Journal of Financial Economics

REF 155 Financing the Energy Transition

In France, climate investments reached €84 billion in 2022, including key sectors, such as energy-efficient building renovation (€22 billion), low-carbon vehicles (€16 billion), and modal shift infrastructure (€12 billion). However, to meet the climate targets, an additional €58 billion needs to be invested every year through 2030. In Europe, climate investments amounted to €407 billion in 2022, representing 2.6% of European GDP. To meet the EU's targets, these investments should be doubled to €813 billion a year, or 5.1% of GDP. In France, as in Europe, closing the climate investment gap requires various government policies, including regulatory measures, carbon pricing and public funding.

The investments required for the transition in Europe are very substantial and mainly involve long-term investments, mostly in production units with high fixed costs. The financing model adapted to this profile requires securing financing from the market and finding investors ready to take on these long-term risks. For the transition to be acceptable, it is crucial that the profits accrue to European economic players, in particular through better management of their portfolio and investments in energy transition assets.

Climate change requires urgent adaptation strategies that complement mitigation efforts. In particular, it is crucial to adapt infrastructures in order to prevent major losses in the future and ensure the socio-economic resilience of regions. This will likely offer a high return on investment. However, exclusively public funding models are inadequate for dealing with the level of adaptation needs, which explains the worrying backlog. It is therefore imperative to develop hybrid models that include private funding to tap into the « hidden value » of adaptation. Various sources of funding can be explored, including public-private partnerships, concessions, third-party investors, as well as innovative mechanisms, such as green bonds and insurance-based financing.

What does a « fair transition » mean for a public agency like ADEME (The French Agency for Ecological Transition)? Grey literature shows that by referring to a « fair transition », trade unions, governments and international organizations set out four different necessities. The transition has to be made and, accordingly, there is a need for policies on pollution/emissions and polluters/emitters. However, while the transition is in everyone's interest, it also has a negative impact on certain jobs, businesses, sectors and regions that are highly dependent on fossil fuels, and which therefore need assistance. Independently from this dependence on fossil fuels, the ability to adapt to transition policies differs across society and the economy, due to economic, social and geographical fragilities that should also be taken into account. Finally, stakeholders, including citizens, must have the opportunity to contribute to the development and implementation of transition policies at all territorial levels.

The electrification of energy uses means that the energy transition will lead to a massive increase in the production of renewable electricity over the coming decades. This increase in the supply of decarbonized electrons will require doubling the amount of investments in electricity grids. To limit the resulting increase of these investments on regulated toll rates and therefore on the price of electricity, several avenues are explored in this article: a reduction in capital costs, better planning of investments on a European scale, and a series of measures to increase the efficiency of the capital employed.

Since February 2022, the natural gas industry in Europe has been completely transformed because of the disruption caused by the war in Ukraine. The European Union (EU) needs to reinvent its gas mix to achieve carbon neutrality by turning to biomethane and hydrogen. Biomethane, produced from organic matter, offers environmental and economic advantages, despite high production costs. The EU aims to produce 35 Gm³ by 2030, doubling its goal by that year. « Green » hydrogen is also crucial for decarbonizing sectors that are hard to electrify, such as heavy industry and transportation, but faces challenges, including the need to build infrastructure and competitiveness with Chinese equipment producers. Overall, the EU has already reduced its dependence on Russian gas, which made up 50% of imports before the war, but only 15% in 2024, and should no longer be at all dependent by 2027.

The financing of new nuclear reactors is based on a mix of renewable and nuclear energies to minimize costs and maximize robustness. However, economic uncertainty, which has been heightened by events such as the Covid-19 pandemic, is having a major impact on future nuclear energy costs. Within this context, the role of government is crucial, not only to raise capital, but also in sharing risk, thereby ensuring the viability of nuclear energy projects. The determining factors in the final cost of electricity are the cost of capital and the discount rate. Government intervention can reduce the risks as seen by investors, which has been demonstrated by models such as Hinkley Point in the UK, where contracts for difference (CfDs) ensure price stability. Financing methods vary, including approaches such as « Project Finance » or direct government funding. Examples, like the Mankala model in Finland, illustrate innovative alternatives for sharing risks and costs.

Today, 45% of our energy consumption is used for heat: heating, hot water and steam for industrial uses. Yet the energy debate remains focused on electricity, which accounts for only 24% of the total. Wood energy can play a key role in decarbonizing heat production, if funding is provided on a regional level to strengthen local networks, which are the only ones to make possible long-term renewable use of the biomass.

The transportation sector constitutes a priority for the ecological transition because it is the largest emitter of greenhouse gases in France, accounting for 30% of emissions and 32% of final energy consumption. To begin decarbonization, several means have been singled out: lowering the demand for transportation, a modal shift towards active mobility and rail transportation, optimizing vehicle occupancy, improving energy efficiency through technology and electrification, and reducing the carbon intensity of vehicles. To overcome the attendant financial hurdles, several avenues are being explored, including increasing carbon pricing to €100 per ton of CO₂ by 2030, and promoting a public-private partnership framework to help with investments.

ETS2 aims to complement ETS1 by covering emissions from the transportation and construction sectors, in addition to emissions from energy and industry. Launched by the European Commission with the Green Deal in 2018, ETS2 should be fully operational by 2027 and begin emissions monitoring in 2024. The emissions cap for ETS2 will decrease by around 62 million tons of CO₂ each year. Emissions quotas will be adjusted and reduced each year, and all permits will be auctioned off. Mechanisms are in place to avoid price spikes, which include adjustments based on natural gas and oil prices and a Market Stability Reserve (MSR). Complementary policies to limit the inequalities arising from ETS2 are essential, notably with the creation of a Social Climate Fund (SCF), which will be funded by the proceeds from selling emissions quotas.

Increasing the pace of the energy transition will require major investments in the power grid in order to produce low-carbon electricity, develop transmission and distribution networks, provide connections across borders, as well as for end uses. After recalling the basic elements of how electricity prices are determined in the wholesale and retail markets, this article presents the new regulations being put in place at the French and European levels, as well as their implications for financing the transition and the incentives that are being passed on to end consumers through electricity rates.

To achieve the goal of neutrality (« net-zero » emissions), energy transition scenarios must ensure that residual raw emissions will be absorbed by carbon sinks that remove CO₂ from the atmosphere. This requires investments that may involve industrial capture and storage techniques or that aim to reinforce the capacity of natural carbon sinks (forests, soils, wetlands, etc.). This article looks at the potential for local diffuse ecosystem carbon capture, for which carbon credit trading can be an innovative financing lever that incorporates the socio-economic and environmental impact carbon sinks can bring on a regional basis. In this connection, the creation of regional carbon cooperatives makes it possible to bring together institutions, businesses, and citizens in local and shared climate governance. These projects then strengthen regional ties and resilience in the face of climate change. The cooperative system is tending to grow, demonstrating the interest for a collaborative and ethical model aiming to achieve carbon neutrality.

Beginning with the recognition that monetary policy is not easily able to stimulate the economy in a recession by lowering interest rates, we propose revising the ISTRI model of Abraham-Frois (2003) and its more complete version proposed by Pollin (2003), which makes the DSGE model more easily accessible for students. We believe that these models are based on the unconvincing assumption that monetary policy plays an effective stabilizing role at all times. We highlight situations in which this is not the case (downward rigidity of interest rates and/or lack of investment despite interest rate moves). In these cases, the shape of the aggregate demand curve is modified. Applying the post-Keynesian critique that investment is only marginally sensitive to interest rates in a DSGE-type model leads us to invalidate many of the DSGE policy conclusions.