Can we Finance the Energy Transition?


The energy sector is pivotal to our aspirations for a sustainable planet and yet two major challenges face policymakers worldwide. The first is to decide what set of technical choices provide the best solution to meet social, economic and environmental agendas; and the second is to decide how these choices can be financed. The bulk of new energy demand will come from the emerging economies where energy demand is expected to increase by 40% over the coming three decades and to have doubled by the middle of the century. However for a number of reasons the investment needs of the energy sector are likely to rise even faster than overall energy demand. This is due to a number of factors over and above the increase in demand and described in the paper, including, inter alia, subsidized prices; the substitution of traditional energy for modern energy; the growth in peak demand in the electricity sector; the rising costs of securing primary energy resources; and the urgent need to replace vintage capital stock (including the decommissioning of nuclear power plants), especially in the developed countries. Clean energy investment will also incur high upfront investment costs in order to reduce long-term recurrent costs (fuel and maintenance). High priority must be given to energy demand management (both to reduce energy use and to reduce energy capital) and investment in upgrading of existing capital stock can provide strong and quick returns. However, the net result of the long-term demand on the energy sector is that investment needs will grow dramatically, from around US $1.6 trillion per annum to over US $2 trillion per annum. The financial challenge is considerable. A level playing field is required that encourages greater competition of technology choice on the basis of correct pricing signals. It will require changes in subsidy policies in order to release finance and to encourage efficient investment; adherence to least-cost planning and investment decisions; changes in decision-tools especially the use of high discount rates and inadequate accounting rules; a stable and appropriate price for carbon, the largest economic externality in the sector; and a major uplift in efforts to conserve both energy and capital. Innovative schemes between public and private finance should be deepened. Long term institutional capital (such as pension funds and sovereign wealth funds) are an important growth area for energy funding. “Green bonds” have shown promise and are growing fast. Public finance, bilateral and multi-lateral, must be increased to address the major public good issue of climate change. However, at heart, lies a financial sector not equipped to provide finance to the real economy and to the kind of investment streams outlined in this report: an overhaul of the global financial sector must underwrite any of the specific financing efforts proposed in this paper.

1. Background

1.1. The energy sector (together with its sister sector, food and agriculture) remains pivotal to the future sustainability of the planet. Energy is required for all walks of life in all countries and by all people.It is also central to concerns about local health and safety as well as environmental concerns, especially global climate change.

1.2. All governments have an expressed desire to provide their citizens with clean, affordable and modern sources of energy. In doing so there are two essential and interconnected challenges facing policymakers. The first is what technical choices make the most sense from a social, economic and ecological point of view. The second is how (and indeed whether) the choices made can be financed in a manner that is feasible and fiscally prudent.

1.3. This paper explores both challenges and, while recognizing that technical choice is also a function of cost, notes that the financing challenge may be significantly more challenging than many realize and that, as a result, sub-optimal technical solutions may well result. It suggests that a major effort is required over the coming two decades to create the fiscal space for a major boost to energy investment on the one hand but also to place energy demand management as a much higher priority activity than it currently receives.

1.4. This note pays special attention to the electricity sector as the sector likely to be most influential in driving energy policy; in curtailing demand; and as the sector that will require the bulk of capital investment over the coming decades.

2. Global Primary Energy Resource Demand

2.1. Estimates vary with regard to the growth in energy demand but plausible scenarios suggest that a continuation of energy demand is likely. The past three decades have witnessed a doubling of energy demand, roughly in line with GDP growth. The current energy balance of primary energy consumption is broadly as follows: 78% fossil fuels (with oil at 33%, 21% natural gas and 24% coal); 5 to 6% from nuclear fuels; 17% from hydro resources (and other renewable energy resources) and the remainder 11% from biomass.

2.2. There is a broad consensus on the likely trajectory of energy demand over the coming three or so decades. Most analysts predict around a 1.6% per annum increase in primary energy through to 2030 (a 36% to 40% increase) and a somewhat slower rise thereafter. This, in turn, implies a doubling of primary energy demand by 2030 and a trebling of demand by the middle of the century.

2.3. The main drivers of energy demand are:

  • Population and demographic shifts with some 1.5 billion or so added to the global population (mainly from non-OECD countries) by 2030 and a large scale migration to urban areas.
  • Income growth and the distribution of income: GDP growth is anticipated to double through 2030 with a growing middle income class with increased energy needs. Structural changes within the global economy will also have an effect.

2.4. What is of vital importance is the fact that all projections note that almost all of the energy consumption growth in that period will be in non-OECD countries (between 90% and 95% by most estimates). Energy consumption in OECD countries is expected to grow but at a slower rate and, depending upon the nature of energy demand measures, could plateau or fall slightly. What is also of importance is that primary energy utilized to generate electric­ity is expected to grow at faster rates than energy overall. This, in part, reflects the need to provide those, currently underserved, with clean energy.

2.5. Such estimates provide a useful benchmark against which policies on energy demand management; on the energy transition from traditional to modern energy sources; and on investment strategies can be formulated. There is considerable uncertainty around growth projections and energy demand is highly sensitive to income.§ On the other hand from a strategic and global viewpoint general directions and understanding of choices are as important as reaching out for precision. There is no doubt energy needs will grow and under almost all plausible scenarios complex choices await the analyst and decision-maker.

2.6. If uncertainty pervades our understanding of overall energy demand it is also reflected in policies towards technical choice and fuel use. The past one hundred and fifty years have witnessed major economic, social and technological progress on the basis of fossil fuel based energy followed some sixty years ago by the promise of low cost nuclear energy. The present period is one of important inflection with regard to energy choice. New factors relating to shifting paradigms on investment and recurrent costs; the rising costs of fossil fuels; and the imperative of dealing with local and global environmental impacts have reshaped the debate and, indeed, investment strategies.

3. Global Energy Investment

3.1. While there is a clear link between the overall demand for energy resources and the required investment resources they do not perfectly co-vary. The demand for investment needs in the energy sector will be driven by a number of factors:

  1. Overall growth in energy demand;
  2. The fundamental role of energy pricing;
  3. The level and pace of substitution of traditional energy for modern clean energy;
  4. The growth in peak demand relative to base demand in the electricity sector;
  5. The overall change in relative costs of securing new energy (renewable energy, fossil fuels) including the extent of rising costs of exploration, development and delivery in the oil and gas sectors;
  6. The pace at which vintage capital stock turnover requires new or life extension investment; and
  7. The potential “lock in” or “path dependency” trajectories of decisions taken over the next decade.

3.2. These issues are considered below in order to form a view on the likely demand for investment resources in the energy sector. The expectation is that demand for finance is likely to rise at a faster rate than the demand for energy due to a number of factors that are discussed in the sections below.

Energy Demand

3.3.As noted the base case scenarios are all consistent with a 40% increase in demand by 2030 and perhaps a doubling by 2050. Most scenarios already make assumptions about improving energy efficiency: a straight line extrapolation from today’s consumption would broadly lead to a doubling of demand by 2030 and a quadrupling by 2050! Certainly this would carry a global public health warning as a scenario that most would conclude as the paradigm of un-sustainability.

3.4. The curtailment of energy demand represents a key pillar of analysis of future consumption patterns. Historically, the relationship between GDP growth and energy use has been stable, at an elasticity of around 1. Electricity demand has typically outpaced overall energy demand with a GDP elasticity closer to 1.2. There are good reasons to wish to change this relationship and it seems to be technically feasible to do so. A wealth of literature has been developed which indicates that technical options now exist to reduce overall energy consumption dramatically while still maintaining economic growth. Ernst von Weizsäcker et al.1 have ably demonstrated that significant savings are potentially available that could reduce consumption in energy use by up to 80%.** Many of the options in this and other publications point to the large range of negative marginal cost actions that could be taken to reduce energy consumption. These “no regrets” investments with seemingly highly attractive Financial Rates of Return (FROR) that are technically and economically viable have not been universally taken up: most analysts still draw marginal cost curves that begin under the zero axis and remain there for quite some time. The question is why? What are the barriers to achieving, in the first round, these energy savings? The underpricing of energy is certainly one factor.

Energy Pricing Policies

3.5. While there are many non-price barriers to securing major energy savings (such as asymmetric information, human capacity, knowledge etc.), the main driver is pricing or perhaps better formulated as the underpricing of energy. This unfolds along two broad issues. The first, and often unstated, is that (certainly in emerging economies with high economic growth) achieving a positive FROR (above the discount rate) is a necessary but insufficient condition for investment. Higher rates of return can squeeze out seemingly positive investments in energy efficiency. The second is that the “cost of un-served energy” to the economy in emerging economies often provides†† an impetus for inaction when it comes to investing in energy efficiency‡‡. But perhaps the larger effect is simply the level of subsidy provided to the energy sector.

3.6. Subsidies are essentially of two types: financial (the market cost to the producer and consumer) and economic (the cost to society or, in the case of global public effects, the planet). Subsidies exist on both energy (fossil fuels in particular) and on energy capital (mainly in the electric power sector).

3.7.Liquid and Gaseous Fossil fuel subsidies are pervasive and vary with the international price of fuels. In 2008 it is estimated that they (oil and gas) reached a level of around US $400 billion. The International Energy Agency (IEA) has estimated that in the absence of a dramatic pricing reform agenda such subsidies could reach around US $660 billion by 2020, equivalent to 0.7% of global GDP.§§ The rationale for such subsidies, which are highly distorting, varies but most often quoted is to protect poor consumers.¶¶ IEA as well as other assessments*** all point to the inefficiencies and level of leakage in such policies. A calculation by IEA suggested that in 2010 only 8% of the global fossil fuel subsidy was provided to the poorest 20% of the population: a high cost and inefficient subsidy.††† Even more telling is that IEA estimates that removal of subsidies could cut fossil fuel consumption by over 4% by 2020.‡‡‡

3.8. Coal and coal derivative subsidies are not as large as liquid fossil fuels but nevertheless are substantial.§§§ OECD has estimated financial coal subsidies (in OECD countries only) at around US $12 billion annually. A more recent survey by the International Monetary Fund (IMF) indicates a much larger global figure of around US $539 billion annually but this includes imputed figures for global and local damage functions (the economic subsidy as defined later in this note).¶¶¶

3.9. Subsidies to the nuclear energy industry are pervasive throughout the nuclear fuel, construction and deployment cycles. It is hard to know where to begin. The largest subsidy appears to be in facilitating the buy down of investment costs and, in the future, there will be a need to add to this the costs of decommissioning. These are dealt with later in this note. Legacy subsidies that now count as sunk cost are also of intrinsic interest and estimates as high as US $5.9 cents per Kwh have been assessed.2 The extent to which R and D functions are a subsidy is also clouded with uncertainty.****

3.10. Smaller and more recent but nevertheless increasingly important is the subsidy to new and renewable energy sources. The most common financial subsidy is through feed-in tariffs providing an incentive to invest in renewable energy. Estimates are in the order of US $88 billion (2011).†††† Typically, subsidies are provided through feed-in tariffs which require consumers to purchase electricity generated by renewable energy.

3.11. Electric Power Subsidies are also important. Some of the overall subsidy comes from the subsidized fossil fuels, coal, nuclear and renewable energy (including hydro) used in power generation but this may be only the tip of the “subsidy iceberg”. The electric power sector is the most capital intensive of energy sectors and requires capital investment in the region of US $800 billion to US $900 billion per annum over the next few decades.‡‡‡‡ Subsidies are provided through a variety of means and a number ways of calculating them have been identified in the literature.

3.12. A simple concept is to consider an electric utility that funds its current energy assets and future expansion program. The financial subsidy (or surplus) is total expenditures on the recurrent fuel and non-fuel cost of generation, transmission and distribution of energy plus the cost of operations and maintenance, plus the cost of debt servicing the current and planned investment expansion program minus the revenue or income from sales of electric­ity (tariffs). Financially few utilities in the emerging world cover these costs with perhaps a 25% to 30% internal cash generation ratio at best (and many a great deal lower). In other words, the financial subsidy is large and likely growing and the incidence is disproportion­ately shared by developing countries.

3.13. Yet if the financial subsidy is confusing and flows from a myriad of sources, the economic subsidy in the energy sector represents a journey that is closer to seeking the “Holy Grail”. The economic subsidy includes the financial subsidy as well as the cost of all externalities in the process of energy production, transformation and delivery and, importantly, it includes the costs of deviating from least cost economic investment. It is larger than the financial subsidy and represents a major drain on society’s resources. The main drivers of the economic subsidy are:

  1. The extent to which investment plans and decisions deviate from the economic least-cost solution;§§§§
  2. The value of environmental externalities at both the global and local levels and, increasingly, the value attributed to greenhouse gas emissions;
  3. The value of water utilized in the extraction and use of energy, especially in the new non-conventional energy sub-sectors;¶¶¶¶ and
  4. The need to take long-term investment decisions and, given the high indivisibilities in large investments, an understanding of the shape and direction of the long run marginal cost curve for energy sources.*****

3.14. While large uncertainties exist about the precise nature and scale of subsidies and while methodological differences and nuances abound, there is little controversy over the fact that energy subsidies are enormous and appear to be growing, whether calculated on financial or economic grounds.

3.15. Energy subsidies have a number of important perverse and negative effects:

  1. They can have a chilling effect on potential investors through low profitability and therefore discourage private investment;
  2. They have an adverse effect on fiscal balances and public debt;
  3. They crowd out other subsidy programs that would have a higher social and economic return in sectors such as education or health;
  4. They distort public and private investment decisions by sending market signals that do not reflect economic priorities; and
  5. They induce excess consumption with low incremental social returns and negative environmental consequences as well as increase leakage and sub-optimal consumption.

3.16. In sum, any attempt at re-shaping our global energy systems and seeking the finance to do so must start with a critical look at subsidies, their rationale, and their eventual elimination other than for highly targeted social objectives. Phasing out of both financial and economic subsidies over a clearly defined period while adjusting relative energy prices can be achieved. Linking such decisions with technical investment in energy demand management and in forward planning least-cost investments could make a major difference to overall costs and financing needs.


1 Ernst Ulrich von Weizsacker et al., Factor Five: Transforming the Global Economy through 80% improvements in Resource Productivity (London: Earthscan, 2009).
2 Doug Koplow, “Nuclear Power: Still not viable without subsidies,” Union of Concerned Scientists
* This note was originally submitted to the Annual General Meeting of the Club of Rome in Mexico, October 2014 as a background note for the discussion session “World Energy Outlook and Sustainability in the World and its prospects.”
† There are many studies of current global energy consumption but most are within the ranges quoted in this note. See Gian Paolo Beretta “World Energy Consumption and Resources: an outlook for the rest of the century” Dipartiemento di Ingenehneria Meccanica, Universita di Brescia. Also International Energy Agency, “World Energy Outlook”; and IIASA: “Global Energy Assessment”. All are broadly consistent and for purposes of this note broad orders of magnitude rather than precision are in order.
‡ In all scenarios the Asia and Pacific region dominates in terms of expected future energy consumption.
§ An article in the The Economist magazine (September 2014) noted that economic growth in many rapidly emerging economies had stalled and may rise at lower rates than previously expected. For purposes of discussion, modest changes to growth rates do not alter the overall assessment of an increasing demand for clean and modern energy.
¶ At a time when the long run marginal cost of securing supplies is rising and, with recent price declines, the short run financial revenues are declining.
** The majority of case work under Factor Five is in the rich world (with some examples drawn from China).
†† When I worked on the energy sector in a number of Asian and African countries, the cost of un-served energy (in the form of electricity) was often quoted at around US $1 per KWh. This was defined as the cost to GDP growth of a KWh not delivered: and was approximate. In countries which were severely power short (many emerging economies) the electricity dispatcher (not to mention the local politicians) was keen to operate inefficient power plants well beyond their capacity, with no let up for routine maintenance and upgrading. Perversely this had both an economic and a political rationale!
‡‡ A recent study by the World Bank and summarized in The Economist magazine (September 27 – October 3, 2014) notes that the cost of un-served energy in Africa is significant. It notes “the World Bank reckons that power shortages trim more than two percentage points from an annual growth rate in GDP on average in Africa: in Nigeria the loss has been almost four percentage points a year”. This can have several effects including the operation of highly inefficient power plants and private investment in sometimes sub-optimal private power facilities. Equally it could have a positive and offsetting effect if private investment in clean energy occurs.
§§ See International Energy Agency (IEA): “World Energy Outlook” 2011 as well as various papers produced by IEA. According to the International Monetary Fund (IMF), the 0.7 GDP figure had already been reached by 2011. This represents around 2% of total government revenues: a not inconsequential amount.
¶¶ A second rationale is to promote and protect industrial development: again with high leakage and inefficiency outcomes.
*** The World Bank routinely reviews the distribution of energy and electricity subsidies and invariably concludes that the level of leakage to higher income groups means that it is an extremely inefficient means to target poor consumers. Subsidy policies of this kind require strong institutions to administer and monitor. In the rich world lifeline tariffs are routinely managed to target poor consumers. The tendency in many countries is to provide broad-based subsidy underwrites rather than selective and focused targeting.
††† The fossil fuel subsidy is evenly distributed amongst fuels with kerosene (at around 15%), the largest, and suggests that the driver behind subsidy policies is poverty alleviation.
‡‡‡ This would simultaneously cut growth in GHG emissions by around 1.7 Giga tonnes during the same period.
§§§ There are a number of important definitional problems in calculating coal subsidies. In particular producer subsidies are especially difficult to measure.
¶¶¶ The IMF imputes figures for damage functions at both the local and the global level and adds these to the financial (or what the IMF terms pre-tax subsidy) to derive a post-tax (or economic) subsidy. The IMF used US $25 per ton for GHG emissions (global external effects) and US $65 a ton for local pollution damage. The figure for global damages seems quite low: other studies range from 40 to around US $125 per ton. The figure for local damage is derived from research in the USA.
**** For example stranded asset charges as an example of uneconomic subsidies were calculated by the Union of Concerned Scientists to be around US $110 billion by 1997: few updated figures seem to be available.
†††† “The International Energy Agency (IEA)” estimated that in 2011 subsidies to renewable energy were US $88 billion. These are still overall small relative to fossil fuel subsidies although a counter argument is often made that on a per energy unit basis fossil fuel subsidies are three times greater than those for fossil fuels.The renewable energy subsidy refers to both small scale renewable energy and commercial hydro-electric dams.
‡‡‡‡ IEA estimates. In the author‘s view these may be under-estimates and the final figure may be closer to US $1 trillion. It is not clear whether the full costs, for example, of nuclear power decommissioning are included. In addition, since much of the capacity is in emerging economies the potential for real cost escalation and financing interest during construction (IDC) can balloon costs even further.
§§§§ This is often the reason given for high subsidies in Africa for example. See IMF op. cit. and World Bank studies.
¶¶¶¶ A recent report by the World Resources Institute (WRI) has evaluated the impact of water use in hydraulic fracturing (“fracking”). Almost 40% of shale resources are in arid and semi-arid areas where water costs are high (and rising) and downstream water pollution represents a high economic diseconomy.
***** Several studies on energy subsidies have made the point that a major part of the subsidy is taken up by the mere fact that decisions in the sector produce sub-optimal economic investment. The economic subsidy could be reduced considerably by better planning.

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