Abstract
Cost of capital is an important driver of investment decisions, including the large investments needed to execute the low-carbon energy transition. Most models, however, abstract from country or technology differences in cost of capital and use uniform assumptions. These might lead to biased results regarding the transition of certain countries towards renewables in the power mix and potentially to a sub-optimal use of public resources. In this paper, we differentiate the cost of capital per country and technology for European Union (EU) countries to more accurately reflect real-world market conditions. Using empirical data from the EU, we find significant differences in the cost of capital across countries and energy technologies. Implementing these differentiated costs of capital in an energy model, we show large implications for the technology mix, deployment, carbon emissions and electricity system costs. Cost-reducing effects stemming from financing experience are observed in all EU countries and their impact is larger in the presence of high carbon prices. In sum, we contribute to the development of energy system models with a method to differentiate the cost of capital for incumbent fossil fuel technologies as well as novel renewable technologies. The increasingly accurate projections of such models can help policymakers engineer a more effective and efficient energy transition.
Highlights
In making the transition to a carbon neutral economy by 2050, the European Union (EU) is facing a very large challenge
We discuss the impacts of using differentiated weighted average cost of capital (WACC) in the Reference scenario for the EU overall and for two specific countries, Germany and Greece, where country risk premia deviate the most and WACC estimates are based on a broad empirical basis
At the EU28 level, we observe that the switch from uniform to differentiated WACCs leads to lower future shares of fossil fuel-based plants and higher shares of renewables in both the Reference and the Ambitious Decarbonization scenarios
Summary
In making the transition to a carbon neutral economy by 2050, the European Union (EU) is facing a very large challenge. What we know with certainty is that the transition requires large amounts of private and public investment. McCollum et al 2013, 2018; OECD/IEA and IRENA 2017; European Commission 2018). This is well below total annual savings and investment, so the challenge is not raising the money but rather “Shifting the Trillions” from fossil fuels to renewables (Hansen et al 2017). The European Commission, for example, in its recent Green Deal programme (European Commission 2020a) has announced it will shift over 1 trillion euros into the transition, as evidenced by the recently approved 7-year budget
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