Financial innovation: How to fund industrial decarbonization

As sustainability targets get translated into action plans, energy-intensive industries are having to grapple with a key challenge of the transition to low-carbon operations. A challenge that keeps Sustainability Leaders, Production Managers, Technical Directors, and CFOs busy is how to fund the required decarbonization measures. It’s a daunting prospect that often stalls progress.

However, innovative approaches are emerging to help move the needle on the necessary investment. In this article, we provide a quick overview of six steps to a comprehensive funding approach.

Increasingly, some companies are changing their ROI thresholds for decarbonization investments. Instead of being subjected to the same standard as general infrastructure CAPEX – a return in 2 to 3 years, companies are raising the threshold to 4-6 years. This practice is becoming more commonplace to enable companies to make initial investments in energy efficiency.

The justification for such changes rests with how these investments still pay for themselves in the short-to-medium term, but also provide immediate value in terms of meeting short-term GHG reduction targets.

With lower ROI thresholds for approval, a lot of low-hanging fruit measures can be financed directly out of CAPEX budgets. When imagining a typical Marginal Abatement Cost Curve (MACC), these are the measures that fall on the left side of the chart and immediately generate savings that lead to quicker ROI.

Blending of different energy efficiency measures with higher and lower ROIs in a package of upgrades can help achieve target ROI. Often, these measures include energy audits, automation software, optimization of motor systems, and others.

Energy as a service (EaaS) structures can be used to pay for decarbonization measures out of OPEX budgets, without impact on balance sheet. These contract structures allow companies to outsource design, construction, and operations and maintenance of systems to a third-party provider, while receiving efficiency, performance, and other guarantees in return.

Typically these contracts generate savings from day 1, do not require any capital outlay, and have no impact on balance sheet. Medium-cost measures, such as technology retrofits and electrification of process heat, can be a good candidate for such contracts.

All or some savings from CAPEX investments and EaaS projects can be locked into an internal green fund to save for most expensive decarbonization measures down the line. Given ongoing innovation in industrial decarbonization technologies, these funds can be saved until technologies mature and are commercially proven at scale.

Zero and low carbon fuels, carbon capture, and other technologies can be good candidates for this funding vehicle. In addition to being replenished by savings, a revolving green fund can also be financed through internal carbon pricing.

An additional tool available for companies that are looking to re-allocate funds to decarbonization projects is internal carbon pricing. One of the approaches of carbon prices is to set the price for a ton of emitted carbon and then collect it as a fee from different business units.

The collected funds are then used for decarbonization projects across the business. Internal trade systems and allowances can be used to help departments manage their carbon footprint. In addition to helping fund decarbonization projects, internal carbon prices also incentivize adoption of more carbon-saving measures from within the business.

For any outstanding capital needs, companies can consider sustainability bonds. These bonds are linked to the achievement of climate targets, are issued by companies, as well as for specific assets and projects, and can be unsecured or secured by a specific asset. These bonds allow companies to secure lower cost of capital than traditional debt.

In combination, these measures can pave the way for a feasible decarbonization roadmap that allows companies to maintain their bottom line.

When combined with strategic focus on new revenue opportunities in sustainable products and services, available incentives from the IRA, and other approaches, decarbonizing energy-intensive operations doesn’t have to be an immediate tradeoff with profit.