A blanket 10% rate of interest on borrowing is being assumed for the European Commission’s upcoming 2030 package of climate and energy laws. This fails to take into account the present low rates across most European countries, writes Ursula Woodburn.
Ursula Woodburn is the head of EU relations at the European Corporate Leaders Group
Clarity on how to finance the transition to net zero economies has never been more critical.
Across the world, governments are assessing how to structure their economic recovery from the pandemic and ratchet up climate action ahead of the global climate conference in Glasgow at the end of the year. As part of the COP26 roadmap, energy and climate leaders are meeting today to discuss the acceleration of clean energy.
This is a once in a lifetime opportunity to drive real change.
And here in Brussels, right now, the European Commission is revising foundational elements of the EU’s climate legislation in order to achieve the increased 2030 ambition, ready for publication in the summer.
But new research indicates this work may be based on incorrect assumptions about real-world macroeconomic conditions.
Let us be clear, the Commission uses world-leading climate and energy modelling, yet there remain core areas that need improvement.
Analysis shows a blanket 10% rate of interest on borrowing is being assumed in impact projections for 2030 emissions reduction targets.
This fails to take into account the present low rates across most European countries, as well as factors such as sectoral difference, the ability for the policy landscape to reduce risk, or the hurdles to investment being increasingly removed as new technologies are tried and tested.
Overestimating the interest rate assumptions means a low carbon future looks much more expensive than it should – in the short and long-term.
This is because it artificially increases the up-front capital cost difference between high carbon and low carbon technologies, hiding the fact that the lifetime cost of low carbon technologies is in fact typically lower.
This affects investment decisions and slows policy changes – and can keep the climate laggards with a place at the table.
In addition, EC assumptions used to discount rates – used for the energy modelling – also inflate the strength of policies required to achieve specific emissions reductions.
Revising these rates could show how higher climate ambitions might be reached with the same policies.
The costs of new technologies are intimately linked with the policy frameworks that can reduce risks for investors, businesses and households. Learning by doing lowers technology cost and reduces risks and barriers to investment.
The relatively high discount rate and interest rate assumptions do not reflect the fact that European policy has already been very successful in driving down the cost of new low carbon technologies, improving access to finance, and reducing the risks associated with low-carbon investments.
Feed-in-tariffs for renewable electricity are a prime example of how policy can increase uptake and bring down the cost of new technologies.
In the future, we hope to see similar impacts as a result of grants and government-backed loans for homeowners to improve energy efficiency in buildings as the Renovation Wave programme gets well under way.
Addressing these blunt data benchmarks could help support the EU’s case that the Green Deal is the EU’s Growth Strategy.
If the assumptions used in the Commission’s economic and energy modelling are updated to be more closely aligned with real-world conditions, the case for ambitious climate action and policies could be stronger still, impacting on how governments and business take decisions on necessary climate actions.
We often see how the bias in society tends towards business as usual. And what we are seeing is that modelling assumptions have the effect of biasing the modelling results in favour of a high carbon future, undermining the EU’s climate action commitments.
For modelling to provide us with more accurate estimates of the ‘cost’ of the transition and the supporting policy framework, it must reflect real-world macroeconomic conditions, the cost of finance, as well as the policy impacts.
Modelling based on the most nuanced assumptions possible will provide the best foundation for the bold, evidence-based decision-making needed to set us on the pathway to a climate neutral and prosperous EU.