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July 2013

Dealing with Uncertainties in Energy Investments

Uwe Deichmann's picture

 John Hogg/World Bank

According to the International Energy Agency (IEA), global energy demand is likely to grow by more than one-third between now and 2035. Mobilizing investment capital is one major task. Additionally, energy infrastructure such as electric power facilities has a long time span – up to 40 or 50 years in the case of base-load nuclear or coal plants. As the new Growing Green report, released by the World Bank’s Europe and Central Asia Region, points out, with such a long time span and the enormous amount of capital at stake, power sector investments need to consider at least three types of uncertainties—changing regulations, changing technology, and changing climatic conditions.

Regulatory Uncertainty

Regulatory uncertainty persists in countries without formal greenhouse gas emission restrictions. Even in the EU, the emissions trading system is still evolving and future prices for carbon emissions will in large part depend on political decisions. Such schemes may spread to other parts of Europe and Central Asia as the implications of climate change become more apparent and support for climate action rises. A price on carbon, either through a cap-and-trade sys¬tem or a tax, can profoundly alter the comparative economics of different power generation technologies. With a price on carbon emissions, the cost differential between fossil-fuel plants and low-carbon alternatives shrinks and in some cases disappears.

Many international firms and banks already incorporate an assumed carbon price into their financial investment feasibility calculations. Expectations of future carbon pricing have already altered investment decisions favoring natural gas over coal-fired power plants in the U.S. (although more recently the drop in gas prices has been a larger factor). Conversely, regulatory uncertainty also hinders investments in low-carbon generation. The IEA estimates (pdf) that uncertainty in climate change policy might add a risk premium of up to 40 percent to such investments, driving up consumer prices by 10 percent.

Three Types of Climate Action for Europe and Central Asia Region

Uwe Deichmann's picture

An array of energy efficient light bulbs.
Under current trajectories, the world is headed toward a world that will be 4 degrees warmer by the end of this century. Despite the mounting concern around this scenario, many countries throughout the Europe and Central Asia (ECA) region are understandably reluctant to introduce more ambitious climate policies because they are worried about the negative consequences on competitiveness or energy affordability, for instance.

However, as we try to show in our recent publication, Growing Green: the Economic Benefits of Climate Action, strategic investment in climate action can benefit these countries in the medium- and long-terms – thus offsetting the negative consequences of these investments.

Above all, countries need to focus on three types of climate action: climate action as a co-benefit, climate action as an investment, and climate action as insurance.