Dr. Sijesh Aravindhakshan
Economist
Domestic Analysis Department
Saudi Aramco
A green bond is a fixed-income financial instrument designed to channel investment into ecologically sustainable projects that address climate and environmental challenges. According to the World Bank, bonds issued to finance projects that focus on mitigating or adapting to climate change are classified as “green.” Mitigation projects include solar and wind energy installations, waste management to reduce methane emissions, and afforestation. Adaptation projects include initiatives such as watershed management to prevent flooding, climate-resilient agricultural systems, and sustainable forest management. The International Finance Corporation (IFC) also supports projects to conserve biodiversity and protect oceans and water resources.
The transition to a low-carbon economy will require trillions of dollars of investment, and green bonds are expected to play a critical role in financing clean energy and other sustainability-focused projects now and in the future. Green bonds serve two main purposes: generating financial returns and advancing environmental goals. At the corporate level, the issuance of green bonds introduces an additional layer of accountability through third-party verification. In addition, the issuance of green bonds cultivates a pool of environmentally conscious investors, thereby increasing the dynamism of financial markets.
Let’s explore the global market for green bonds. Since the European Investment Bank introduced the concept in 2007, green bonds have made significant progress in supporting climate-related programs and initiatives. According to the Climate Bonds Initiative, total green bond issuance reached $2.8 trillion by the end of 2023, reflecting the growing interest in sustainable finance. Green bond sales have grown steadily over the past decade, with a notable exception in 2022. Last year, green bond sales increased by 15%, driven by expectations of lower interest rates in the US and Europe.
According to reports from the Climate Bonds Initiative, over two-thirds of the proceeds from green bonds are being invested in the energy, buildings, and transport sectors. Recently, the transport sector has seen significant growth, doubling its share to account for over a fifth of total green finance by 2023. Although investment in water and waste management has risen sharply since 2020, its overall share remains small compared to other sectors. Conversely, the allocation of green bonds to investments in the building sector has declined from 2021, falling from 29% to 18%.
Geographically, Europe leads with almost half of all green bond issuance, followed by the Asia-Pacific region and North America. Latin America and Africa continue to have relatively small shares. In terms of individual countries, the US, China, and Germany top the list, with other European countries following closely behind. Saudi Arabia ranks 24th in terms of green bond issuance, reflecting its growing role in the green finance landscape.
According to the Saudi Ministry of Finance (MoF), meeting the country’s climate commitments will require significant investment from both the public and private sectors. Green bonds are an important tool for financing projects that will help reduce emissions by 278 million metric tons of CO2 per year by 2030 and achieve net-zero emissions by 2060. The Ministry of Finance and the Public Investment Fund (PIF) have established a Green Financing Framework (GFF), which outlines priority areas for investment in line with Vision 2030 and the Nationally Determined Contributions under the Paris Agreement. The GFF is aligned with the Green Bond Principles (GBP) 2021 and focuses on eight key sectors, including renewable energy, clean transport, and sustainable water management. Under this framework, the PIF has issued six green bonds, totaling $8.5 billion as of September 2023, with the proceeds used to finance environmentally sustainable projects.
Research indicates that both companies and investors gain from green bonds. In a study of 1,070 green bonds issued by 464 companies, Badia, Cortez, and Silva found that companies issuing green bonds experience better short-term stock performance than those that do not, as investors value the green attributes that signal a company’s commitment to sustainability. Green bonds are often associated with a “green premium” where the investors may accept lower returns for the benefit of sustainable investment. However, the green certification impacts the green bond premium and varies by bond rating and other factors. For example, AAA-rated green bonds usually have a higher financing cost and a BBB-rated green bonds have lower financing cost when compared to similar conventional counterparts (Wu, 2022).
Given Saudi Arabia’s robust economic growth and strong credit rating, green bond issuance is expected to increase significantly, facilitating the financing of critical energy and environmental projects. With one-third of global green bond proceeds allocated to the energy sector, Saudi Aramco has the potential to issue green bonds to broaden its investor base and diversify its funding sources. This strategy would improve the company’s access to capital, promote long-term sustainability, and contribute to climate change mitigation and adaptation efforts. By issuing green bonds, Saudi Aramco would further align with the country’s Nationally Determined Contributions (NDCs), thus reinforcing Saudi Arabia’s position as a key player in the global green finance movement.