AlwaysFree: World Economic Forum - How Tracking Changes In The Cost Of Capital Can Accelerate Investment In Low-Carbon Energy

• A recent report tracks the cost of capital across the global energy system between 2020-2021.
• It highlights the need to accelerate investment in low-carbon energy to meet climate targets.
• Policy-makers can influence the cost of capital as we transition to a low-carbon economy.

According to World Economic Forum article published on March 28, 2023, central to achieving the Paris Agreement goals is the need to channel large amounts of capital into low-carbon energy, with the price of renewables highly dependent on the cost of capital. The cost of capital is a major determinant of the total cost of different energy technologies and reflects the risks financial markets perceive, for example, how quickly coal might be displaced by renewables.

It acts as a key transmission mechanism between the financial system and the real economy, affecting the investment decisions of both financial institutions and corporates. Therefore, to accelerate the low-carbon transition a fall in the cost of capital for clean energy is required.

Oxford University and Oxford Sustainable Finance Group recently published the most comprehensive analysis of trends in the cost of capital in the global energy sector over the past two decades. This report tracks the changing cost of capital in sectors including oil and gas production, coal mining, wind, and solar.

This large-scale and robust approach provides a broader vision of changes in the global energy system’s cost of capital informing policy-makers about changing market sentiments and risk preferences by region and asset class incarbon-intensive industries. This is a sequel to the first report released in 2021 which tracked the cost of debt in the energy sector – this updated version expands to equities, corporate bonds, and accounting data in addition to syndicated loans.

Electric utilities

We found that renewable electric utilities companies with a higher share of solar and wind power capacity have a lower cost of equity and debt than fossil fuel focused peers on a global scale. This trend is particularly pronounced in Europe, showing that climate-friendly policies and actions have been successful at making investments in clean energy generation a highly cost-effective energy source. However, this trend varies considerably by region. In Europe, low-carbon electric utilities have a lower cost of capital than their high-carbon counterparts. But the opposite is true in China. And in America, the report found no consistent trend.

We find that the cost of debt of renewable electric utilities is 6% in 2021, compared to 6.7% for fossil fuel electric utilities. Similarly, utilities focused on renewables have a cost of equity (15.2%) lower than those relying on fossil fuel (16.4%). In Europe, the gap between lower-carbon electric utilities and higher-carbon peers has been widening over time. This suggests that forward-looking equity investors in Europe are pricing in rising transition risks embedded in fossil fuels.

Energy production

Examining energy production, we show that globally, coal mining has the highest cost of capital, with the cost of debt increasing to 7.9% in 2021 and the cost of equity increasing to 18.2%, followed by oil and gas production and renewable fuels. Since 2016, the cost of debt to raise capital for renewable energy and technology has been on a downward trajectory, while that of coal mining has risen. As with electric utilities, trends vary considerably by region. However, within oil and gas, there is a consistent gap between companies engaged in exploration and production and the rest of the sector, with financing for these upstream activities becoming increasingly costly in absolute or relative terms.

Accelerating the energy transition

These findings show that it is becoming increasingly risky to invest in carbon-intensive activities as well as capital-intensive upstream activities in the oil and gas industry. Against the backdrop of Russia’s invasion of Ukraine, oil and gas prices have been driven to their highest levels in a decade, further spurring economies to wean themselves off fossil fuels and shift capital flows to clean energy.

In Europe we show that environmental policies matter in asset pricing, which can serve as a model for North America and China, where climate action has been less consistent. In North America, where we don’t yet see a consistent trend in the cost of capital for renewable versus fossil fuel power, we will be watching closely to see if the Inflation Reduction Act can shift the pricing of risk in favour of clean energy.

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