Financing the energy transition

A successful global energy transition will require trillions of dollars of infrastructure investment globally.

To meet the world’s climate goals, transitioning to a clean energy system needs to happen, and it needs to happen fast. Implementing climate and energy targets will require coordinated global action in many domains, including capacity building, institutional strengthening, and arguably most importantly financing. Transitioning to clean energy will require cumulative investments of trillions of US dollars globally. Average annual additional investments in the EU alone are expected to be roughly €180 billion between 2011 and 2030 to achieve the EU’s stated climate and energy goals. Planbureau voor de Leefomgeving (PBL) has estimated that around €200-300 billion of investment will be needed between 2020 to 2040 in the Netherlands to achieve emission reductions of 80-95% from 1990 levels by 2050.

These financing requirements are substantial, and research clearly shows that current investment levels are insufficient to meet the Climate Goals.

Given the scale of investment required to achieve global, EU and national climate and energy targets, it is clear that limited public budgets will not be enough, especially taking into account the competing uses of these funds to address other economic and societal challenges. A large proportion of the required investment levels must come from the private sector in the form of companies and institutions. In particular, institutional investors such as pension funds, insurance companies, and investment banks, that have trillions of euros in Assets Under Management (AUM) could play a critical role in providing the amount of capital needed for a successful energy transition.

Although these institutions have vast amounts of capital at their disposal, finance is currently not flowing towards the energy transition at the rate and scale that is needed.

Innovation contributes to reducing the costs of the energy transition.

Technological progress is steadily reducing investment costs. 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 and mitigated to improve investment decision-making and reduce financing costs.

Financing costs are higher, the higher the risks of an investment. When technologies become more mature and proven, these risks are better known and risk mitigation measures are more common, which in turn lowers the financing costs of investments .

Knowledge plays an essential role in correctly assessing and mitigating risks. For example, an early closure of a coal-fired power station can be a significant unexpected cost item for an investor who expects revenues for years to come. Analysis and research can help to remove uncertainties surrounding investments, reduce perceived risks, and thus reduce the costs of financing the energy transition.

A higher share of capital investment costs for sustainable energy assets, compared to assets based on fossil fuels, will lead to additional financing costs.

Sustainable energy asset investments are characterised by high up front capital costs and minimal operational and fuel costs. This is in contrast to installations using fossil fuels where fuel costs form the lion’s share of total costs. An exception is biomass as a renewable energy source, where fuel costs remain an important component. As large capital expenditure is required for a successful energy transition, financing costs will become increasingly important.

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

Clear, consistent, and transparent government policies will contribute to reducing uncertainties surrounding investment in the energy transition. These policies can also have a signaling function: by lowering the actual and perceived risks 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. Credible, consistent, transparent climate and ‘green’ energy policies will help to remove uncertainty and scale up and accelerate investment in the energy transition.