Financing the transition: Strategies for fossil fuel dependent economies

Global dependence on fossil fuels for electricity generation remains significant, with approximately 60% of the world’s electricity coming from these sources. This reliance is particularly pronounced in major economies. For instance, the United States derives 59% of its electricity from fossil fuels, while China and India rely on them for 65% and 75% of their electricity, respectively. Other key players such as Japan, Poland, and Turkey also show substantial dependence, with figures of 63%, 73%, and 57%, respectively. This widespread reliance underscores the critical need for efforts to reduce carbon emissions and promote sustainable alternatives.

Numerous global commitments have emerged to reduce dependency on fossil fuels and to address climate change. The Paris Agreement aims to limit global warming to well below 2°C, with efforts to cap it at 1.5°C, by driving countries to cut greenhouse gas emissions and transition to cleaner energy sources. At COP28, nations reinforced their commitment to phasing down unabated coal power and reducing fossil fuel subsidies, reflecting a growing consensus on the need for accelerated energy transitions. Additionally, over 140 countries, including major emitters such as China, the United States, India, and the European Union, have committed to net-zero targets, accounting for approximately 88% of global emissions. Further, the International Energy Agency (IEA) has outlined pathways to achieving net-zero emissions by 2050, focusing on diminishing fossil fuel reliance and boosting investment in clean energy technologies.

As these global commitments to reducing carbon emissions and fossil fuel dependency gain momentum, economies heavily reliant on fossil fuels would face a complex set of challenges. A report by the International Institute for Sustainable Development underscores the significant reliance on fossil fuel revenues in Brazil, Russia, India, Indonesia, China, and South Africa (BRIICS). It warns that this economic dependence could lead to substantial revenue shortfalls for these countries in the coming decades as the world transitions to cleaner energy sources to limit global warming to 1.5°C.

In this context, to adapt to the evolving energy landscape, and to steer the energy transition effectively, these economies must implement strategic measures to navigate the financial and structural hurdles of moving away from traditional energy sources while striving to maintain economic stability and growth. In this regard, following are several key financing strategies that help fossil fuel dependent economies to aid their energy transition.

1. Diversifying economic activities
The World Economic Forum highlights that diversification is key to building economic resilience. By investing in new industries, such as technology, renewable energy, and sustainable agriculture, countries can create alternative revenue streams and reduce their dependence on fossil fuels. This approach is particularly crucial for nations heavily reliant on fossil fuel production and exports. For example, Saudi Arabia, a major oil exporter, is actively pursuing economic diversification through its Vision 2030 plan, by investing in non-oil sectors, including manufacturing, renewable energy, transport and logistics, tourism, digital infrastructure, and healthcare. This strategic shift aims to reduce the nation’s reliance on oil and build a more resilient economy.
2. Leveraging international climate finance
Fossil fuel-dependent economies can tap into global climate funds, such as the Green Climate Fund (GCF) and the Global Environment Facility (GEF), to finance projects that mitigate greenhouse gas emissions and promote sustainable development. According to the GCF, these resources are crucial for enabling countries to undertake significant renewable energy projects and build climate resilience. By tapping into international funds, nations can accelerate their transition efforts. For instance, Tonga (Small Island Developing States), heavily reliant on imported diesel for 90% of its electricity, is transitioning to renewables with a $47.6 million Green Climate Fund project. This initiative aims to reduce fossil fuel dependence by installing utility-scale storage systems and green mini-grids, helping Tonga meet its 70% renewable energy target by 2030. Further, the project will avoid 265,100 tonnes of CO2 emissions and enhance grid stability, supporting a shift to a low-carbon energy system over its 25-year lifespan.
3. Implementing carbon pricing mechanisms
Carbon pricing mechanisms, including carbon taxes and cap-and-trade systems, can generate revenue while incentivizing the reduction of carbon emissions. By placing a price on carbon, governments can encourage businesses to adopt cleaner technologies and energy sources. The revenue from carbon pricing can be reinvested into renewable energy projects, energy efficiency improvements, and support for affected communities. The European Union’s Emissions Trading System is a prominent example of a successful carbon pricing mechanism that has led to substantial emissions reductions and provided funding for clean energy initiatives.
4. Encouraging green investments
Green investments, such as green bonds and green loans, play a crucial role in facilitating the transition away from fossil fuels by financing renewable energy projects and promoting sustainable development. By creating a favourable investment environment and offering incentives for green investments, countries can attract capital for clean energy projects. For example, In June 2019, Chile issued €861 million ($950 million) in 12-year green bonds, becoming the first sovereign Euro green bond issuer in the Americas. This issuance, part of a $2.5 billion program, funds projects in renewable energy and clean transportation, and supports Chile’s transition from fossil fuels.
5. Fostering public-private partnerships (PPPs)
PPPs offer another avenue for financing the energy transition. In these arrangements, governments collaborate with private companies to share the costs and risks associated with renewable energy projects. For instance, Norwegian state-owned energy company Equinor is utilizing its expertise in energy management to lead the development of hydrogen power plants, offshore wind farms, and carbon capture infrastructure across Europe. Similarly, the Scottish renewable energy sector has expanded by over 50%, driven by projects to establish wind farms throughout the country. This growth has generated more than 15,000 jobs, supporting workers transitioning from the declining fossil fuel industry. These examples illustrate effective approaches to managing the transition from fossil fuels to renewable energy.
The transition from fossil fuels to renewable energy is a complex but achievable goal. By leveraging carbon pricing, green bonds, public-private partnerships, international climate finance, and other innovative strategies, economies can secure the funding needed to support this critical shift. As nations around the world work towards a sustainable future, these financing mechanisms will play a pivotal role in enabling a cleaner, greener, and more resilient global economy.