Financing climate solutions: challenges and opportunities
Jul 5, 2024

What is the new number going to be? The number on the new collective quantified goal on climate finance, that governments have to agree at the upcoming UN climate conference COP29 in Baku, Azerbaijan.

$100 billion annually from 2020 to 2025 is the number developed countries committed to mobilising for supporting developing countries in building low-carbon economies and adapting to the impacts of climate change.

But current estimates show trillions are needed. One element of mobilising these amounts of money is to find “new and innovative sources of finance outside the process” of the UN Framework Convention on Climate Change (UNFCCC), Executive Secretary Simon Stiell said at the Bonn Climate Change Conference.

Countries also grapple with what implementing Article 2.1 (c) of the Paris Agreement would look like –  to “make [all] financial flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.’

At a Climate Hub session organized by Exponential Roadmap Initiative and We Don’t Have Time, experts from H2 Green Steel, Ninety One, the Environmental Investment Fund of Namibia and the Swedish ministry of environment, dove deeper into questions of mobilising private and public investments into climate solutions and net zero value chains.

Offtake agreements at the heart of project financing

For H2 Green Steel, Chief Financial Officer Otto Gernandt described how his company pulled in finance for the Swedish startup that is building the world’s first large scale plant for green steel that has a 95 per cent lower carbon footprint than traditional steel.  “Setting out four years ago, we designed and built a company specifically to be financed,” Gernandt said. 

H2 Green Steel was the first manufacturing company to join Exponential Roadmap Initiative as a climate solutions company.

H2 Green Steel’s Chief Financial Officer Otto Gernandt explained the approach its company took to securing finance.

Debt financing is not a product that is usually available to start-ups because they have no balance sheet, no annual reports to show, no cash generation and so on. But we realized early on the need to debt finance what we were building. And one of the critical pillars was to secure offtake agreements. We were able to secure long term contracts with customers under what we call hard take or pay commitments, meaning customers entered – n our case seven years – legally binding commitments to buy the product, with no outs, and with a green premium.

 

Traditionally the steel industry doesn’t engage with long-term binding volume commitments. Companies negotiated on a quarterly or an annual basis and customers retained a lot of flexibility, similarly to buying a commodity. But In the green steel space, we have a supply-constrained product that also has a differentiation against the rest of the market. That allowed us to establish a different balance in the relationship between buyer and seller.

 

The offtake agreements are really unique and that is what we build upon to create the full financing package.

However, for companies in developing countries, including emerging economies, financing options are more limited, as Nazmeera Moola pointed out, Chief Sustainability Officer at Ninety One, an investment firm based in South Africa with a focus on emerging economies:

Ofttake agreements aside, one of the things that had underpinned H2 Green Steel was a grant from the European Innovation Fund. That sort of capital is not usually available in emerging economies at the quantum you see in developed markets.

 

Emerging economies don’t have the same fiscal space as developed countries and don’t have luxury of responding to crises by printing money. Therefore they have to fund climate transition projects at higher interest rates and they re not able to subsidise their local industries in the same way as developed countries are.

But in Otto Gernandt’s view’s the challenge lies less in the public funding:

The subsidy part in our financing is significantly less than 10% of the total funding.

I think the bigger hurdle in putting this kind of finance together in a developing market will be the offtake side. Securing the willingness to pay for that green product and securing the green premium and long term offtakes – that revenue side will be more challenging for building a green steel plant in South Africa, for an example. 

 

Using public finance to mobilise private capital

Indeed offtakes are on Benedict Libanda’s mind as well. He’s CEO of Namibia’s Environmental Investment Fund, with big plans for producing green hydrogen. 

Hydrogen is an energy carrier and as green hydrogen considered a key enabler of the transition. Green hydrogen is hydrogen that results from splitting water molecules into hydrogen and water molecules using renewable electricity. Green hydrogen for example will be used by H2 Green Steel to produce steel.

For starters, Namibia’s government has set up a bespoke fund together with the Dutch government, the SDG Namibia One, to enable Namibia’s green hydrogen plans.

Benedict Libanda, CEO of Namibia’s Environmental investment Fund:

Clean hydrogen requires a large ticket size of investments. We do have a pipeline of $20 billion project under the SDG Namibia One, and that is two times our GDP as a country.

 

The aim of this financing platform is to attract different sorts of capital and targeting concessional capital. Mainly from donors, though we also use public seed capital to de- risk and attract private investment.  And this fund has now been seeded with about €40 million from the Dutch Invest International, and we’re about to close another €60 million for the development fund.

 

It’s a blended financing structure, where we have a development fund, which is more for de-risking, which is $100 million. Then we’re working on a construction fund which is more for commercial investors, as well as an operational fund which is more for fixed income investors. All these these kinds of funds have got different risk appetites, depending on the investors choices.

Offtakes would come into play further into the future:

We see the offtake mechanisms to be one of the best avenues to unlock investment. If we can establish the pricing of clean hydrogen within the next two or so and establish the green premiums, that would give impetus to investors’ confidence.

Encouraging examples, challenges – and solutions

For Mattias Frumerie, Swedish Climate Ambassador and Head of Delegation to the UNFCCC, both cases – the one from H2 Green Steel and Namibia’s green hydrogen finance – are examples of “Article 2.1 (c) in practice”. He welcomed the fact that finance conversations under the UNFCCC have shifted from a very strong focus on public finance from donors to developing countries to a conversation on wider financial flows and the implementation of Article 2.1 (c), including highlighting the importance of the regulatory environment.

Much of this is going on outside the UNFCCC, but what we can do here is of course provide a platform overview to highlight all these various channels which are becoming increasingly available for countries globally to accelerate the transition.

But, said Nazmeera Moola, while the examples were encouraging, the challenge remained to get broad based, developed market private capital interested in investing in emerging markets.

The reality is that the average developed markets pension fund or insurer has very little interest in investing in projects in emerging markets. Creating alternative revenue streams I think is very important. Some derisking at fund level from the multilateral development banks and development finance institutions are potentially quite important, because part of the problem is just a lack of familiarity.

 

One challenge is the higher risk of these investment but the bigger challenge is the higher perceived risk. Our own experience, investing across many of these markets, is that realized risks are a lot lower than expected.

 

So how do we get more investors into the space to increase their familiarity, and therefore have this experience firsthand?

Mattias Frumerie agreed there was “work to be done” in terms of increasing awareness. But, he said, that went both ways:

How can investors from, for example, European countries, raise their own awareness and how can countries like South Africa and Namibia also be part of raising that awareness? How do we make those sort of two ends meet in that sense?

 

There may be other fora than the UNFCCC process to do that, but I do think it’s an area to work on which would in the end also benefit the work that we’re doing here. 

Otto Gernandt identified another blocker in the capital structure: limited mandates for equity funds.

Certain equity funds or pension funds do not take construction risk, they do not invest pre-revenue. Surprisingly enough, that’s true even for some climate-focused funds. I think climate investors that want to drive climate action through their equity fund also have to have a mandate to invest in assets that involve these kind of risks.

 

We’ve seen some change over the past three and a half years, but only very slow change. So I would say so if there’s anywhere in the capital structure that we need to see change, this is it.

Levers exist that can be pulled to accelerate finance towards climate solutions. On the country level, governments in developing countries even despite limited fiscal space do have opportunities to attract investments, Nazmeera Moola said:

Countries can and must focus on putting in place supportive regulatory environments. They have to make it super easy and remove regulatory blocks to build out renewables. Aside from China, India is probably furthest along in doing that.

Otto Gernandt also saw room for customers in the real economy to accelerate money flowing into clean technologies :

Where I think customers and private sector actors can play a bigger role is in allowing us to disconnect the abatement or the green element from the steel production from the brown element of the steel production, to essentially sell certificates. A tonne of CO2 saved in South Africa is after all just as valuable as a tonne of CO2 saved in Sweden.

 

So if a green steel company in a developing country was able to sell certificates on one hand and on the other hand sell a cheaper product in the domestic market, where there is no willingness to pay the green premium, that will be a very powerful tool that the private market can provide basically, to unlock more financing in development.

Already, said Nazmeera Moola, exciting change was underway from corporates in emerging markets and development finance institutions (DFIs):

In many countries, you see companies acting ahead of their governments, because the government’s are reluctant to make overly ambitious pledges. And so, companies that face the global markets that sell into Europe or face global financial institutions are taking ambitious action. The fastest growth when it comes to signing up to science-aligned targets, certainly in percentage terms has been in India. That’s despite the fact that the country’s national net zero target is as far ahead as 2070. 

 

I’ve also recently started seeing DFIs to start talking about adjusting their business model. That has not yet translated into a floodgate of monies yet, but it’s a whole lot further than it was two years ago.

Otto Gernandt, too, has seen positive change over the past three and a half years that H2 Green Steel has been fundraising.

If you really properly put together the technology, construction contracts, the infrastructure, the offtakes, the team that’s going to execute it and so on, and structure the project, you will have senior funding available. You will have export credit agencies available providing credit guarantees.

 

We’ve seen that it’s possible. It’s not easy, it is difficult – but in a way it shouldn’t be easy to raise $7 billion, either. It is possible, and I think people see that as a positive signal.  

A positive signal when it comes to accelerating the development and production of climate solutions – but what’s more, a positive signal for development much more widely.

Benedict Libanda:

If we transform and diversify our economy to a low carbon economy using renewable energy resources as a conduit to our economic development, we are looking at creating much needed jobs in the country. It’s not only action to assist the global North to decarbonise but also to transform and benefit our country.

Watch the recording (duration 30 mins)

Related content:

Watch “Funding net zero value chains – an interview with Carl-Erik Lagercrantz, CEO, Vargas Holding, and Johan Falk” (June 2024)

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