Challenges persist in ESG financing for heavy industry transition

The landscape of environmental, social, and governance financing has seen notable progress in recent years, but several challenges persist, especially when it comes to supporting the transition of heavy industries. Sectors such as steel, cement, oil and gas, and petrochemicals face unique challenges due to their hard-to-abate nature with conventional electrification technologies, making the adoption of environmentally sustainable practices more complex. Consequently, their decarbonization strategies hinge on technologies like carbon capture, utilization, and storage and clean hydrogen, which require substantial capital investments to scale up.

According to the International Energy Agency’s net-zero pathways, achieving global net-zero emissions by 2050 requires a substantial financial commitment. Approximately a total of $5.3 trillion is needed for investments in CCUS, and an additional $10.3 trillion is required for clean hydrogen projects in the next three decades. However, the actual investments in these technologies remain far below these targets. 

As global transition investment reached $1.2 trillion in 2022 according to the Bloomberg New Energy Finance database, CCUS project investment received only $6 billion, with only $1 billion allocated to clean hydrogen projects. This stark difference between required and actual investments indicates a significant gap that needs urgent attention.

Government regulations and incentives have historically played a pivotal role in driving heavy industry decarbonization finance. Policies such as the Inflation Reduction Act in the US and the Carbon Border Adjustment Mechanism in the EU aim to incentivize businesses to adopt greener practices. The IRA offers payments to American businesses for each unit of carbon captured or hydrogen produced, providing a carrot for companies to invest in sustainable technologies. On the other hand, CBAM acts as a stick by penalizing imports into European markets with high carbon content, primarily products from carbon-heavy industries like cement, iron and steel, and hydrogen.

According to the most recent project data from the BNEF, many American, Canadian, British, and European along with some Asian companies have released various CCUS and clean hydrogen project announcements more recently. However, some 98 percent of these projects are in the very early stages and increasingly experience financing difficulties. It remains to be seen if these projects will soon become online or drop out along the way.

The challenges in heavy industry decarbonization financing go beyond technological uncertainties. Ambiguities and vague treatment of these technologies by the current global ESG practices impede the scaling up efforts of the much-needed external finance. The emerging global ESG standards under the International Sustainability Standards Board must address the vague treatment of technologies related to heavy industries by adopting a more inclusive, flexible and holistic approach. Clear guidelines and standards will help investors navigate the complex landscape of heavy industry transition, instilling confidence in ESG financing for these projects.

Another challenge arises from the increasing cost of capital due to global inflationary pressures. The cost of capital is a critical factor for the economic viability of projects, and the current inflationary environment poses risks to investor appetite, particularly for capital-intensive projects in heavy industries. Policymakers and financial institutions need to explore mechanisms to mitigate the impact of inflation on the financing of sustainable projects.

Supply chain issues further complicate the economic viability of projects, particularly in the case of green hydrogen. The availability and affordability of inputs, as well as the logistical challenges in establishing a robust supply chain, are essential considerations. Policymakers should focus on addressing these challenges to ensure the smooth transition of heavy industries to more sustainable practices.

At the core of these challenges is the need for consolidating global standards and certifications for carbon capture and storage, as well as hydrogen production. Standardization will create a level playing field for companies and investors, reducing uncertainties, and encouraging more significant investments in sustainable technologies.

However, amidst these challenges lie significant opportunities. Policymakers need to adopt a more comprehensive vision that considers the broader benefits of successful heavy industry decarbonization. These sectors are integral parts of global supply chains, and disruptions in their transition to sustainability can have cascading effects on various parts of the economy and the financial system. For instance, the asset portfolios of banks, insurance companies, and equity markets in most advanced and emerging economies have significant exposure to these sectors.

According to a recent European Central Bank study, European banks have a loan exposure of around 60 percent to high-emitting firms, potentially in heavy industries. Despite ongoing ESG trends and efforts, the share of high-emitting firms’ securities held by the European financial system is still above 30 percent. The potential disruption in asset values caused by a disorderly transition in these sectors can be a trigger for the next economic turmoil. Policymakers should carefully manage the transition, considering the broader economic implications and implementing measures to avoid sudden shocks to the financial system.

In conclusion, while challenges persist in ESG financing for heavy industry transition, addressing these challenges presents an opportunity to drive meaningful change. Policymakers, financial institutions, and the investor community need to work collaboratively. A successful transition in heavy industries will not only contribute to global sustainability goals but also safeguard the stability of the global economy.

• Dr. Yilmaz currently works as a Fellow in the Climate and Sustainability program at KAPSARC. Prior to joining KAPSARC, Dr. Yilmaz worked as an economist at the Central Bank of the Republic of Turkiye, where he was actively involved in the research and the design of policies for the private and banking sectors.