Investment estimates for 2020 continue to point to a record slump in spending

Investment in fuel supply continues to be hit hardest, with upstream oil and gas spending set to decline by 35%. This somewhat weaker outlook stems from cuts of around 45% by shale companies in the United States, which have experienced a surge of bankruptcies, layoffs and shut-ins, as well as a 50% jump in financing costs. These conditions have set the stage for consolidation of businesses in the hands of fewer, better capitalised players, typified by the recent merger announcements between Chevron and Noble Energy and Devon Energy and WPX.

Investment by oil and gas majors is down by around one quarter. Despite manageable borrowing costs, the extra hits to revenue from lower prices and demand, together with investor pressure, are forcing a focus on high value projects with relatively quick cash flow benefits. National oil companies, who comprise 55% of production, have sharply cut investment, but on average less than the overall decline.

Spending is better supported in producer economies with some financial buffers, such as Saudi Arabia and Russia (where companies benefit from currency depreciation and flexible taxation) compared with those, for example in Africa, that are under more budgetary strain from heavy reliance on hydrocarbon revenues. However, financial pressures have prompted even some relatively strong players to turn to new funding strategies, such as Adnoc’s USD 10 billion sale of its stake in its gas pipelines business.

Some oil and gas companies are responding to such pressures by stepping up diversification efforts, guided by new long-term emissions goals. While these vary in scope and ambition, several European majors have increased capital guidance for low-carbon projects. Investment commitments are most visible in renewable power, where USD 3.5 billion of final investment decisions (FIDs) have been taken by oil and gas companies in 2020, two-thirds higher than their capital spend outside of core areas in 2019.

Near-term decisions to finance low-carbon fuels and carbon capture are facing more of an uphill struggle, though momentum is being supported by sustainability goals, projects under development (potentially representing over USD 25 billion of CCUS investment to 2030) and new funding announcements, such as for Norway’s Longship project.

Recent years have seen a wave of interest in liquefied natural gas (LNG), including a pivot towards more equity financing, which has sped up project sanctioning. This trend reflected strong demand expectations and a view among investors that this type of investment is relatively resilient to more ambitious climate scenarios. But no FIDs for new projects have emerged in 2020. That said, a record $18 billion of refinancing and acquisitions through August reflects efforts to better position this segment for the future.

We now expect that power generation investment is set to decline by 7% in 2020, a somewhat more optimistic assessment compared to the 11% fall envisaged in May, mostly due to better prospects for low-carbon generation. Annual spending for renewable power is now seen down by only 3% compared to the prior year, supported by continued development of large projects with long lead times, such as offshore wind (where several large North Sea projects recently closed financing) and hydropower.

A rebound in second quarter FIDs also supports stronger investment expectations for utility-scale solar PV and onshore wind. The boost is concentrated in advanced economies, where favourable monetary conditions, improved technology maturity and policies supporting reliable cash flows have reduced the cost of capital over time. Our analysis of utility-scale solar PV suggests the pandemic has pushed up financing costs in 2020, but with the cost of capital still around 5% in the United States and Europe, generation costs associated with FIDs with revenue support remain mostly below that for new gas-fired plants. Greater risks to renewables investment persist in emerging market and developing economies where state-owned utility counterparties are under financial strain and some markets, such as Brazil, have put off capacity auctions, though project sanctioning has so far remained relatively robust in India.

Such risks also contribute to continued weakness for spending on coal-fired power. Despite an uptick in FIDs to over 10 GW in the first half of 2020 and announcements from China of a larger set of permitted projects, coal power investment appears to be at its lowest level in over 15 years. Investments in new gas power have become less viable in a lower demand and price environment for wholesale markets. At nearly 25 GW in the first half of 2020, FIDs remain much higher than those for coal power, but are still trending near decade lows, with a fall-off in the United States.

Investment in electricity networks is set to decline for a fourth straight year. Higher renewables investment and modest grid spending growth in China through the first eight months of 2020 support a moderately improved estimate of a 6% decline compared with the 9% estimated in May. Rising shares of variable renewables during the pandemic have brought system reliability and resilience more into focus. Utilities in advanced economies also face few difficulties in accessing finance, in part due to the regulatory buffer provided by grid assets. However, grid operator revenues dipped across major economies in the first half of the year and growing vulnerabilities for state-owned utilities in developing economies creates risks for timely future investments. Meanwhile, battery storage investment is proceeding at nearly the same pace as in 2019, with a large project pipeline likely to support growth next year.

Spending on energy efficiency improvements is set to decline by around 9% in 2020, compared with an earlier estimate of 12%. Higher expectations for 2020 economic growth have somewhat damped spending declines in China and advanced economies. While sales of new cars are expected to have fallen by more than 10% compared to last year, fuel economy targets and zero emissions vehicle mandates are supporting EVs, whose annual market share is anticipated to reach 3%. The resumption of annual growth in industry and construction activity in China since the second quarter buffers these areas, but global momentum depends on the integration of efficiency measures into recovery strategies, such as efforts under consideration in Europe to use financial instruments and performance standards to stimulate widespread buildings renovation.

At the same time, growing income uncertainties are inhibiting consumers from taking advantage of low interest rates for mortgages and car loans in advanced economies while progress in expanding efficiency-related finance offerings in developing economies is likely to slow. Refinancing of smaller-scale energy assets (e.g. efficient housing, distributed solar PV) through asset-backed securities issuance has fallen to its slowest pace in four years, sapping the ability of banks and developers to redeploy scarce capital. Lower energy prices have extended payback periods for key energy efficiency measures by 10-40%, undermining the case for interventions by energy service companies and the financial health of independent players. In the near-term, efficiency spending is more reliant on direct public finance and utility obligations, as well as on efforts to reduce energy consumption subsidies.

Overall capital expenditures for clean energy have remained static in recent years at around $600 billion per year. Falling costs for key renewable technologies have put downward pressure on this figure. There are also a rising number of sustainable finance initiatives and taxonomies, and evidence that associated investments can deliver better risk-adjusted returns for investors. But these trends have yet to make a visible impact in pushing capital expenditures up. Even though the share of clean spending is set to jump in 2020, this stems more from weakness in fossil fuel-related investments, with levels far short of what would be required to put the world on a more sustainable pathway, discussed more in detail below.

Overall, China remains the largest market for investment and an area where prospects have improved since May, with potential additional support from recent state announcements to boost multi-year investment in electricity grids, pipelines, nuclear and “strategic emerging industries”, such as battery storage and EVs. Investment conditions have also improved in Europe, notably on the back of higher spending expectations for renewable power, electricity networks and efficiency, even as the region still registers double digit percentage declines in overall capital spending. Despite higher expectations for renewables investment, the United States remains the market with the largest investment decline due to a sharp reduction in oil and gas investment.

Investment prospects have worsened in emerging market and developing economies, notably India, Latin America, Southeast Asia and sub-Saharan Africa. While some pressure on currencies and sovereign bond yields from rapid capital outflows during the crisis has subsided, economic risks and pressure on state-owned enterprise balance sheets, responsible for the bulk of energy investment, are translating into higher financing costs in these regions. In countries such as South Africa, Indonesia and Brazil, changes in financial indicators observed in the first-half of 2020 would translate into a 10-25% increase in generation costs for an indicative onshore wind investment, depending on local conditions.

The slump in energy investment is likely to have major repercussions for energy markets in the coming years, even though the economic downturn is also putting downward pressure on demand. Based on the announcements made thus far, recovery policies designed to boost investment do not generally have a strong energy or sustainability component, with the notable exception of those in Europe, Canada and a few other countries. As governments consider ways to mobilise private capital, they will need to consider three major investment issues.

First, the future energy system will require significantly more capital to ensure that supply is both reliable and adequate to meet demand. Under the IEA’s Stated Policies Scenario, energy supply investment would rise to nearly $1.9 trillion within ten years, from $1.3 trillion in 2020, with higher levels required to meet the accelerated emissions reductions goals of the Sustainable Development Scenario (SDS). 

Second, meeting sustainability goals would require a dramatic shift in capital allocation across sectors. The share of clean energy in total investment would need to rise to around two-thirds by 2030, accompanied by a dramatic scale up in clean power, electricity grids and demand-side sectors.

Third, much greater investment is needed in emerging market and developing economies, especially beyond China. There are developing economies with strong records of attracting investment in renewables, as illustrated by the surge of solar PV in India. Yet, global financial capital is concentrated in advanced economies. Progress hinges on better linking sources of sustainable finance with the areas of greatest need, and aligning these sources with the requirements of companies and assets. Our first detailed analysis of the capital structure of energy investments points to growing needs for both equity and debt, but with a higher level of reliance on debt-based financing in the SDS as a result of the increased emphasis placed on power projects and spending on demand-side technologies and efficiency improvements.

While public finance has an important role to play, via development and green banks, more than 70% of clean energy-related investment in the SDS is likely to come from private sources of capital, incentivised by appropriate market design, regulatory frameworks and policy incentives. In developing economies, in particular, improving the bankability of projects and the ability of companies to raise funds will have an important part to play in managing the affordability of clean energy transitions.