for the access, depth, and efficiency of financial institutions and markets.”
Countries with more developed financial systems have a comparative advantage in adopting these emerging norms and are therefore better positioned to attract sustainable funding for their decarbonization projects, notes Yilmaz.
Funding the future
The researchers offer a number of policy recommendations, such as expanding the environmental, social and governance (ESG) frameworks in developing countries. ESG, which is often referred to as responsible investing or impact investing, would require improving finance infrastructure in markets, building capacity, and transferring knowledge.
“Increasing direct financing from the developed world to the developing countries by delivering on the $100 billion pledge (under the UNFCCC framework) would provide a significant push,” says Yilmaz. “Such funds can deliver important financial resources for the least developed countries in the form of grants, while mobilizing more concessional or low-cost private funds for other developing countries.”
Hejazi is quick to note that the team’s analysis only looks at power sector decarbonization, which has been the main focus of the global energy transition so far. “Considering other sectors, like industry and transport, these investment gaps are likely to be much larger than the power sector estimates,” he says.
The KAPSARC team is expanding its research and is now pursuing a more systematic study to identify the key factors affecting countries’ access to private sustainable funds.
“These factors include financial development, various climate and macroeconomic risks, climate policy action, and the presence, or lack of, investment incentives,” says Yilmaz. “We are trying to provide a ranking for the relevance and magnitude of these factors, which could be used by policymakers to prioritize their policy focus.”
Reference
Yilmaz, F.; Alswaina, F.; Belaid, F.; Hejazi, M.; Luomi, M.; & Soummane, S. Closing the investment gap to achieve Paris Agreement goals. KAPSARC (October 2023)│ Article
