Capital is increasingly being allocated to help heavy polluters fund their costly decarbonization plans. ‘Transition finance’ may be the greatest economic opportunity ever in the race against climate change.

At a plant outside Montevideo, Vantem pours and presses materials into concrete-like boards. The electrified process runs at nearly room temperature, consuming only a fraction of the energy for making cement at high temperatures with fossil fuels. The panels make buildings five-times more energy efficient than their traditional counterparts. Add solar panels onto the roofs, and buildings can achieve net-zero carbon dioxide emissions and sell the excess electricity on the grid.

This lower carbon footprint has caught the attention of construction companies. To reach net-zero emissions by 2050 in the race against climate change, total emissions from buildings – cooling, heating and powering – as well as construction and materials must be slashed. Buildings may only account for 10% of energy-related emissions, but when factoring in operational and process-related emissions it made up 37% of the total in 2021, more than industry at 30% and transportation at 22%, according to the International Energy Agency.

Vantem, with backing from the Bill Gates-founded Breakthrough Energy Ventures, has sold its panels to Japanese electronics maker Panasonic for a factory in Brazil. Homes, a five-star hotel and a co-working space have been built with them in Uruguay, and an observatory for the Chilean Navy on cold and windy Cape Horn.

“We’re seeing a rapid shift toward sustainability in the market,” says George Satt, president of Latin America at Greensboro, North Carolina-based Vantem.

More companies are taking steps to reduce their carbon footprints with growing urgency to become green and, in the process, sustain access to financing and markets. New technologies are helping, such as carbon capture and storage. But vast amounts of financing will be needed to develop and scale up these and other solutions for a low-carbon economy.

So far, most of the transition financing has been flowing into renewable energy, says Tony Rooke, the London-based head of transition finance at the Glasgow Financial Alliance for Net Zero, or GFANZ.

The next step is to help heavy polluters decarbonize, he says.

Photo: Tony Rooke

The financing needs for this are huge. GFANZ and Bloomberg New Energy Finance estimate that for every $1 invested in fossil fuels this decade, $4 must go into climate solutions to manage the transition. That will increase to $6 to $1 in the 2030s, $10 to $1 in the 2040s and $11 to $1 in the 2050s.

“This transition is the greatest economic opportunity ever,” Rooke says. “We’re talking trillions and trillions of dollars in investment."

Divestment Strategies?

A few years ago, banks and investors began pulling out of fossil fuels and heavy polluting sectors, concerned about the social and shareholder backlash. But there has been a change in sentiment, influenced in part by the need for energy security after the Russia-Ukraine war escalated in 2022. Investors have come to understand that it will take more time to wean society off fossil fuels and for hard-to-abate sectors to decarbonize.

“We don’t live in a world where you can just flick your fingers and switch off fossil fuels unabated,” Rooke says. “That would lead to chaos. It would lead to economic ruin.”

Invenergy, a Chicago-based energy company, says the appetite for financing renewable power projects has been growing. The willingness hasn’t abated for natural gas-fired generation, either. These plants meet peak demand, providing reliability to the system that renewable sources struggle to do at times of drought, low winds or at night.

“We haven’t seen any pull back from anything that we're doing,” says Jim Murphy, Invenergy’s president and chief operating officer. “We haven't gone to our traditional lending sources and said, ‘We have this project we want to talk to you about,’ and heard, ‘No, we're not doing fossil fuels anymore.’ That is just not what we're seeing.”

Invenergy invested $1 billion to build a gas-fired power plant in El Salvador that went into operations last year. The plant has allowed El Salvador to replace diesel and heavy fuel oil with a cleaner fossil fuel to meet 30% of the country’s power needs, offsetting 600,000 metric tons of carbon emissions per year and providing grid support to expand renewable power capacity in the country to gradually replace fossil fuels.

“I think that generally as people have gotten a little bit more sober about the math and the economics, they see a continuing role, probably a diminished role, but a continuing role for fossil fuels in the mix,” Murphy says.

Rooke says banks are taking a more “nuanced approach” for decarbonization. They are financing carbon emissions in the short term for energy security while investing in the transition over the longer term.

“I’m not saying exclusion or divestment policies aren’t used,” he says. “But if you use it straight from the start, you basically lose leverage to help the transition.”

Lucas Arangüena, head of sustainable technology at the Spanish bank Santander, says the key for these heavy polluters to access sustainable financing is to have credible, detailed and robust decarbonization plans, high standards of transparency and disclosure, and the ability to demonstrate the social benefits of deals, such as a toll road connecting underserved communities.

Santander has structured a sustainability-linked pre-delivery payment facility for an airline to renew its fleet with more fuel-efficient aircrafts, while for others it has linked financing to emissions reduction and the use of alternative fuels.

“The rise of transition finance … could unlock significant financing for hard-to-abate sectors,” Arangüena says.

The rise of transition finance … could unlock significant financing for hard-to-abate sectors.

Lucas Arangüena, Santander

Martha Rocha, a managing director at Fitch Ratings, says there’s been an increase in financing with “sustainability targets attached to what these companies have stated as their goals.”

Grupo Aeroportuario del Centro Norte, for example, has sold MXN8.6 billion ($500 million) worth of green and sustainability-linked bonds to fund projects to reduce emissions at the 13 airports it operates in Mexico, including through energy efficiency and on-site solar parks.

GFANZ’s Rooke warns that the risk of not coming up with a bankable plan could leave companies with stranded assets like coal power plants and oil pipelines.

Moving Faster

A growing number of investors are pressing for more ambitious decarbonization plans in Latin America to capture the global growth in transition finance, still a relatively new type of funding structure.

Ninety One, a global investment firm that manages $10 billion in emerging market corporate debt, is recommending that companies bring forward their net-zero targets from 2050.

“We’re seeing a lot of investments that are happening globally that could be easily implemented into business programs in the region,” says Matthew Christ, a New York-based portfolio manager at Ninety One.

Mexico’s Cemex is doing this. The world’s third-biggest cement maker is increasing the use of renewable energy at its plants, while working on longer-term decarbonization projects. It has teamed up with Switzerland-based Synhelion to use solar energy to heat up a rotary kiln enough to fuse together clay, limestone and other materials to make clinker. Fossil fuels are typically used to heat the kiln, and they are responsible for approximately 40% of the direct carbon emissions in the process.

This strategy has allowed Cemex to bring forward its carbon reduction targets to 2030, and some to 2025, Christ says.

“Cemex is doing all the short-term stuff with today’s proven technology, and at the same time they are really engaged in the moonshot activities,” Christ says. “Their plan is so credible that we are fine lending to them on a general corporate purpose standpoint. We don’t need to see capital in a green bond. We don't need to see something in a green framework. What we need is a credible plan.”

Brazilian pulp and paper producer Klabin is aware of this, too.

“The heat is on for companies to commit themselves to aggressive energy transition targets,” says Gabriela Woge, Klabin’s finance director. “There is a movement to restrict the availability of capital to companies that have a polluting business or have not set decarbonization goals.”

She believes that a growing number of companies will be under pressure to commit to ever more ambitious targets as the financial sector adapts itself to the Scope 3 emissions of the Greenhouse Gas Protocol, which significantly expands the breadth of responsibility borne by companies.

“As Scope 3 consolidates, the process will gain traction. Banks themselves have Scope 3 targets to meet, where they will have responsibility for their suppliers and clients,” Woge says. “Scope 3 makes companies responsible not only for what they do at home, but also for the actions of their whole supply and client chains.”

Woge says financial institutions are key for helping companies advance together toward sustainable targets that are shared in the same sector or country. The companies that have committed to the energy transition, she adds, are already benefiting from better conditions in the financial markets.

Klabin has taken advantage of its use of renewable energy – 88% of its total – to issue green bonds and sustainability-linked bonds and obtain a revolving credit line linked to sustainability key performance indicators (KPIs), she says. Both multilateral and commercial banks are participating in this process, but transparency and clear metrics are of essence to benefit from their new approach.

“Today, when we analyze a project, we not only look at the financial return, but also the impact that this project will have on our emissions,” Woge says. “We have seen, especially when we issue debt, that when we attach sustainable KPIs to commit the company to firm targets that require effort to be met. If we meet them, we enjoy financial benefits.”

Climate Technology

Technology will play a key role in the transition, but it will take time to develop, commission and demonstrate the effectiveness and cost benefits. Of the five sectors that represent 85% to 90% of the world’s emissions – agriculture, buildings, heavy industry, power and transportation, “not one of those sectors has the technology available to get fully to net zero,” Ninety One’s Christ says.

Green hydrogen, which is made from renewable energy, still needs to be produced at scale as a fuel to decarbonize the power sector and some manufacturing processes like steel, he says.

In the meantime, carbon capture and storage technology is likely to gain in use to reduce emissions.

Alejandro Solé, the Milan-based chief investment officer at TechEnergy Ventures, part of the Argentine-Italian industrial conglomerate Techint Group, says carbon capture is “significantly cheaper and more competitive” than producing green hydrogen.

“In the long run, green hydrogen is a fuel that can serve many, many uses,” he says. “But when you go to the specifics of it, it’s not very competitive because it’s very expensive to produce. The amount of renewable energy that needs to be put in to deliver one kilogram of hydrogen to a client comes with many energy penalties in the middle. You’ve got to produce it. You’ve got to transport it, and you’ve got to deliver it.”

Solé sees more opportunities for green hydrogen as a feedstock for “making sustainable fuels, more than an actual fuel that can replace natural gas.”

With carbon capture technology, the carbon can not only be stored but monetized to make sustainable aviation fuel or mixed with steel slag to make construction materials, he says.

Political Support

Ninety One’s Christ says emerging markets will need the most financing for the transition, as they are the source of 60% of global emissions because developed economies have outsourced hard-to-abate industries there.

“When you look at where the growth of emissions is going to be over the next five, seven, 10 years, 90% of that growth is going to come from emerging markets,” Christ says.

When you look at where the growth of emissions is going to be over the next five, seven, 10 years, 90% of that growth is going to come from emerging markets.

Matthew Christ, Ninety One

The challenge is that emerging markets are less creditworthy, which limits investment flows or confidence. This is where multinational and development banks are helping to channel financing into transition projects, making them more attractive for private investors.

Even so, Christ says corporations in Latin America “have the ability and the willingness to implement these types of investment programs.” Many of these companies have been facing investor scrutiny on climate issues for the past decade, they’re now “best-in-class operators” that have made “massive progress in their carbon reporting, in their carbon commitments and their disclosure,” he says.

Broken down, however, some countries may benefit more than others, such as in energy transition projects, says Saverio Minervini, a senior director at Fitch.

Italian utility ENEL, for example, is selling its Argentine and Peruvian business to concentrate on Brazil, Chile and Colombia.

“They're only focusing on markets that have an energy transition plan that they can benefit from,” he says.

Energy Transition

Latin America stands to benefit from the global transition to net-zero. It is rich in copper, lithium, metallic silicon, rare earths and other materials for making electric vehicles, wind turbines and solar panels. With the Inflation Reduction Act, the US government is seeking to link the supply chain for decarbonization to the Western Hemisphere in the wake of the Ukraine war and tensions with China. Companies in Latin America, many of which have been producing these materials for up to 60 years, can grow their net operating income five to 10-fold over the next decade as the United States tries to gain a leading foothold in the manufacturing of the decarbonization trade, Christ says.

This raises the concern of the frequent economic, political and regulatory instability in some of the region, warns TechEnergy’s Solé.

“In all these capital expenditure-heavy investments, the cost of capital kills a lot of your dreams,” he says. “You don't want to be reshoring again in five years because the country doesn’t allow you to export anymore what you produced, or it doesn't allow you to actually get money out of the country to pay for the products you need for production.” LF