Cut carbon emissions with transition financing

Labanya Prakash Jena | Updated on December 29, 2020

Think green Decarbonisation is key   -  Getty Images/iStockphoto

It’s an innovative solution that helps high-emission industries fund their efforts to decarbonise operations

Does the world want to go green in all sectors? Most likely. But this goal faces a key complexity — how do you enable transition polluting industries and help them reduce emissions? This is where innovative financing solutions can play a role.

Take the case of India. It is on a trajectory to decarbonise its economy, fulfil its Nationally Determined Contributions (NDCs) commitment and achieve sustainable development goals. In relative terms, India’s industrial emissions per unit of gross value added is twice that of G20 countries — reflecting the country’s emissions-intensive fuel/energy usage.

As India’s economy grows, the demand for various carbon-intensive commodities — such as steel, cement, and chemicals — is likely to grow by at least three-fold between 2014 and 2030. The current low levels of per capita resource consumption in India are also moving towards the global average, with the increase in per capita income.

The energy sector accounts for 67 per cent of India’s greenhouse gas (GHG) emissions, followed by the industrial sector (20 per cent) and the agriculture and land-use sectors (13 per cent). Within the energy sector, industries are the highest consumer of electricity, accounting for 42 per cent. In total, the industrial sector and so-called ‘polluting industries’ account for around 48 per cent of the total GHG emission in India.

Investment dilemma

While there is a need to focus on ‘polluting industries,’ many of them are asset-heavy in nature. There is a large sunk cost in the existing facilities and the complexity of operations. As a result, the investment cycles are incredibly long — companies in these industries change their facilities and operation only gradually over the years. These industries typically have significant long-term financing needs to reduce their GHG emissions. But alarmingly, these industries are not investing in decarbonisation technologies at the expected levels. Why so?

One reason is that while the market for decarbonisation (including energy efficiency) appears to be very large, it has only seen limited dedicated investment options. Traditional forms of sustainable/green finance do not cover these. Take the case of green bonds — they are designed for green industries only. For example, a coal power company cannot issue green bonds to finance its supercritical plants or decommission old power plants. This is despite the fact that both those activities could reduce GHG emissions.

This is where transition finance can step in. Transition finance allows polluting industries to attract capital to transform into low-GHG-intensive businesses, but not necessarily become totally green. This enables firms that would not qualify to issue green bonds to obtain sustainability-related financing.

It also helps these industries raise long-term capital to become less carbon-intensive in the long-term. The fund usage is more flexible compared to green finance, and creates more investment and decarbonisation options.

So how does it work? Companies can raise capital at a corporate level and utilise it to optimise profitability and reduction of carbon emission. The financers can set certain terms and conditions, particularly to link financing to specific outcomes, for the corporates to create accountability and transparency. A third-party verifier can be appointed to verify the company’s GHG emissions target.

One example is the $350-million transition bond issued in 2020 by the Hong Kong-based Castle Peak Power Company. The funds were used to construct an offshore LNG receiving terminal and other supporting assets, to move away from a coal power plant to a less carbon-intensive natural gas power plant. Similarly, the Brazil-based meat production company Marfrig issued a transition bond in 2019 to practice sustainable cattle ranching — ensuring that cattle farmers do not encroach the Amazon rainforest.

Some caveats

Like green bonds — accused of ‘greenwashing’ — transition financing also draws criticism from environmental groups. There are fears that polluting companies will issue these bonds to mitigate their reputational risks but will continue with their carbon-emitting operations without taking concrete actions to reduce pollution.

However, financial companies are developing guidelines for transition financing which can alleviate these concerns. Third-party verifying agencies can also play an important role here, in ensuring that the proceeds are indeed used for decarbonising operations.

With the right principles, financial incentives for issuers, and clear key performance indicators, transition financing can play a powerful role in decarbonising India’s polluting industries and help India to meet its NDCs and sustainability goals.

The writer is a Manager (Climate Finance), Climate Policy Initiative

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Published on December 29, 2020
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