Financing the energy transition: Where’s the money?

Incoming Commission President Ursula von der Leyen's pledge to turn Europe into "the world's first climate-neutral continent" means efforts to green the economy are set to go into overdrive. But where will the necessary funds come from to back the energy transition?

Investments in low-carbon energy and related infrastructure will have to increase from an annual 2% of GDP to at least 2.8%, according to the European Commission's long-term climate strategy, which aims for net-zero emissions by 2050.

That means an estimated €500-600 billion extra per year.

For some like France, the transition will be less difficult, given the country's existing nuclear fleet and geographical advantages in developing solar and wind energy.

But for others like Poland, which rely on coal for more than 80% of their electricity, the shift to low-carbon energy sources will be more challenging and require a larger financial effort.

So where will the money come from?

[Edited by Frédéric Simon]

Cost of action and inaction

The Commission’s 2050 climate plan estimates that 2.8% of GDP would have to be funnelled every year into ditching fossil fuels and deploying low-carbon technologies.

Overall, European taxpayers stand to foot an annual bill of around €550 billion to reduce emissions in line with the EU's proposed climate neutrality objective. 

But the cost of inaction may well be far bigger. A landmark UN report last year warned that global warming in excess of 1.5C will have catastrophic consequences on human societies across the globe and the ecosystems on which our livelihoods depend.

Floods, droughts, heatwaves and other climate-related extremes caused economic losses of €453 billion between 1980 and 2017, claiming the lives of more than 115,000 people across Europe, according to the European Environment Agency (EEA).

That's more than €12bn every year and those costs are only going to rise as global average temperatures continue to increase.  

Tackling climate change also opens economic opportunities. The European Commission calculated that the EU’s GDP will increase by 2% by 2050 if the bloc slashes its emissions to a net-zero level. 

If the EU achieves that net-zero feat, it could also save €200 billion every year in avoided health costs, such as premature deaths and pulmonary diseases caused by air pollution. And the European labour market could swell by 1 million jobs in the green economy, mostly concentrated in clean energies.

But perhaps the biggest prize for Europe is energy independence. According to the Commission estimates, the EU's fossil fuel import bill could be slashed by €2-3 trillion over the 20 years leading up to 2050.

Still, both public and private spending in the green economy will need to be considerably boosted in order to achieve the EU's goals. And most of it is expected to come from the private sector.

According to the EU executive, “private business and households will be responsible for the vast majority of these investments,” which are being promoted as part of an EU sustainable finance initiative.

But public money and dedicated funds will also be a major catalyst. Here's what's on the table:

EU long-term budget (2021-2027)

Negotiations on the EU’s next long-term budget, the multiannual financial framework (MFF), are still ongoing. Talks are unlikely to wrap up in 2019 as unresolved disputes continue over the size of national contributions and where the money should be spent.

The European Commission has proposed a budget for 2021-2027 that would be equivalent to 1.11% of GNP but wealthy net-contributors like Germany and the Netherlands would prefer a lower figure, to a round 1%.

Poland has raised the stakes in the negotiation. Earlier this year, it rejected the EU's proposed 2050 climate neutrality objective unless “significantly larger” amounts of funding are made available under the MFF. Europe’s increased ambitions require “new instruments – including finances – in order to support effectively the transition to a climate-neutral economy,” Poland said in a memo circulated to EU leaders in October.

And to make sure EU money goes in priority where it’s most needed, Poland has also called for new “conditionality” rules to support regions and countries with the biggest needs.

But while Poland's calls for more funding are backed by other net-recipient countries like Hungary and the Czech Republic, others have stood up to question those claims.

Spain and Portugal in particular, have held up an agreement on a proposed Just Transition Fund, arguing that they didn't receive such favourable treatment to support their own energy transition a few years back.

Matters are further complicated by high-level politics, like filling the €10 billion-plus hole left by the UK’s exit from the bloc and a proposal to link EU funding to rule-of-law requirements, which has infuriated Poland and Hungary.

Aside from these scuffles, there is broad agreement that a greater share of the EU budget should go to green objectives. In a March 2018 announcement, the Commission proposed ring fencing 25% of the budget for so-called climate mainstreaming, which could be spent across sectors on various environmental projects.

That would mean around €320 billion earmarked for climate action, an increase of €114 billion compared to the 2014-2020 budget.

But that was deemed inadequate by the European Parliament, which in a November 2018 resolution insisted the proportion of climate funding should ratchet up to 30% by 2027 at the very latest.

In October of this year, the Parliament adopted another resolution to take into account the new measures suggested by the incoming Commission of Ursula von der Leyen, in particular the ambitious Green Deal for Europe.

A communication on that overarching policy is due on 11 December, as well as a proposal on the so-called Just Transition Fund, which is meant to grease the cogs of the log-jammed talks.

Just Transition Fund

A new fund dedicated solely to helping countries deal with the financial burden of the energy transition was first proposed by Polish centre-right lawmaker Jerzy Buzek in November.

The €4.8 billion-strong pot would draw its resources from the EU's new long-term budget and help poorer nations with initiatives like reskilling coal miners.

Initially referred to as the Energy Transition Fund (ETF), the instrument has evolved to be known more broadly as the Just Transition Fund (JTF).

Commission officials have since then been working on the proposed fund. And the instrument became a key talking point during Ursula von der Leyen’s bid earlier this year to secure Parliamentary support for her EU Commission presidency.

The new Commission President has tasked her deputy, climate boss Frans Timmermans, and other Commissioner-designates such as Kadri Simson and Elisa Ferreira, with overseeing the Fund as part of their energy and regional portfolios, respectively.

A proposal on the JTF should be published on 11 December, just in time to influence the ongoing MFF talks ahead of an EU summit scheduled for 12 December, where the EU's 2050 climate strategy is set to feature heavily.

But complaints are already being heard. Although the JTF is welcomed in Warsaw, critics say its scope is too narrow and limited to retraining workers laid off as a result of the coal phase-out.

According to industry sources, fresh money should also be made available to build new plants that replace coal-fired power stations. While funding for renewable energy projects like offshore wind is relatively easy to secure these days, the industry worries about financing for new gas-fired or nuclear power plants, which would also help Poland lower carbon emissions when they displace coal installations.

In order to placate Poland, the fund is expected to be larger than the Parliament’s proposed €4.8 billion, an amount that was widely criticised by NGOs and industry associations alike for being “just a drop in the ocean”.

How much bigger the new fund will be is still unclear though and a matter of political haggling between EU leaders. It is also unclear which countries will be eligible for the JTF, with Spain and Portugal complaining that they didn't receive any such funding for the energy transition after they joined the EU.

It is therefore likely that access criteria to the JTF will not preclude any specific nations from accessing financing, unlike the Emission Trading System’s (ETS) Modernisation Fund, which is limited to just 10 applicants.

ETS Modernisation Fund

The EU's cap-and-trade system for greenhouse gases, the emissions trading scheme (ETS), is the bloc's flagship climate policy tool. By putting a price on carbon emissions, and allowing polluters to sell surplus credits, it rewards industries who invest in low-carbon technologies.

Part of the monies collected from the sale of pollution credits will fuel a Modernisation Fund aimed at supporting the transition to low-carbon energy. 

Under the ETS, about €26bn is expected to become available over the next decade for 10 lower income countries: Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Slovakia.

That select group of EU members will be allowed to channel money from the Modernisation Fund and a part of their auctioning pool into low-carbon investments between 2021 and 2030.

No investments in solid fossil fuels are permitted, except in Bulgaria and Romania, which have secured exemptions for district heating systems fuelled by coal.

Funding will instead be allocated towards priority projects in renewable energy generation and use, energy efficiency improvements and network modernisation efforts.

Just transition measures in coal-dependent regions will also be supported under the ETS-derived fund. 

An estimated €10bn will also be on offer through the EU-wide Innovation Fund, which pools money by selling unsold carbon permits under the ETS. It aims to give European companies “first-mover advantage” in using innovative technology and business models.

The funding pot will also include any unused money left over from the NER300 programme, which pooled together nearly €2 billion for use in carbon-capture-storage (CCS) and new renewable technology development.

European Investment Bank

The EIB will assess projects applying for Modernisation Funds money, with first tenders set to launch in 2020. The Luxembourg-based lender will control who is allocated what money based on its energy lending policy, which was just updated to align the bank with the Paris Agreement on climate change.

According to bank figures, the EIB lent more than €11 billion between 2013 and 2017 to fossil fuel projects. That was composed of nearly €8bln for gas infrastructure and €1.68bln for gas extraction.

In 2018, loans helped to construct approximately 26,000 km of power lines and generate 15,228 MW of electricity, of which more than 86% was produced by renewable energy sources.

The triple-A rated lender is also involved heavily in financing energy efficiency measures, heating and cooling developments and projects tied to electro-mobility.

Ceiling raised

Projects are normally eligible for loans of €25 million and more, which generally covers up to a maximum of 50% of costs.

That financing limit is set to change though. EIB officials will raise the ceiling to 75% for the ten countries eligible for the ETS Modernisation Fund, in order to boost investments in priority areas. The three-quarters limit will also be rolled out to renewable energy projects for all bank shareholders.

The new lending policy also means fossil fuel support will end in 2021, with some key exceptions. A new emissions performance standard of 250g of CO2 per kwH of electricity generated will now dictate which power plants can receive funding. The old standard was a less strict 550g.

Low-carbon gas projects like biogas and hydrogen will also keep the door open for a certain amount of investments in infrastructure, although a review of the policy in two years time will look into whether the new criteria are effective or not.

As part of the energy transition and in conjunction with the Innovation and Modernisation funds, the EIB is likely to increase its funding of technologies like carbon-capture-storage (CCS).

During a conference dedicated to the fledgling tech in September, bank vice-president Andrew McDowell, who oversees energy policy for the lender, acknowledged that “it will be a big part of our business moving forward”.

In the wake of agreeing its new rules on 14 November, the bank insisted that €1 trillion in investments can now be unlocked between now and 2030 and that it is now in a better position to help EU countries hit their energy efficiency and renewables targets.

World Bank

The World Bank also channels billions worth of investments into Europe. The US-based international lender is – or has been – active in most European countries, funding energy projects in the Czech Republic, Romania, as well as EU candidate countries such as Montenegro and Serbia.

In Poland, the government wants to renovate 4 million homes and buildings over the next ten years, in what has been labelled the most ambitious and widespread renovation programme ever launched in Europe.

Although kinks still need to be worked out, the scheme is set to leverage funding from the EIB and the European Bank for Reconstruction and Development (EBRD) in order to attract the €25 billion needed to fund the update.

The World Bank has been involved in a consultancy role and has shared best practices on how Poles should access grants and how national banks should be utilised.

Buildings account for more than 35% of EU emissions and absorb around 40% of energy production, so better and more efficient edifices are seen by policy-makers as an essential part of the energy transition.

Heating those buildings is also a part of the puzzle, as outdated boilers and heaters contribute to more emissions and worsen air quality. When it was launched, environment minister Henryk Kowalczyk said the scheme “will help to drastically improve air quality in Poland and tackle the problem of smog," especially in cities like Warsaw.

The European Environment Agency estimates that 400,000 people die prematurely every year across Europe as a result of air pollution.

Sustainable Finance Taxonomy

Even though funding for wind and solar projects are relatively easy to obtain, private investments on clean tech is still considered too low, or at least not going where it should.

In the absence of any clear classification scheme, banks are free to decide independently what is green, with no oversight, opening the door to abuses and "greenwashing" when brown assets are repackaged and branded as green.

The EU's proposed sustainable finance taxonomy aims to fix this, providing investors, pension funds and private equity firms with “a common definition of what is green and what is not,” the European Commission said last year when it tabled its draft regulation.

Talks between the European Parliament and the 28 member states in the EU Council are still underway, under the Commission's supervision. 

Political wrangling over nuclear, and gas

But with the 2050 climate objective also on the agenda, the discussion has since taken a political twist, bringing to the surface old disputes over nuclear and natural gas. 

In September, EU finance ministers voted to reinstate nuclear power as a clean source of energy under the proposed taxonomy, causing joy in Paris and consternation in Austria, Germany, and Luxembourg, which had earlier issued a joint statement to oppose atom-smashing in the EU’s draft regulation.

Gas industry representatives have since jumped on the bandwagon, saying gas-fired power stations should also be considered green when they displace coal in power generation. Business activities cannot be defined as green “in absolute terms” but only in relation to a starting point, which varies depending on the local circumstances, they argued.

The gas industry even warned against the “perverse effect” of aiming for 100% renewable electricity immediately, saying some heavy-polluting industries will be rewarded for sticking to coal otherwise.

Environmental groups, for their part, have called on policymakers to promote only “fully sustainable economic activities” in the EU taxonomy to he exclusion of everything else. In a joint statement, they called for natural gas to be entirely excluded from the taxonomy, saying the current emission threshold identified by the Commission’s Technical Expert Group (TEG) should be lowered in order to exclude gas with Carbon Capture and Storage (CCS).

“More generally for the power sector, we recommend reducing the Emissions Performance Standard from 100gCO2/kWh to eg 50gCO2/kWh,” the green NGOs said in a joint statement, a threshold that would de facto exclude gas with CCS.

Moreover, the taxonomy should also align with the EIB's new energy lending policy, which aims to exclude fossil fuels "completely,” the NGOs have argued.

In what was likely an olive branch to the pro-nuclear camp, the EIB clarified that it will not change its stance towards atom-smashing, saying it will remain eligible regardless even after the bank updates its energy lending policy.

However, the EU bank also pointed out that it has not funded a new nuclear build since the early 1990s. Any investments in the sector since have been limited just to safety and decommissioning efforts, the EIB added, dampening the hopes of aspiring nuclear nations such as Poland.

In the European Commission, the technical expert group (TEG) established in 2018 published an in-depth report in June. The TEG saw its mandate extended until the end of 2019 so that it can assess feedback on its findings and inform the EU executive’s position.

Given the complexity of the matter, it is unlikely that a final deal on establishing the taxonomy will be completed this year, although MEPs hope to wrap up work during the first quarter of 2020.