3 smart ways investors can better play the transition to net zero emissions

According to the Paris Agreement, the world needs to reach net zero by 2050. But there is little progress so far. Transition to net zero is not just a challenge, however, but also an opportunity for investors if they know how to seize on it.

Here are some simple suggestions for investing in the climate cause instead of competing in saturated markets or chasing expired opportunities. 

The grid bottlenecks

Investors tend to focus on solar and wind energy projects, while the real investment opportunities lie within grid upgrades and connectivity.

Alternative energy has been a topic of interest and a main trend for investors for at least a decade, if not more. However, the focus on increasing alternative energy capacity has led to a situation where this energy has nowhere to go.

The networks in Europe are old, and their capacity is low. For example, in the Netherlands, according to Tennet, the increase in transformation capacity will be completed between 2026 and 2029, so new projects might face connectivity jams, leading to delays until 2029.

Looking more broadly, at least 3,000 gigawatts of renewable power projects worldwide, including 1,500 GW in advanced stages, are waiting in grid connection queues—equivalent to five times the amount of solar PV and wind capacity added in 2022.

If you are a conservative investor wishing to keep money “home”, there are more opportunities and higher returns in solving the distribution problem. In the EU alone, an investment of a total 400 billion euros is required in distribution grids, with a significant chunk for infrastructure upgrades.

Additionally, a few billion should be allocated to asset-light businesses, in which private equity typically invests, such as cybersecurity, remote control and digitalization.  Some private-markets fund managers that focus on these areas include Arborview Capital, Greenbelt Capital Partners, BlueWater PE, HitecVision, Riverstone, RG GreenInvest, BlackRock Temasek Decarbonisation Partners, and others. 

Geopolitical dilemma

Investors prefer to allocate their funds to climate projects within the EU and U.S., while they are most needed and present more opportunities in developing countries. Where are the main investments in reducing emissions going right now? If you check the list of 10 countries leading the energy transition and the list of 10 most polluting countries, you will see no coincidences. Not a single one.

Most investments still go to Europe, where emissions are already decreasing, as investments in European countries are considered clear and safe. How, then, will we achieve net zero globally if our focus is solely on developed countries?

However, for a country to be on the list of the 10 most polluted countries presents both a problem and an opportunity. Take China as an example. For the last 20 years, it has always been at the top of this list.

Fifteen years ago, China encouraged the foundation of multibillion-dollar enterprises that are now actively investing in climate tech scale-ups destined to become future climate market leaders. Currently, China has installed more solar panels than the United States, and Premier Li Qiang has stated that the construction of wind, hydroelectric and solar panel farms is among the country’s priorities.

Western investors should research opportunities in the rapidly growing developing industrialized countries and act quickly, or all opportunities will be seized by local investors. The best course of action is to look to local venture or growth capital funds while there is still room in the market.

Asian climate-focused private markets managers have a smaller product offering compared to Europe and the U.S. (in terms of amounts under management) but are emerging at a quick pace. Some prominent names to follow include NIO Capital in China, Trirec in Singapore, and GEF Capital in India.

There are also a number of Europe-based private equity firms focusing on emerging markets, such as ResponsAbility’s Emerging Markets-focused Food & Ag fund.

Industry investment disproportion

Investors prefer to allocate funds in industries where decarbonization solutions already exist and are easy to implement, while the most significant impact and returns are expected in other industries.

Currently, investor capital mainly goes into more regulated sectors, such as transport, energy and mobility, where relatively smaller investments can yield visible changes. These sectors are heavily regulated, so companies are more keen on finding solutions, and a range of different technologies for decarbonization are already being applied.

Meanwhile, industries like food/agriculture, construction, and the built environment receive the least amount of venture capital, even though they need it the most. Emissions from these three industries account for 73% of the total, yet they received only 26% of investment in Q4 22 – Q3 23 (and even less in the previous 10 years).

As a result, our overall decarbonization progress is stagnating because improvements in transport or energy alone will not suffice. However, if we look at the results of some private equity funds specializing in these heavy-emitting sectors, we see a net internal rate of return track record of more than 15% for their investors.

For example, according to calculations by the Drawdown project, the adoption of Regenerative Annual Cropping solutions could provide $2.34 trillion to $3.52 trillion in lifetime net operational savings and lifetime net profit of $134.40 billion to $205.35 billion on an investment of $77.10 billion to $115.27 billion by 2050.

Both heavy industries and investors will benefit from increased investments, as they have the potential to provide the necessary breakthroughs for overall decarbonization. Investors might switch to products offered by more mature private equity funds targeting heavy-emitting sectors, such as Blume Equity, Conservation Resource Partners, Peakbridge, Ara Partners, Circularity Capital, Closed Loop Partners, and others.

Such funds have an overall lower risk and a more diversified return profile, which can be acceptable to a broader investor base with low risk tolerance.

Read more: 10 global companies leading their sectors on climate change