Business uncertainty

The deep uncertainties that are stalling energy transition

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The need to move to a low-carbon economy is urgent, but the sheer number of ‘unknown unknowns’ is deterring policymakers and investors from taking action.

Climate change is one of the planet’s most pressing issues. Whether its impact is on the places we inhabit, the air we breathe or civilisation itself, it is clear that climate change is having a disastrous effect on the world in which we live. Something must be done to reverse its detrimental effects, and there are a number of industries in particular where change could drastically improve the environment.

The energy sector is one, contributing to much of the carbon dioxide emissions that are affecting the planet. That is why the global energy sector must transition to clean energy - a fossil-based carbon-zero structure.

In principle, this switch sounds relatively simple, given we have the fossil-based fuels to make this transition. But not only is substantial investment needed to do so, there is also limited knowledge about where or how to make that investment. To be effective, it needs to be focused where carbon-intense infrastructure is to be replaced by low-carbon alternatives. Two sectors without which an energy transition is impossible are power and transport - power represented 40 per cent of global carbon emissions in 2018 and transport 23 per cent – but both come with huge challenges.

I have recently worked with other researchers to identify what these challenges are and how these sectors can become carbon zero, in order to understand the drivers that are holding transition back; not just the obstacles to policymakers, but to investors as well.

In these sectors, neither policymakers nor market actors have estimates or probabilities to work with in tackling these issues. Under these circumstances, decision-makers find it difficult to make any investments, as traditional toolkits used to assess and handle risks do not work when such deep uncertainties are involved.

From our research, this appears to be the underlying issue with energy transition – a deep uncertainty of unknown unknowns. Investment is being delayed in vital energy-transition technologies, such as offshore wind farms or electric vehicles, because we simply do not have data, information or predictions on how to implement the most effective approach. This is drastically slowing the speed of a transition.

Energy infrastructure is capital intensive. We know that we need substantial investment in clean energy and we know that we need it fast. How can we ensure that policymakers and investors have the correct knowledge and an understanding of these current unknown unknowns, in order to effectively transition to a clean energy sector?

Investors and policymakers should work together on this if the policy signal is such that investors can rely on it. And to be clear - that is not easy. A simple law that can easily be changed will not do the job. Financial contracts, such as contracts for difference simulating a high carbon price for investors, may be more helpful.

There must be a credible commitment from policymakers signalling that, for example, the path towards zero emissions by the year 2050 will be implemented. This will allow for a better and more forward-looking plan for investors who are then more likely to invest in clean energy. Policymakers must make the decisions to push for this, but ultimately it needs private investment to be successful and policymakers have to make that investment as attractive as possible. 

Governments need to send a credible long-term signal that the transformational change will happen. There may be concerns about this inducing costs and risks to competitiveness, but that could at least partly be compensated by strong and broad public support of research and innovation.

Energy transition is vitally needed if we are to reach carbon zero, not only in the clean energy industry, but as a contribution to tackling climate change as a wider issue. It is important that we can gather the most amount of information as possible in order to reduce the unknown unknowns and ensure investment in clean energy is as attractive as possible.

Ulf Moslener is professor of sustainable energy finance in the faculty of Frankfurt School of Finance & Management.

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