Reflections on COP28, and hopes for Davos
Mercer - Investments
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By Rich Nuzum, Global Chief Investment Strategist
Ahead of COP28, I had mixed expectations of what governments, technology and the private sector could deliver in Dubai, yet came away immensely surprised by the scale of commitments and collaboration achieved during the summit.
Governments, investors, companies and philanthropies announced over $57bn in climate investment commitments. Of course, these pledges must now be turned into actual investments. While actual implementation remains ahead of us, the world’s community of project sponsors and entrepreneurs now has a significant carrot to encourage further efforts.
Reflecting on my experience at the summit, I have become increasingly optimistic about the global economy’s ability to mitigate the worst-case scenarios of climate change. Looking ahead to the World Economic Forum, here are some observations that I hope will prove useful to investment fiduciaries considering how climate transition may evolve from here.
1. We’re past the tipping point on renewable energy economics, with reason for further optimism
My greatest “a-ha” moment at COP28 stemmed from an improved recognition of the future implications of the fact that the cost of producing solar energy has fallen by around 90 percent over the past 15 years.
Historically, scaling of solar has been premised mainly on subsidy support, carbon taxes, or other policy measures. In recent years, a combination of major steps forward in photovoltaic technologies coupled with continued policy support have reconfigured the economics of solar. Between 2010 and 2020, the cost of solar fell by around 15% each year[1], a decline in the cost curve that has seismic implications for energy systems and investors globally. Because the cost of solar energy has been declining exponentially, it is reasonable to anticipate further declines as technologies continue to progress.
The cost of battery storage, the efficiency of long-distance energy transition, the cost of wind power, both onshore and offshore, and other adjacent and supporting technologies have also been on exponential cost decline curves, while adoption of technologies such as electronic vehicles have been experiencing exponential growth curves.
On the ground in Dubai, discussions with scientists, investors, academics, companies and policy makers gave me hope that we have breached that crucial tipping point – the point at which renewable energy technologies are more cost competitive for many large-scale applications than fossil fuels.
At the current rate of cost declines in solar power and adjacent and supporting technologies including for transmission, storage and usage, the conversation over the next 10-15 years may flip on its head. Instead of talking about whether and when renewable energy will become cost competitive without policy support, we appear likely to be talking about whether fossil fuels can remain cost competitive with renewables.
Consider a thought: If the cost of solar were to decline by another 90%, repeating our past 15 years’ actual experience, oil prices would have to go from around US$72 per barrel as of this writing, to around US$7.20 – far below the US$20 lows plumbed through the Covid-19 pandemic – to remain competitive.
Exponential declines in cost curves have been enabled by the science. Funding the science is ultimately supported by supply and demand in the real economy. On an increasingly global basis, supportive policy drivers are delivering crucial tailwinds to innovation and investment volumes. This is now happening in an environment where these technologies are already cost competitive, speeding the adoption, and the crowding out of traditional sources of energy.
More specifically, industrial policy measures in China aimed at solar power generation, transmission and storage have delivered major technological breakthroughs that the rest of the world is now benefitting from. Across Europe, evolving regulation and carbon pricing has created a market for renewables. And more recently, the US Inflation Reduction Act has delivered a US$369bn package of subsidies designed to accelerate investment into green technologies. While the policy measures adopted in the world’s three largest economies/economic blocs do not appear to have been well coordinated and are inconsistent, they have in aggregate created a highly supportive policy environment.
The impacts of these policy tailwinds are already proving transformative to investment volumes into green and clean technologies; Q2 2023 proved to be a record quarter for fundraising into green technology and clean technology venture capital, with US$7.5bn raised at a time when “mainstream” venture capital fund raising remained far off its peak rate. The IEA estimate that for every US$1 spent on fossil fuels in 2023, US$1.7 was spent on clean energy. Five years ago, this ratio was 1:1[2].
From here, there is an opportunity for investment to further accelerate declines in the cost curves of renewable energy generation, transmission and storage, and drive further adoption of technologies that make more effective use of electrical as opposed to other power sources.
2. Diversifying into innovation
For institutional investors assessing how to navigate a potentially disruptive period of energy transition, it is important to consider where innovation is being funded and taking place.
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Investment into clean tech, green tech and infrastructure is concentrated largely in private markets, with public markets more typically the domain for traditional energy companies. As in other areas of the economy such as mainstream digital technology, lack of diversification into private markets may leave investors underweight in innovation and overweight past success in listed businesses.
From a purely economic perspective, there is a case for investors to diversify into innovation across the energy sector due to its support of growth without inflation. The cost of energy is already declining in real terms, but the potential for further declines in energy cost curves may prove inherently deflationary – and could deliver the opposite of a stagflationary shock. This is a factor that should be in the mix of considerations as investors consider our longer-term potential inflation pathway.
Another aspect of the diversification story is encapsulated in the widespread activist and media criticism of the UAE’s Presidency of COP28. While it may be counterintuitive, it is observable that some economies reliant on traditional energy sources are among the most active investors in renewable energy. From a policy perspective, this emphasis on renewables makes sense as they seek to diversify their drivers of national wealth and tax revenue, and hedge against the risks of oil going below US$10 a barrel or otherwise declining substantially as outlined above. In my opinion, the UAE has done a better job of diversifying its economy by making meaningful investments than many other oil-producing nation states. Other nation states that have relied on traditional energy for a large proportion of their wealth production would be well served by following a similar policy path.
More generally, with oil arguably trading above its equilibrium price because of the Russian invasion of Ukraine, a great deal of wealth has been created recently in the Middle East. Anyone trying to raise money for venture capital or infrastructure investment may well focus on Middle Eastern sovereign wealth, endowment, pension, family office and other investment pools as a source of liquidity and demand for efficient fund raising. This is true for mainstream venture capital and infrastructure, and also for clean technology, green technology and green infrastructure.
Viewed from these perspectives, as an investor and an economist, the UAE’s hosting of COP28 made complete sense to me. It helped bring together capital providers with project and deal sponsors seeking capital, and the private sector deal making undertaken by many of COP28’s estimated 100,000+ attendees is likely to help further accelerate real world investment going forward.
3. Turning pledges into real economy outcomes
Given the aforementioned estimated 100,000 registered official delegates at COP28, it is worth reflecting on the value of collective learning, collaboration and human connections enabled on the ground in Dubai.
The momentum behind these relationships, ideas and ambition can now drive forward tangible action in the real economy. The global investment community has an opportunity to commit capital to projects across the real economy. New contacts forged at COP28 can become deal partners at Davos, working together to overcome historic barriers and risks to scaling green and clean projects.
Our own digital platform, Mercer’s Catalytic Investment Exchange (CIX)[3], seeks to help project sponsors and entrepreneurs find interested capital providers, and vice versa. The platform provides preliminary due diligence questionnaires completed electronically by sponsors of green infrastructure, green technology, clean technology, biodiversity and natural capital projects and ventures. These questionnaires can then be screened by both portfolio and strategic investors, impact investors, and donor entities, who may then form bidding coalitions which structure the financing of these projects to take advantage of the latest innovations in catalytic finance and blended finance. By increasing visibility and connectivity between project sponsors and potential investors on the ground at COP28, we aimed to catalyze capital flows into green infrastructure, cleantech and green tech, and derisk direct investment in climate projects, including across the Global South.
A major stone left unturned, and an area for renewed focus at Davos, is the future of carbon capture and offsets. To date, so much of collective efforts have been on emissions reduction, energy transition and evolving technologies - but there is an opportunity for us to work both sides of the equation, by tackling carbon capture and offsets at scale. Capital markets are not yet rewarding the extraction of carbon from the atmosphere in a meaningful way, nor is carbon priced to drive mass recapitalization. Until carbon has that per unit price, progress on transition may continue, but perhaps not at the scale required to offset the challenge we face.
[1] Way, R., Mealy, P., Farmer, J. D. & Ives, M. Empirically grounded technology forecasts and the energy transition. INET Oxford Working Paper No. 2021-01 (2021).
[3] Mercer, and its affiliates, is not acting as an underwriter of the deals or functioning as a broker-dealer or agent of the deal sponsors.