3. Financing the energy transition
The first major obstacle for energy transitions is attracting financing for renewable energy projects and innovation. Fossil fuels still dominate energy investment worldwide, and fossil fuel investments undercut renewable energy investments until recently. The cost of bioenergy-for-power, hydropower, geothermal and onshore wind projects commissioned in 2017 largely fell within the range of generation costs for fossil-based electricity. The International Renewable Energy Agency (IRENA) reports that some renewable energy projects have started to undercut fossil fuels.
Initial policies to incentivise investors to fund renewable energy projects were implemented through government support schemes. Three types of support mechanisms are widely used: feed-in-tariffs, tax incentives (including subsidies and tax deductions), and tradable green certificates.
Feed-in-tariffs offer a long-term purchase agreement for the sale of renewable electricity, and this has been one of the most widely used and effective instruments in promoting renewable energy deployment in Europe. However, as technologies mature, the EU requires feed in tariffs to be replaced by feed in premiums and other support instruments that incentivise producers to respond to market developments. Tax exemptions are also used as a fiscal incentive measure to enhance renewable energy deployment in many countries. These incentives can be provided at the investment, production or consumption stages of renewable electricity projects. Green certificates are a mechanism created by state statute or regulatory action to make it easier to track and trade renewable energy. They can be traded, bought and sold separately from commodity electricity. Green Certificates represent the environmental attributes associated with one megawatt-hour (MWh) of electricity production. Green Certificate systems can support a market-based and flexible approach to expand renewable energy investment.
Despite the significant cost reductions (as technology matures) in renewable energy projects, a worldwide transition to a low-carbon energy future will not be cheap. The EU provides public funding for clean energy through a variety of programmes and instruments. Developing economies will require large-scale infrastructure investments to achieve the SDGs and the Paris Agreement.
In response, Green Climate Fund (GCF) a global fund created to support the efforts of developing countries to respond to the challenge of climate change, was established in 2011 by the 194 countries who are parties to the UNFCC. GCF helps developing countries limit or reduce their GHG emissions and adapt to climate change. GCF has a growing portfolio of projects that are driving this clean energy transition. They provide concessional climate finance to mobilise private sector investment, while supporting developing countries in establishing the policy frameworks to enable renewables to enter the energy mix at scale. All developing countries are eligible, and the GCF takes into account the needs of most vulnerable developing countries. In addition to GCF, parties to the UNFCCC established the Special Climate Change Fund (SCCF) and the Least Developed Countries Fund (LDCF).
Multilateral and bilateral development finance can help nurture the enabling conditions for energy transitions and low carbon energy access. The World Bank, IFC and ADB already support a range of renewable energy technology options to help countries supply energy to their populations in a manner that is consistent with 2°C pathways.
De-risking renewable energy investments
Today, renewable energy projects are more capital intensive than fossil fuel-based technologies, therefore they are impacted by increased investment risks and higher financing costs. Experts claim that renewable energy will be consistently cheaper than fossil fuels by 2020. And it is true that there is a downward trend in the capital cost of renewable energy. However, in a number of African countries the scaling-up of renewable energy continues to be constrained by high financing costs as a result of informational, technical, regulatory, financial and administrative barriers and their associated investment risk. There are a number of tools available to policy makers to address the high financing costs for renewable energy in developing countries. There include:
- Policy de-risking
- Financial de-risking, and
- Direct incentives
Policy risks can be reduced by putting in place a clear regulatory framework for access to grid and on grant of permits and licenses for electricity generation, environmental impact assessments for energy projects and land use and acquisition provisions. Strengthening institutions and capacity building in the public sector could also support implementation of policies and build investor confidence. Another factor to reduce policy risks is communication of political support from government to the renewable energy sector.
Taken together, these initiatives can help create and maintain an investment friendly environment. Financial risks could be eliminated by transfer of such risks from private sector to public actors, such as off-take guarantees by the public utilities. Introduction of incentives such as premium price (and feed-in tariffs discussed below) could provide compensation for risks to investors.
The UNDP introduced a framework called “De-risking Renewable Energy Investment (DREI)” which systematically identifies the barriers and associated risks which can hold back private sector investment in renewable energy. It then assists policymakers to put in place packages of targeted public interventions to address these risks. Each public intervention acts in one of three ways: it either reduces, transfers or compensates for risk. The overall aim is to cost-effectively achieve a risk/return profile that catalyses private sector investment at scale. The targeted outcome is reliable, clean and affordable energy solutions in developing countries.
The DREI framework consists of a suite of publicly-available methodologies, financial tools/models and resources. Current renewable energy sectors covered by the DREI framework are (i) utility-scale, (ii) on-grid rooftop PV, (iii) off-grid mini-grids, and (iv) solar home systems.
UNDP is applying the DREI methodology in its support to developing country governments. Country applications include:
- Belarus (utility-scale wind; 2017)
- Cambodia (utility-scale, on-grid rooftop, SHS, mini-grids; all solar PV; 2018) [forthcoming]
- Kazakhstan (utility-scale wind and solar PV; 2017)
- Lebanon (utility-scale wind and solar PV; 2017)
- Tunisia (utility-scale wind and solar PV; 2014; 2018)
Challenges and opportunities for governments of fossil fuel exporting countries
The current trend towards the decarbonisation of the world economy poses some challenges to country exporters whose economies are vulnerable to the direction taken by the energy transition. In particular, the time frame for profitable production is becoming smaller. There is also associated reluctance from long-term investors to commit to fossil-fuel projects. Pension funds and sovereign wealth funds are increasingly excluding fossil fuels from their portfolios and using their shareholder votes to influence company behaviour. However, there is no conflict between investing in renewables and in hydrocarbons for fossil fuel exporting countries with subsidised prices and rising domestic energy consumption, as these countries can liberate oil and gas used in domestic consumption for export markets, improving the economics of renewables projects. This Oxford Energy Institute study notes that the ultimate safeguard against energy transition of fossil fuel exporting countries will be diversification of their economy away from oil and gas.
The nature of energy transition will be different in each resource rich country, in line with its dependence on revenues from the sector – cost of production, reserves and resources, domestic consumption rate. The opportunities and challenges will vary among established and newly resource rich countries. Tanzania and Mozambique for instance are mainly developing their gas fields for export potential, whereas in Ghana the gas sector developments are aimed to meet domestic power supply. There are significant benefits in engaging in an energy transition early on – as switching from one fuel source to another would be expensive at a later stage. The level of urbanisation and population of a country will also play a role to play. Nigeria and Angola with a high fossil fuel consumption rate and high dependency on revenues will inevitably have less flexibility as opposed to a small country like Guyana, which is just starting offshore oil production. Another country with rising domestic energy consumption is Saudi Arabia, mainly due to population growth, industrial development and a subsidy regime encouraging wasteful consumption. A key opportunity for Saudi Arabia from the energy transition is harnessing energy efficiency and renewable energy potential to all Saudi Arabia with the possibility to free up significant amounts of its domestic oil and gas use for export or as feedstock for the country’s growing petrochemical industry. One of the major challenges Saudi Arabia faces is to reverse the long period of low prices and vested interests and to manage the transition to higher prices.
Fossil Fuel Subsidy Reforms
Subsidising fossil fuels undermines climate change, energy security and sustainable development objectives. Fossil fuel subsidies also put a restrain on public budgets, limiting the funds that can be spent on economic diversification, education and health alike, and they also distort competition with low carbon energy technologies. Therefore, fossil fuel subsidy reform is an important policy issue for all countries.
Currently in many African countries there are incentive structures in the form of fossil fuel subsidies which are not necessarily efficient and may be a barrier to the development of renewable energy infrastructure. Reform of these structures is likely, however will need to be integrated into the country’s broader aims for an energy transition. For instance, fiscal incentives for renewable energy projects such as feed-in tariffs and premium price or tax breaks might be more effective than abolishing these subsidies overnight and introducing a carbon price. The distributional impacts of green fiscal reforms has to be taken into account, and these changes should be ideally implemented gradually. Carefully crafted policies can also mitigate the negative impacts of removal of fossil fuels on poor households. It is also important that savings from fossil fuel subsidy reform are used to establish compensation schemes for poorest groups of the population, and that these savings can be used to mobilise infrastructure investments required in the energy sector.
These subsidies take two forms; consumption subsidies and production subsidies. Consumption subsidies are intended to reduce the price of energy for end users. This can be executed by the government by introduction of a cap on petroleum, power or natural gas prices. Production subsidies are often used to reduce the cost of extraction of oil and gas resources, and can be executed, among others, through tax incentives or government funding for fossil fuel production. Three major international organisations are working the field, the IEA, OECD and International Monetary Fund (IMF).
IMF 2015 Survey provides country level estimates on the cost of energy subsidies and reports on the reforms carried out. The OECD brings together the estimates of subsidies and other forms of support for fossil fuels under its analysis of budgetary support and tax expenditures. The fossil fuel support data is available on a country-by-country basis. The IEA measures fossil fuel subsidies in a systematic way and its famous World Energy Outlook the IEA demonstrates the impact of fossil-fuel subsidy removal for energy markets, climate change and government budgets. However, the data on fossil fuel subsidies consist of estimates mainly, the lack of information about the scope, magnitude, and effects of fossil-fuel subsidies remains an important obstacle to current and future reform efforts.
Carbon pricing could also have a significant impact on the speed of energy transitions and profitability of fossil fuel industries. Carbon pricing (along with removal of inefficient fossil fuels) makes low carbon solutions, such as renewables and carbon capture, use and storage, more cost competitive. There are two main types of carbon pricing: emissions trading systems (ETS) and carbon taxes.
An ETS, which is also referred to as a cap-and-trade system – caps the total level of GHG emissions and allows those industries with low emissions to sell their extra allowances to larger emitters. By creating supply and demand for emissions allowances, an ETS establishes a market price for GHG emissions. The cap helps ensure that the required emission reductions will take place to keep the emitters (in aggregate) within their pre-allocated carbon budget.
A carbon tax directly sets a price on carbon by defining a tax rate on greenhouse gas emissions or – more commonly – on the carbon content of fossil fuels. It is different from an ETS in that the emission reduction outcome of a carbon tax is not pre-defined but the carbon price is.
Putting a price on carbon is one of the most widespread policy options, as it is considered to be one of the most cost-effective way to drive reductions in GHG emissions and promote investments into alternative technologies. The Paris Agreement (Article 6) forms the legal basis for establishment of market-based climate change mitigation mechanisms. The role of carbon pricing is likely to grow towards 2030. Already more than half of the signatories of the Paris Agreement referenced carbon pricing as a tool to achieve their national climate commitments in their NDCs. This report provides an up-to-date overview of existing and emerging carbon pricing instruments around the world, including national and subnational initiatives.
The choice of the instrument will depend on national and economic circumstances. There are also more indirect ways of more accurately pricing carbon, such as through fuel taxes, the removal of fossil fuel subsidies, and regulations that may incorporate a “social cost of carbon.” GHG can also be priced through payments for emission reductions.