Rewiring the financial system to double down on the energy transition

A wind power project in Ninh Thuan, Vietnam.

Two outcomes of today’s crisis

The war in Ukraine has thrown into sharp relief the need for secure and reliable energy supply. Meanwhile, the latest reports from the Intergovernmental Panel on Climate Change (IPCC) are a grim reminder that we will likely reach 1.5°C of global warming sometime in the 2030s.

With today’s double global crisis of energy security and climate change, it’s human nature to face off the one that is right in front of us. How is it possible to roll off Russian oil and gas without investing in new fossil fuel capacity elsewhere; and how do we marry this against the International Energy Agency’s (IEA) 2021 call for no new oil and gas reserve development to make net zero by mid-century possible?

We are in new territory here – an overnight major shift in how countries think about their energy resilience against the backdrop of a multi-decadal, yet equally urgent energy transition.

Even before the war, we were looking at an “unsynchronised transition”. Renewables have not grown fast enough to match the required drawdown in fossil fuel use, particularly coal, in a decade where energy generation needs to increase 40% to meet demand. Now the challenge has ballooned.

There are two indisputable outcomes of today’s crisis: first, we need to rapidly accelerate the energy transition – unlocking capital globally for clean energy and storage, electrification, and energy efficiency; and second, we need to design-in resilience and better understand the role of fossil fuels in the transition. The latter includes the carbon intensity of different fossil fuel sources and producers, and the evolution of carbon removal technologies, as well as tackling the grey areas of what constitutes new oil and gas versus maintenance investment to maximise the output of existing reserves. The financial sector will be critical players in both, and will need to work in partnership with government, industry, and the scientific community to get the right outcome.

Finance rewired towards energy transition

The emergence of the Glasgow Financial Alliance for Net Zero (GFANZ) last year was a seismic shift for the financial sector. GFANZ includes over 100 banks with “net zero by 2050” commitments, and science-based 2030 targets that cover the financed emissions of the customers they serve. Finance is perhaps one of the most competitive sectors in the world, but here the case for cooperation is undeniable: as banks we all face the same systemic risk, and we have a shared customer and community base that needs to transition. Now we must all completely rewire our business decision-making and inject new skills. “Financed emissions” is a new metric we need to drive down, and a client’s transition plan will be critical to client engagement and decision-making.

Unsurprisingly, the thorny issue of fossil fuel financing grabs the headlines as stakeholders look for evidence on the reliability of banks’ net zero commitments. It’s not a black and white subject. Some incumbent oil and gas companies are looking to pivot their skills and market strengths to become critical players in the transition as integrated energy companies. And let’s not forget that according to the IEA, a net zero energy system by 2050 still has oil production (at 25% of today’s levels) and gas production (at 50% of today’s levels). Maintenance investment will be needed in this transition: the IEA says this will require “upstream oil and gas investment averaging $350 billion per annum from 2021-2030, similar to levels in 2020”, and then declining to about half that after 2030. That said, the IEA and IPCC present a very clear red line of no new oil and gas reserves or coal mines if the world is to reach net zero by 2050.

At HSBC, we made an explicit commitment this March to “phase down our financing of fossil fuels to what is required to limit  the global temperature rise to 1.5°C”. This includes our policy to phase-out thermal coal financing in the EU/OECD by 2030, and worldwide by 2040 as well as releasing a wider energy transition policy later this year. It also means achieving our short-term financed emissions targets for the energy sector and engaging with every oil and gas major and large power and utilities customer on their transition plan over the course of the next one to two years, and continuously thereafter.

Dr. Celine Herweijer, Group Chief Sustainability Officer, HSBC

The Science Based Targets Initiative (SBTi) recently launched the “Net-Zero Foundations for Financial Institutions” report, including guidance for financial institutions on how to address fossil fuel finance in the context of net zero targets. The SBTi recommends “engagement with fossil fuel companies to adopt net zero targets and action plans,” as the “priority for financial institutions to influence fossil fuel company GHG emissions,” with “divestment (only) for companies unable and unwilling to decarbonise”. This is the approach we are taking: we will assess whether to continue to provide financing for a client if no transition plan is forthcoming, or if, after repeated engagement, the transition plan is not compatible with a 1.5°C pathway.

Unlocking trillions per year

HSBC has a huge footprint and more than 150 years’ history in Asia – a region that will make or break the world’s ability to get to net zero on time. Here the cost of transitioning just the energy system to net zero by 2050 is estimated at $37 trillion from 2020-2050.

However, the hard truth is that investment into the energy transition isn’t happening fast enough, in Asia and elsewhere. Our goal, working through GFANZ and other organisations, must be to break the pattern of under-investment in green assets. There are three principal ingredients to this:

First, the current energy crisis should catalyse better and more consistent policymaking to de-risk investment into renewables and wider clean energy – whether large-scale consistent carbon-pricing, long-term auctions with trusted counterparties, or a supportive and consistent balance of feed-in tariffs, subsidies, and other price incentives.

Second, we must unblock the pipeline of sustainable investment projects. Investors often find it difficult to ascertain whether a project is truly green; disclosure standards are weak and uneven across different jurisdictions. Where appropriate, public finance should de-risk projects to attract further private investment – so-called “blended finance” – whether that is providing a development guarantee or taking a first loss tranche. Through GFANZ, we can build new partnerships to help overcome these problems. We need new creative solutions to accelerate investment into clean infrastructure, but also for the early retirement of legacy coal assets.

Third, regulators can better align prudential capital rules to a net zero agenda and thereby address systemic risks in the sector. The transition risks of “brown assets” being identified in the current rounds of prudential climate stress tests need to be looked at symbiotically with the risk of underinvestment in the “green” (such as renewables deployment, clean fuels, or electrification infrastructure) which could prevent an orderly transition. Current capital treatment inhibits financial institutions from scaled balance sheet backing of critical nascent climate technologies or the long-tenor large-scale project financing vital to building the clean, equitable and resilient energy, mobility, infrastructure, and industrial systems of the future.

A rewiring of the financial system towards energy transition is underway which should dramatically improve our ability to reach net zero in time. It’s early days though, and there is a lot to be worked through which will require radical collaboration – between banks and their customers, their investors, and critically also with regulators and scientific bodies. But “business-as-usual” has changed: the financial world now understands that it must be at the heart of the transition to net zero.