Despite geopolitical and macroeconomic challenges, climate-related investments experienced significant growth in 2022, driven by emission reduction policies in the United States and Europe. This trend will continue despite global economic difficulties. The article proposes a framework for investors to navigate the volatile landscape and highlights key factors for strategic capital deployment. Climate technology investment remains strong, with governments and corporations prioritizing energy security and sustainability. Government programs like the Inflation Reduction Act and the EU Green Deal provide capital for net-zero emissions by 2050, offering lucrative investment opportunities in a rapidly growing market projected to reach trillions of dollars annually by 2030.
Breakthrough Growth
Climate investing experienced impressive capital growth in the past four years, with over 330 new funds focused on sustainability, ESG, and impact launched by private-market equity investors. The assets under management in these funds tripled from $90 billion to over $270 billion. Additionally, significant investments were made in energy transition technologies and climate solutions, with transactions increasing by more than 2.5 times from $75 billion in 2019 to around $196 billion in 2022. The power and transportation sectors received the largest shares of investments, while hydrogen and carbon management also saw notable growth.
Weathering the Downturn
Climate investing faced challenges in 2023 that affected investor confidence and slowed economic growth globally. The cost-of-living crisis, driven by inflation, a strong labor market, pent-up service demand, and increased government spending during the pandemic, led to higher financing costs for capital-intensive climate projects. Supply chain constraints and labor shortages further escalated construction and operational expenses. Moreover, the emphasis on energy security overshadowed sustainability, with governments and companies prioritizing the acquisition of gas, coal, and oil reserves, particularly in Europe, to ensure sufficient winter supplies and beyond. These obstacles had a broad impact on capital markets across sectors and regions.
The difference this time
In the current turbulent environment, climate investing is expected to maintain its growth trajectory due to several persistent factors that support its stability and resilience.
1. Strong demand signals amidst the energy crisis:
Despite the energy crisis, countries and companies are committed to reducing greenhouse gas emissions, with a significant increase in science-based targets and a large number of countries setting net-zero goals.
2. upportive policies and regulations:
Major economies have implemented legislative actions to support climate and energy transitions, including programs like the European Union’s Green Deal and the US Inflation Reduction Act.
3. Decreasing cost differentials for climate solutions:
Mature climate solutions like solar and wind are cost-competitive with fossil-based alternatives, and the costs of emerging solutions like grid-scale storage and hydrogen are decreasing.
4. Alignment in the financial system:
Financial institutions and investors are dedicated to financing the energy transition, with significant funds pledged towards net-zero goals and a focus on investing in climate technologies.
5. Coalition building and ecosystem development:
Collaborative efforts and standard-setting initiatives are driving systemic changes across value chains to accelerate decarbonization in various sectors.
Doing good deals well
Although the climate-focused tailwinds will persist, the investment landscape in this sector is expected to remain complex, mirroring the challenges of 2022. To succeed, investors must be cautious in selecting targets that can benefit from favorable conditions while withstanding macroeconomic headwinds. Here is a framework of eight factors, divided into two categories, for assessing climate-focused deals. The first four factors are crucial dealmakers or deal breakers, while the last four are emerging priorities for sophisticated investors.
Dealmakers or deal breakers
The first four factors encompass demonstrated technology and operational performance, a clear roadmap to achieve cost competitiveness, the ability to secure customer demand, and a proven track record of leadership and talent attraction.
Emerging technologies need real-world evidence and third-party verification to support their claims, ensuring proximity to actual conditions and replicable results.
Solutions should have a viable plan to achieve cost advantages over existing offerings and competitors, leveraging factors like accelerated learning, economies of scale, and design improvements.
Meeting immediate customer needs and securing long-term purchase agreements or commitments is essential. Partnerships and commitments from corporations help drive demand and support project development.
The leadership team should have the experience and skills to navigate rapid growth. A compelling plan to attract and develop talent is necessary, focusing on capabilities like project execution, financing, negotiations, and workforce management.
Soon-to-be table stakes
In the future, accessing policy support, scaling rapidly, securing affordable financing, and leveraging ecosystems will be essential for success.
Accessing policy support and incentives is crucial for evaluating climate-focused investments and technology adoption. Incentives at both macro and micro levels impact the market and individual solutions, such as sustainable aviation fuel and the ETS.
Rapid scaling is essential for disruptive climate technology companies. They need to quickly expand manufacturing capacity, supply chains, operational processes, talent recruitment, and partnerships to meet high demand.
Having a clear financing roadmap is crucial for climate tech companies to secure lower-cost capital. They should reach derisking and growth milestones to access equity, project finance, and debt, particularly for capital-intensive solutions like hydrogen and carbon capture.
Creating and leveraging ecosystems is vital for transforming value chains in complex industrial sectors. Collaborations and partnerships beyond company boundaries help overcome supply chain challenges and enable shared solutions, like direct agreements with mines for raw material procurement.
Staying disciplined in the next chapter
Climate-focused investing is gaining momentum and overcoming market complexities. Concerns about another cleantech hype cycle are fading, as investors continue to pursue deals and launch new funds. However, the growth of investable climate technology companies may not be keeping pace. Achieving net-zero emissions by 2050 requires substantial capital deployment, far exceeding current levels. The field of climate investing needs to scale up, identifying resilient technologies for long-term success in the energy transition.
