The cost of capital has increased worldwide, affecting emerging and developing economies the most. This rise in finance costs significantly impacts energy investment. To meet sustainable development and energy security targets, a substantial increase in energy investment is necessary. Understanding the trends in capital allocation decisions is crucial, which is why the latest World Energy Investment report starts with a chapter on finance. This chapter explains current financing trends, differentiating between investment (capital expenditure to build or acquire an asset) and finance (the origin and form of funds supporting an investment). It also examines the roles of capital providers (like governments, households, and the private sector) and finance providers, including development finance institutions and other public and private sources. Additionally, it explores emerging themes like transition finance and carbon markets.
In 2023, interest rates spiked in many countries, including advanced economies. The 2020-2022 pandemic had lowered interest rates, but inflation pressures in 2022 reversed this trend. The invasion of Ukraine and other geopolitical conflicts increased political risks, raising the cost of capital. Interest rates on long-term government bonds rose significantly in many countries, except China. For example, yields on ten-year US Treasury bonds increased by about three percentage points between 2020 and 2023. This rise in US interest rates affects global capital investments, especially in emerging markets and developing economies, as many international investors value assets in US dollars. Local-currency financing also became more expensive in many emerging markets, raising borrowing costs and affecting the cost of equity.
Developing and emerging economies face higher costs of capital due to perceived risks, making it harder to attract investment. Clean energy technologies, which require large upfront investments and depend more on debt financing, are particularly affected. Although government policies, technological advancements, and declining costs have helped offset rising capital costs, high interest rates and a strong US dollar are challenging for investment.
China’s situation is different. It has kept benchmark lending rates low due to low economic growth and property sector weakness. Globally, there are signs that high benchmark interest rates may not last long, but the era of near-zero interest rates is likely over. The US Federal Reserve plans to cut its short-term benchmark rate in 2024, though inflation above the Fed’s target has delayed this.
Commercial finance supports about 73% of energy investments, with public finance playing a larger role in China and some other emerging economies. Debt financing is more common in power and grid investments in developed markets, while equity stakes are more prevalent in emerging markets and end-use technologies.
Clean energy is increasing the private sector’s role, while government funding remains significant in China and for fossil fuels in emerging markets. From 2016 to 2023, clean energy’s share of total energy investment grew from 50% to 63%. Private finance made up the bulk of spending, with public finance playing a larger role in emerging markets.
Debt sustainability is a growing concern in emerging markets, making private finance crucial. Government investment in global energy assets has stayed stable, with significant involvement in fossil fuel asset ownership. State-owned enterprises are expected to remain key players in the energy transition.
Households have doubled their share of new energy spending since 2015 due to growth in rooftop solar, energy efficiency, and electric vehicle purchases. This shift emphasizes the need for policies and financing instruments tailored to households.
Sustainable finance regulations have supported clean energy investments, but 2023 was challenging for sustainable investment practices. Despite a net outflow in sustainable funds in the fourth quarter, the value of sustainable funds globally increased by 8% in 2023. The banking sector, with its large capital pools, plays a crucial role in financing energy projects.
To meet investment needs under the NZE Scenario, further evolution of today’s financial architecture is needed, including tailored solutions for transition activities and for emerging markets and developing economies. Ensuring the availability of affordable capital is vital for rapid energy transitions, particularly for financing projects, companies, and necessary household spending.
