Hideki Takada and Rob Youngman, OECD Environment Directorate
We know decarbonisation will require a massive shift of investment away from fossil fuel and into such areas as renewable energy, energy efficiency in buildings and industry, electric vehicles and public transport. A key challenge for policy makers is to understand how to make best use of available policy levers to help accelerate this shift towards low-carbon investment. This includes facilitating the financing of low-carbon investment, including financing through equity investment or – on the debt side – through bank loans and bonds.
Green bonds have gained considerable prominence in recent years as one way to finance the transition to a low-carbon economy. These bonds are an instrument which is used to finance green projects that deliver environmental benefits. The green bond market is still young – it got started only ten years ago – but has experienced rapid growth. With growing market appetite for such bonds, annual issuance rose from just USD 3 billion in 2011 to USD 95 billion in 2016. Many initial green bond issuances were made by public finance institutions such as the European Investment Bank and the World Bank.
Green bonds have become increasingly popular amongst banks, corporates, and national and local governments to finance green projects. In 2016 Apple issued a USD 1.5 billion green bond backing renewable energy for data centres, energy efficiency and green materials, becoming the first technology company to issue a green bond. Other landmark issuances in 2016 included Poland’s sovereign issuance – making it the first country to issue green bonds to fund projects that address climate change. Last year also saw the first municipal green bond issuance in Latin America (Mexico City), which raised USD 50 million to pay for energy-efficient lighting, transit upgrades and water infrastructure. This year, in January, the French government announced the largest sovereign green bond issuance to date – EUR 7 billion – to fund the energy transition.
Why do green bonds trigger such interest?
Bond finance is a natural fit for low-carbon investments such as renewable energy infrastructure, which is characterised by high up-front capital costs and long-dated income streams. They also can offer several benefits to both bond issuers and investors. For example, by issuing green bonds, bond issuers diversify and expand their funding sources by attracting investors who would not normally purchase their bonds. “Over-subscription” of green bonds – i.e. cases where demand exceeds the amount of bonds being issued – can also provide benefits. For example, excess demand for the French sovereign green bond issuance (EUR 23 billion versus the EUR 7 billion actually issued) allowed the government to raise several times more capital than initially targeted. Issuers can also gain reputational benefits by highlighting their green activities. At the same time, green bonds can help investors satisfy ESG (environment, social and governance) objectives while also securing risk adjusted returns.
The new OECD report Mobilising Bond Markets for a Low-Carbon Transition, published today, takes a closer look at the importance of green bonds and policy actions to promote further growth of this market. The report also provides a unique quantitative framework for analysing potential bond market evolution and the contribution it can make to financing key low-carbon sectors: renewable energy, energy efficiency and low-emission vehicles. The analysis provides a projection of the four major markets (China, the European Union, Japan and the United States) between 2015 and 2035 under a two degree scenario identified by the International Energy Agency. The results of the analysis suggest that by 2035 green bonds have the potential to scale to USD 4.7-5.6 trillion in outstanding securities and USD 620-720 billion in annual issuance for these key three sectors in the four markets.
While these figures may seem large on an absolute basis, they are small (approximately 4%) relative to the scale of debt securities markets in general – in 2014 USD 19 trillion of bonds were issued in the four markets and USD 97 trillion of outstanding debt securities were held globally. In these deep pools of capital, there is plenty of room for the green bond market to grow.
The OECD report finds that bond markets have the potential to play a significant role in the transition to a low-carbon economy. Nevertheless, as the green bond market evolves, it faces a range of challenges and barriers. Greater transparency may be needed to avoid confusion, inefficiency and the risk of “greenwashing” where bonds are sold as “green bonds” but projects financed by those bonds do not deliver expected green benefits. Policy makers are faced with the challenge of developing green guidelines and standards and, in particular, defining international rules without imposing overly stringent requirements that could raise issuance costs. Striking a balance between securing market confidence and reducing green transaction costs will be critical and the right set of policies will be crucial. In addition, while the green bond market can facilitate the financing of projects, it cannot itself create a pipeline of bankable projects. Governments will need to set ambitious policies to ensure low-carbon investment needs are met. Ultimately, credible and consistent energy and climate policy and attractiveness of low-carbon projects will be the drivers of investment.
For a closer look at the potential contribution of the green bond market to the low-carbon transition and policy options see: Mobilising Bond Markets for a Low-Carbon Transition just released today.
Join us on 28 April at 13:30 CEST to discuss Green Finance and Investment at our next free OECD Green Talks LIVE webinar. For more information and to register: http://bit.ly/GreenTalks
Most of us would agree that clean energy is a worthwhile goal, and the world has invested more than $2 trillion on renewable-energy plants in the past decade. In 2014, energy generators added more renewable capacity than even before. But are we doing enough? According to the IEA, cumulative investment in low-carbon energy supply and energy efficiency will need to reach $53 trillion by 2035 to keep global warming to 2°C. It sounds a lot, and it is, but it’s only 10% more than the $48 trillion that would likely need to be invested in any case in the energy sector if the economy continues to expand and demand for power continues to grow as it has been doing in recent decades.
And the price difference with other types of energy is shrinking. Clean energy, especially electricity generation from renewable-energy sources, is increasingly competitive with new-built conventional power plants. It could therefore play a significant role in the transition to a low-carbon economy and help to meet broader economic and development goals. For example, the fact that electricity generation from renewables such as wind or solar power can exploit small distributed systems makes this form of energy suitable for areas not served by the large, centralised grids of traditional systems.
However, the deployment of low-carbon technologies is heavily influenced by government support, in particular in the solar- and wind-energy sectors. In the past decade, governments have provided substantial support to clean energy that has benefited both domestic and international investment. Globally, public support to clean energy amounted to $121 billion in 2013. At least 138 countries had implemented clean-energy support policies as of early 2014. Incentive schemes have contributed to enhancing clean energy investment worldwide, even if clean energy investment had to coexist with disincentives to investing in the sector, for example fossil-fuel subsidies, and the difficulties inherent in shifting away from fossil-fuels in the electricity sector, given the massive investments already made in traditional generation and the way electricity markets function.
Largely driven by government incentives, new investment in clean energy increased six-fold between 2004 and 2011, reaching $279 billion in 2011, before declining in 2012-13. Solar and wind energy have received the largest share of new investment – $114 billion and $80 billion respectively in 2013.
Prices of the equipment needed to generate clean energy, such as wind turbines and solar panels, have been falling, in part thanks to international trade and investment helping the solar photovoltaic (PV) and wind energy sectors to become more competitive. However, since the 2008 financial crisis, the perceived potential of the clean energy sector to act as a lever for growth and employment has led several OECD countries and emerging economies to design green industrial policies aimed at protecting domestic manufacturers, notably through local-content requirements (LCRs).
Local-content requirements typically require solar or wind power developers to source a specific share of jobs, components or costs locally to be eligible for policy support or public tenders. A new OECD report on Overcoming Barriers to International Investment in Clean Energy shows that as of September 2014, such requirements have been designed or implemented by at least 21 countries, including 16 OECD and emerging economies, mostly since 2009.
New, empirical evidence presented in the report shows that LCRs have hindered global international investment flows in solar PV and wind energy, reducing the potential benefits from international trade and investment mentioned above. This might be related to the fact that such policies increase the cost of intermediate inputs (the components needed to build the final products). This could lead to less competition in downstream segments of the value chain such as installation. Downstream activities are associated with more value creation than midstream manufacturing activities or upstream raw materials production and processing. The estimated detrimental effect of LCRs is slightly stronger when both domestic and international investments are considered. This indicates that LCRs do not have positive impacts on domestic investment flows.
In addition, according to results from a 2014 OECD Investor Survey of leading global manufacturers, project developers, and financiers in the solar-PV and wind-energy sectors on “Achieving a Level Playing Field for International Investment in Clean Energy”, LCRs stood out as the main policy impediment for international investors in solar PV and wind energy. It’s not surprising that a majority of international investors involved in downstream activities of the solar and wind-energy sectors selected LCRs as an impediment. More unexpectedly, a majority of international investors involved in upstream or midstream activities also identified LCRs as an impediment. This result suggests that LCRs can hinder international investment across the value chains.
As demonstrated in the OECD report, evidence-based analysis is needed to help policy makers design efficient clean-energy policies. Policy makers should reconsider measures in favour of domestic manufacturers for enhancing job and value creation in the clean energy sector if, as the OECD study suggests, the overall result is less investment and probably fewer opportunities for the very sector protectionism is supposed to help. Co-operation at a multilateral level is needed to address barriers to international trade and investment in clean energy.