Financing the energy transition

Innovation contributes to reducing the costs of the energy transition.

The energy transition requires significant investments in low carbon technologies. Technological progress is steadily reducing investment costs. At the same time, the energy transition also encompasses a shift from operational to capital expenditures. Support and knowledge among investors will provide extra incentives to finance the energy transition.

In many cases, energy from renewable energy sources are cheaper alternatives to fossil fuels. For example, in recent years the costs of solar and wind energy have fallen more than expected. In some cases, these costs are already cheaper than the cost of generating electricity in coal-fired power stations. Due to continuous investments in innovation, the cost reductions in solar and wind energy will continue in the coming years (Faaij and van den Brink, 2019).

Even though cost reductions allow solar panels and wind energy to compete with fossil fuel alternatives, there are more reasons for the energy transition to take place. Positive effects on air quality, limiting quakes in Groningen, reduced noise pollution from electric transport and reduced CO2 emissions from clean energy generation are all examples of benefits that are only partly expressed financially. A green energy supply also ensures that less money is spent on importing fossil fuels from unstable regions. When financing the energy transition, the challenge is therefore to include such factors that are not directly reflected in a cost comparison in the investment decision.

Risks must be identified to improve investment decisions and to reduce financing costs.

Costs incur when securing the necessary finances for investments. These costs are higher, the higher the risks that the investment will not pay back or will not fully recover. When technologies become more mature and proven, the risks are lower, which in turn lowers the investment costs. In some countries, it is easier and less risky to borrow money from the bank than in others. Clear and consistent government policies can help to reduce risks and impact the business case.

Knowledge plays an essential role in correctly assessing risks: it is important to consider which investments will no longer be profitable in the future. For example, an early closed coal-fired power station can be a significant unexpected cost item for an investor who still expected revenues for years to come. Analysis and research can largely remove uncertainties surrounding investments, reduce the perceived risks and thus reduce the costs of the energy transition.

A higher share of capital investment costs relative to operational costs in energy will lead to additional financing costs.

Renewable energy is largely generated via solar and wind energy by installations that require a lot of capital and minimal annual operational and fuel costs. This is in contrast to energy from installations using fossil fuels where fuel costs form a much larger part. The energy transition is therefore in many cases a transition in the structure of the costs of energy generation, from more operational expenditure to capital expenditure. An exception is biomass as a renewable energy source, where fuel costs remain an important component. As investments will become a greater cost item in energy expenditure, interest on borrowed money will also become more important. This ensures a relatively larger share of financing costs in the costs of the energy transition.

Clear and ambitious policies can reduce risks, reduce financing costs, and thus accelerate the energy transition.

Lowering the financing costs will attract additional investments. Clear, stable and transparent policies will contribute to reducing uncertainties surrounding investments. Clear policies also have a signal function: it lowers the risk of investments whose business case depends on existing and future energy policy. For example, an announcement of an extension of the Dutch net metering scheme is likely to have direct consequences for investments in solar panels. If the same policy is followed but not announced, potential buyers do not know where they stand. Whatever measures are taken, by credibly announcing additional climate policies, uncertainty will be removed and the number of greener investments will increase.

In addition to direct subsidies in places where the energy transition is not independently profitable, the government can also invest itself. When the government itself invests in companies and institutions that support the energy transition, this says something about future regulation. The next cabinet will be less inclined to change course if it has already invested in green technology and makes its investments less valuable.

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