In this post, we frame the financing challenge for climate mitigation and adaptation in the coming decades. In future posts, we will drill into how this translates to opportunities within specific segments - and where, therefore, we think the most exciting white spaces are for new climate finance start-ups.
The global economy needs to invest $4.4 trillion annually in order to limit climate change to 1.5C, according to the International Energy Agency (IEA). This is a 5x increase from our current yearly spend of $755B. $4.4 trillion in annual investing is large; by comparison, it represents:
The scale of this is world-historic: As noted climate economist Nicholas Stern has put it, the green transition is “the biggest capital reallocation since the Industrial Revolution.”Note: $5.7T in annual investment is what's needed for our current decade from 2020-2030. For 2030-40 and 2040-50, the yearly investment is $3.7T, leading to a weighted average across three decades of $4.4T.
Almost half of the $4.4T required will need to go to four sub-sectors. The IEA says these are building energy efficiency (22% of the total), electricity network improvements (14%), industrial energy efficiency (8%), and solar PV (5%).
However, some sub-sectors will need to grow much more than others, in relative terms. For example, spending on EV charging infrastructure will need to grow ~65x from its current level. Similarly, biofuels supply will need to grow ~44x, grid flexibility measures by ~33x, and concentrated solar by ~28x. This creates a variety of opportunities across both major markets and smaller markets that will scale meaningfully.
Insight for entrepreneurs: There is significant opportunity in the largest sub-sectors of the transition, but there are also meaningful pockets of huge growth that are exciting, too. Smart plays can take advantage of huge scaling in smaller sub-sectors.
The majority of financing for the transition will come from private lending and capital markets. The International Renewable Energy Agency (IRENA) predicts that 30% of the financing required between now and 2050 will come from commercial lending, and a further 23% from capital markets - primarily in the form of bonds. The remainder will come from private sources of equity (29%), public equity (11%) and development finance lending (7%). In the current decade, the share of private lending and capital markets will be even higher - worth 56%, or $3.2T of the $5.7T in annual financing required.
This creates a significant opportunity for financing technologies that achieve maturity and scale this decade. While IRENA does not break down the type of capital required by specific technologies, we can infer that a meaningful share of the projected private lending and capital markets needs will come from maturing technologies. As Carlotta Perez’s framework of capital needs across the technological development cycle shows, private lending and capital markets are best-suited to technologies approaching and exceeding 25% market share (see Appendix for framework). This leads us to expect that the large pool of private lending and capital markets required this decade will likely be focused on things such as renewable energy generation today and, later this decade, electric vehicles.
Insight for entrepreneurs: Climate finance start-ups should consider the type of capital that is required by different technologies over the coming decades - not just the size of the value pool.
There is white space for climate finance companies that can bring together the right parts of the capital stack with key segments of the energy transition. Businesses that we believe can succeed will:
Of course, the prospects for businesses like these will vary by sub-sector. In future Ezra Insights posts, we will go deep on some of these to understand what the capital stack looks like today, what will need to change, and how climate finance businesses might be able to play.