Financing Energy Innovation: Internal Finance and the Direction of Technical Change

Joëlle Noailly,Roger Smeets

doi:10.1007/s10640-021-00602-9

Abstract

AbstractAchieving the goals of the Paris Agreement and of climate neutrality by 2050 in the European Union will require mobilizing financial investments towards clean energy innovation. This study examines the role of internal finance (cash flows and cash holdings) and financing constraints for innovation in energy technologies. We construct a dataset for 1,300 European firms combining balance-sheet information and patenting activities in renewable (REN) and fossil-fuel (FF) technologies and estimate the sensitivity of patenting activities to firms’ internal finance. We use count estimation techniques and control for a large set of firm-specific characteristics and market developments in REN and FF technologies. We find that patenting activities of firms specialized in REN innovation are significantly more sensitive to a shock in cash flows than firms specializing in FF innovation. Hence, our results emphasize that innovative firms in clean energy may be particularly vulnerable to financing constraints. We discuss the implications of these results for energy transition policies aiming to redirect finance towards clean energy R&D.

Highlights

The ability to achieve sizeable greenhouse gases emissions reductions to address climate change without compromising future economic growth is linked to the deployment and development of clean technologies
Mobilizing more finance towards clean energy is key for the energy transition as recent climate models estimate that the low-carbon energy investment gap to achieve the 2 degrees target of the Paris Agreement represents about one-quarter of annual total energy investment (McCollum et al 2018)
Drawing on the result from the corporate finance literature that firms that are financially constrained tend to be more sensitive to shocks in the supply of internal finance, we investigated whether firms specializing in REN innovation exhibit a higher innovation-cash flows sensitivity - an indication of binding financial constraints - than firms specializing in FF innovation

Summary

Introduction

Decarbonizing the energy sector implies shifting away from fossil-fuels, such as coal, oil and gas, which today still account for 70% of worldwide electricity production and 80% of global energy investment. Despite recent developments in renewable energy, in particular in wind and solar energy, experts worry that the current pace of innovation efforts in renewable technologies may not be sufficient to achieve the commitment of the Paris Agreement to limit global temperature rise below 2 degrees Celsius (IEA 2017). Mobilizing more finance towards clean energy is key for the energy transition as recent climate models estimate that the low-carbon energy investment gap to achieve the 2 degrees target of the Paris Agreement represents about one-quarter of annual total energy investment (McCollum et al 2018). According to Polzin and Sanders (2020), Europe still faces a lack of investments to promote R&D in novel clean energy technologies, such as energy storage, energy-efficiency, decentralized renewable energy, or advanced biofuels and they strongly advocate for a need to “move (some of) the trillions to where they are most needed to facilitate the energy transition in Europe” (Polzin and Sanders 2020, p.2)

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