Financing the energy transition: investor diversity is critical for success

25 Aug 2021

Investments in low-carbon technologies across the energy sector need to increase to £50 billion per year by 2030 (and to remain at that level until 2050) to successfully deliver the UK Government’s net-zero target by 2050. Moreover, it is estimated that to reach the UK Government’s target of 40 GW of offshore wind by 2030 £50 billion will be needed.

A complex transition

The energy transition is complex: the substantial investment required to decarbonise the sector has to be delivered by a diverse set of actors with different investment strategies, who respond differently to policy designs and incentives.

The UK renewable energy investment landscape is diverse. Besides big utility companies, it also comprises new types of investors and local players (e.g. households, community energy initiatives) who invest in decentralised renewable energy, and who are becoming increasingly important to help finance the UK energy system transition. Local investors have different rationales for investing in renewable energy projects and different risk-return requirements as compared to big utility companies and can be less driven by economic motivations and more by wider socio-environmental considerations.

Hence, key challenges for the future will be to: 1) understand the uncertainties posed by the different investment strategies of existing and new low-carbon investors, and 2) deliver effective polices which can incentivize the large level of required low-carbon investment, by creating an attractive environment for the different types of investors.

There is a pressing need for these policies to be effective from the 2020s as current investment choices will shape the energy sector over the next few decades and have a significant impact on whether net zero is successfully achieved.

How can new modelling approaches help?

New modelling approaches, such as agent-based models, are useful to capture investor diversity and can provide valuable insights on the responses of different actors to different policies and governance arrangements. This can help reduce uncertainty in decision-making and help inform effective policies to encourage low-carbon investments.

For example, BRAIN-Energy, a UK electricity sector agent-based model developed at the UCL Energy Institute, explores the risks and opportunities that different investment strategies pose to decarbonisation efforts.

Why are diverse investors so important?

Insights from BRAIN-Energy illustrate the impacts of different investment strategies of local and national investors, and of the interventions of different policy bodies (national government and regulator, and local authorities) on UK electricity sector decarbonisation pathways to 2050.

Results show how a diverse investor base, which also includes local actors (despite leading to slightly higher total investment costs) brings about a faster and deeper deployment of renewables to 2030 and then to 2050, and a reduced reliance on nuclear. This could be considered an advantage, especially if there were societal concerns over nuclear technology. A stronger market diversification can be achieved through a lower cost of capital, which helps local actors to flourish.

What can be done to encourage market diversification?

The UK energy sector is currently very centralised, with regulations and policies mainly focus on large-scale projects. Policies to support the growth of local energy infrastructure, as well as financing mechanisms appropriate to local actors, are lacking.

Encouraging market diversification, including the growth of local investors, provides a valuable opportunity to scale-up investments in renewable energy technologies. Policy-makers should seek to encourage market diversification through a stable and strong policy regime, coordinated with the diverse investment strategies of the different actors, and should introduce new financing mechanisms to unlock or underwrite finance for all types of investors.

New business models and the involvement of public sector investors such as local authorities should also be encouraged, and could lead to a higher participation of those interested in the environmental and social aspects of the energy system transition.