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Part 1: The current landscape of climate finance

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Part of our report

How big is the Net Zero financing gap 2023?

Published Date

Sep 25 2023

Related people

How much is being invested in Net Zero today? And how does this affect the future cost of achieving the goals of the Paris Agreement?

Key findings

Climate finance has grown consistently over the last decade, but still falls far below what is needed to meet the goals of the Paris Agreement.
Estimates for 2022 suggest that global climate finance surpassed USD1tn for the first time. However, our research reveals USD6.2tn is needed annually by 2030 – and USD7.3tn by 2050 – to deliver Net Zero. These needs may increase in future if investment does not reach required levels in the next few years.
While the cost of decarbonization is huge, the potential benefits are even greater. Some estimates suggest that climate action could create almost USD1tn of additional economic output per year by 2070 compared to business as usual.
Recent policies such as the U.S. Inflation Reduction Act and Japan’s Green Transformation Act offer hope of a step change in climate finance.

Increased investment across sectors and regions is critical to achieving the goals of the Paris Agreement. Significantly raising climate finance flows in the near term will help to avoid the costs of future harm and also realize long-term growth opportunities.¹

By contrast, any delay in climate action will cause finance needs to rise. As of 2022, the available “carbon budget”² (the total volume of emissions possible to keep average global temperature rises within 1.5°C) was 380 gigatons.³ Annual emissions hit 58 billion tons (more than 15% of the total) in the same year.

Each year of inaction exhausts our carbon budget more quickly. This takes us further from our climate mitigation goals and increases physical and financial risks, creating the need for more dramatic investment in the future, potentially including the deployment of more expensive carbon removal technologies and other technologies that are still maturing. The more we overshoot our carbon limits, the worse the physical, financial, and social harm will be. Potential consequences include greater likelihood of breaching climate “tipping points,”⁴ greater sea-level rises, more extreme weather events, and more severe heatwaves.⁵ These worsening climate impacts will increase poverty, lower crop yields, and raise the risk of injury and death, especially for vulnerable communities. In 2022, for example, India was hit by unprecedented heatwaves while flooding devastated vast swathes of Pakistan.⁶

While the cost of decarbonizing the global economy over the next 30 years is substantial, the potential economic benefits in terms of asset appreciation and productivity growth are even bigger. One study estimates that concerted climate action and investment could add net USD43tn to the global economy – equivalent to a rise of up to 3.8% in global GDP by 2070.

This would equate to additional economic output of almost USD1tn per year.^7,8 Meanwhile, the negative economic consequences of climate change are being felt now. Annually, over USD300bn of infrastructure damage can be attributed to climate change,⁹ not to mention the health costs associated with fossil fuel-induced pollution.¹⁰

In addition, carbon-intensive investments through the middle of this decade are increasingly likely to become stranded as the carbon budget is exhausted,¹¹or will require large-scale investment in carbon capture, utilization and storage (CCUS) in the future, adding to the social cost of energy infrastructure. Some studies suggest that the effects of climate policy could result in upstream oil and gas assets with the potential to generate USD1tn in future profits becoming stranded.¹²We anticipate that regulations aimed at curbing carbon-intensive investments will continue to exhibit a time lag, with governments not providing clear pricing signals (either positive for low-carbon or punitive for high-carbon). Subsequently, swift re-alignments with legislative changes may trigger major disruption.

It is better that we make sensible choices now rather than invest in assets that quickly become unusable. For example, a large investment in nuclear power post-2030 could strand high-carbon power plants and renewables. The reluctance of governments to lead their electorates and address the difficult decisions that lie ahead – and, it must be said, the inability of some voters to accept that tackling climate change will come at a cost – means insufficient thought is being put into system design.

The current socioeconomic and geopolitical context has made the case for investing in low-carbon infrastructure more compelling, although not yet sufficiently compelling to overcome cost parity issues or the legal and regulatory barriers that are preventing a faster transition. At a fundamental level, energy must be secure, sustainable, and economical. Renewable energy ticks many of these boxes and it is more freely available globally than fossil fuels, offering most countries greater potential to enhance energy access and energy security, though some (including Germany and Japan) will still need to import renewable power.

Power from new renewable infrastructure – specifically wind and solar – is also cheaper than power from new fossil fuel plants in most parts of the world. Studies show that as installed capacity rises, the price of renewable electricity falls, thanks to economies of scale and technological advances (similar price reductions are not a feature of high-carbon generation). Building renewable infrastructure requires materials such as concrete and copper, which carry an environmental cost. But overall renewables are much cleaner and cheaper than oil and gas, with the cost differential an opportunity for developing economies to accelerate growth while increasing energy access.

Realizing these benefits will require trillions of dollars of investment (further detail in Part 2). In addition, countries may need to address legal and regulatory barriers that are currently preventing a faster transition.

For individual businesses, the transition to a Net Zero future presents opportunities to secure market share in growing industries, and to take advantage of policy tailwinds and the evolving regulatory environment.

Despite these benefits, investment in renewable energy is unevenly distributed across the world, and 90% of the growth in clean energy investment in recent years has occurred in advanced economies and China.¹³Developing nations can learn from this activity and leapfrog some of the issues that other countries have faced, but they require more financial and technical support to do so.

Transition opportunities are not being realized fast enough: the rate of climate finance growth is weak, and remains far below that needed to deliver on Net Zero goals. Our research shows that investment in climate-positive solutions and adaptation and resilience has grown at an average rate of 7% annually over the past decade. While this may appear encouraging, it is from a low base and does not reach the necessary growth rate.

We estimate that climate finance rose to USD850bn in 2021, a 28% increase on 2020 (Figure 1). Initial external estimates suggest that climate finance for the energy transition broke the USD1tn barrier for the first time in 2022, which would represent a 29% uptick year-on-year.¹⁴

The rate of Net Zero investment is accelerating, but not quickly enough. Our research shows that global climate finance flows may need to increase by 625% by 2030 to meet the goals of the Paris Agreement (estimated needs range from USD4.8tn per year to USD7.8tn).¹⁵By comparison, global defense spending reached a new high of USD2.2tn¹⁶ in 2022, while consumers worldwide are predicted to spend almost USD2tn on tobacco and alcohol in 2023.¹⁷

In addition to expanding the amount of finance, spending also has to be channeled to solutions that will most effectively reduce emissions. This can include an initial focus on renewables, energy efficiency, batteries, and electrification, followed by new technologies related to nuclear power, CCUS, and low-carbon industrial processes at scale over the subsequent decade. Work must be done to scale this development before the 2020s are out.

There are further challenges on the horizon. First, many countries, including the world’s most populous, China and India,¹⁸,¹⁹ continue to build new coal-fired power plants, although India is considering ending construction after its current wave of new projects come on line. Across developing economies, governments face the challenge of balancing the investment required to decarbonize their economies against the spending needed to improve healthcare, education, and infrastructure, all while keeping their debt load sustainable.

Then there is the rapid increase in demand for – and limited supply of – critical energy transition minerals, including lithium, polysilicon, copper, and nickel (required in everything from wind turbines to batteries). Prices for some of these materials soared by as much as 700% year-on-year in 2022, although prices have moderated in 2023.²⁰ Further, a rapid and sustained increase in interest rates in 2023 has also raised the cost of capital for new projects.

Pessimism among scientists over whether 1.5°C limit remains within reach

Finally, while leading economies, including the U.S. and China, remain committed to achieving Net Zero by 2050 in order to stay on a 1.5°C climate pathway, there is growing pessimism among scientists over whether keeping within this limit remains within reach. ²¹

Research from the World Meteorological Association suggests the 1.5°C threshold could be breached as early as 2027,²² although temperatures would need to remain above this level for a sustained period before we would consider the Paris Agreement to have failed. Despite doubts over the feasibility of current targets, the imperative to reduce emissions remains.

This is because the pace and magnitude of harm escalate significantly with every incremental increase in global temperature. The urgency generated by staying committed to the 1.5°C target remains our best chance of driving the necessary policy interventions and massive scaling of investments needed to tackle climate change.

Recent climate policy developments offer hope

There have been some dramatic climate policy developments over the past year, including the passage of the U.S. Inflation Reduction Act, which provides a USD370bn boost for low-carbon investment in the U.S. via a series of grants, loans, and tax incentives.

Jurisdictions including Japan and the European Union have similar policies, and the EU’s Carbon Border Adjustment Mechanism is due to take effect in 2026, which will strengthen the carbon price across the world’s second-largest market. Developments such as these may encourage copycat policies and could accelerate the deployment of existing technologies and foster breakthroughs in solutions such as green hydrogen that will have benefits across the world.

These policies are already resulting in deployment of mature technologies such as wind and solar, and novel projects such as Norway’s North Lights CCUS project, “the world’s first cross-border, open-source CO2 transport and storage infrastructure network,” which is set to launch in 2024. Whether these policies will be sufficient to decarbonize the global economy by 2050 remains to be seen.

As discussed in Part 3, bridging the Net Zero financing gap will involve a greater role for non-government public institutions. This will include MDBs and the entire ecosystem of public banks increasing financing flows towards mitigation and adaptation, aligning export credit agency funding with the goals of the Paris Agreement, and developing more sources of blended financing.

These are critically needed now to prevent greater environmental damage and financial losses in future. Cutting-edge solutions are being developed to free up MDB funding and create pools of blended capital, but it is early days.