This statement highlights one of the major challenges associated with the mitigation of and adaptation to climate change – financing the related measures and investments. Since the energy sector accounts for over 80% of the European Union’s greenhouse gas emissions as of 2017^[2], financing the energy transition is going to be an essential step to reach the Union’s target of carbon neutrality by 2050.

Over the past years, rising public awareness regarding the risks associated with climate change has prompted a rise in green marketing in all sectors, including finance. Financial institutions have developed multiple tools and mechanisms ensuring that funds are directed towards financing projects mitigating climate change or adapting to its consequences. These notably include green funds – investment vehicles pooling funds from multiple investors to finance environmentally-friendly companies – and green bonds, defined by the World Bank as financial instruments “issued to raise capital specifically to support climate-related or environmental projects”^[3]. Since the launch of the first green bonds by the European Investment Bank (EIB) in 2007 and the World Bank in 2008 and after a slow start in the early 2010 decade, the market for these financial instruments has gained in popularity: 36 billion US dollars’ worth of green bonds were issued in 2014 whereas this figure amounted to 271 billion in 2019^[4].

Green finance directs funds towards a large variety of initiatives (low-carbon transport, land use, industry, water&waste etc.). However, the energy sector is by far its largest beneficiary. According to the International Renewable Energy Agency, half of all green bonds issued between 2010 and 2019 globally were partly or totally directed towards renewable energy projects. In Europe, 21% of the green bond emitted were fully dedicated to the financing of renewable assets, the highest regional share globally^[5]. Although the Covid-19 pandemic is having a significant impact on the level of investment in all energy projects, renewables, energy efficiency and clean transport/heat projects have shown much more resilience than their carbon-intensive counterparts. Compared to 2019, investments in oil and gas fell by more than 30 % whereas investments in renewables fell by less than 10%^[6].

While its necessity is sustained by scientific and economic literature^[7] as well as European political institutions, the contribution of institutional finance to the energy transition has often been met with widespread scepticism over the past years. Banks, states and other financial institutions have often been targeted by accusations of greenwashing, labelling products or actions benefiting from green financing even when they have no positive impact on climate change. In the energy sector, some extremely carbon intensive processes have benefited from preferential financial conditions in the past on the basis of their hypothetical impact on mitigating climate change^[8].

The reluctance over the sincerity of the financial sector’s efforts is largely due to the lack of standardized definition based on which investments are labelled as green from an environmental standpoint. In 2017, the European Commission published a report aimed at identifying a clear definition of green finance which disclosed over 50 different labels, certifications, guidelines and standards utilised worldwide by financial institutions, international cooperation bodies and research organizations, each using its own different categories, criteria and eligibility principles to qualify projects and companies^[9].

While these efforts contribute to transparency, the lack of a unified definition framework is a major source of risk, largely undermining the trust of public and private investors in the ability of green bonds or funds to efficiently deliver money to projects mitigating climate change. Poor reporting from projects and firms benefiting from green finance also plays a major role in this distrust. Even green bonds respecting the strictest definition standards risk being diverted from their initial goal and can sometimes end up financing greenhouse gas-intensive projects, as the data reported to investors is largely of a voluntary nature and non-standardised, undermining the reliability of its content and thoroughness. Moreover, green bonds are often seen by financial institutions as illiquid products compared to conventional bonds due to the emerging status of the market. Indeed, the volume of green bonds available on the market makes them a niche compared to their conventional counterparts. As of early 2020, green bonds only represented between 1% and 2% of the overall bond market globally^[10].

In addition to the lack of effectiveness of current mechanisms directing finance towards climate mitigation efforts, including clean energy projects, the current level of investment in these projects is largely under par compared to the sums estimates deem necessary for the energy sector to meet the climate change requirements of the Paris Agreement.^[11]

In order to tackle the lack of a unified definition hindering the proper development of green finance, hence favouring greenwashing, the EU has made green finance a key element of its “European Green Deal”. Presented on December 11, 2019, this plan includes a series of legislative projects and policy objectives across multiple economic sectors aimed at creating the conditions for the EU to reach its 2030 climate and energy targets and achieve carbon neutrality by 2050^[12]. One of the cornerstones of this plan is the EU taxonomy for sustainable activities, which establishes a clear list of activities and investments that can be considered environmentally sustainable by financial institutions. The foundations of this taxonomy were set by the EU Taxonomy Regulation (Regulation (EU) 2020/852^[13]).

Under the EU taxonomy, “generating, transmitting, storing, distributing or using renewable energy” as well as efforts to enhance energy efficiency are considered a substantial contribution to climate change mitigation. The key role of the energy sector in this taxonomy, and as such in the Union’s overall climate political agenda, was confirmed by the delegate regulation of the Commission of June 6, 2021, detailing which renewable energy generation technologies qualify as substantially contributing to climate mitigation^[14]. Another key delegate regulation is expected by the end of the year, which will detail the sustainability disclosure obligations applying to financial institutions and products included in the EU taxonomy, marking a significant step in the fight against greenwashing^[15].

This new legally binding taxonomy is considered to be a major milestone to effectively direct financing towards the energy transition and other climate mitigation efforts^[16]. However, the potential inclusion of natural gas and nuclear energy as sustainable technologies or as transition fuels in the EU taxonomy has sparked heated debates both in Brussels and within EU member states.

Concerning nuclear energy, while some member states argue that the safety and environmental concerns disqualify it totally from being considered sustainable, others, such as France, are heavily reliant on this low-emission technology in their current electric mix and could see its exclusion from the taxonomy as an industrial risk for their energy transition. Some member states such as Romania also have plans for new nuclear reactors that could be threatened by an exclusion from the taxonomy. Concerning natural gas, this fossil-fuel is seen by those member states with a coal-intensive electric mix such as Poland as a way to gradually reduce the carbon footprint of their electric mix, limiting the social and economic consequences of their energy transition. Major lobbying efforts have been undertaken by firms and member states to include both natural gas and nuclear energy in the taxonomy. Expert groups have been mandated by the Commission to assess the role of both technologies and the relevance of qualifying them as green investments^[17][18]. Their reports should prompt a decision by the European executive in the coming months.

Beyond these technological considerations, the overall efficiency of the EU taxonomy in directing investments towards the energy transition has been questioned by multiple organisations. The taxonomy will not prevent investors from financing activities actively contributing to climate change, which is a major issue considering investments into fossil-fuel extraction, exploration and end-use still significantly dwarf those into renewable energy and energy efficiency. Economic stimulus packages that boost post-pandemic recovery have included various degrees of sustainability-based conditionality. Nonetheless, fossil-fuel intensive industries have also received significant funding on the basis of their major socio-economic impact (job creations, tax revenue for local and national administrations, etc.). The level of investments into clean energy required to meet carbon neutrality remains extremely far from being met, both on a European and global scale. Although the EU’s taxonomy efforts are exemplary, they remain an exception on a global scale, where obscure reporting and shady labelling remains the norm.

Moreover, financial institutions have seen the past decade be the source of multiple consecutive reinforcements of their reporting obligations, both regarding financial^[19] and non-financial^[20] data, with a very limited degree of international harmonization. The addition of complementary obligations to the pre-existing concerning the sustainability of their activities could be met with criticism. The costs associated with the compliance obligations vis-à-vis both financial and non-financial reporting could prompt market players to develop alternative, less regulated mechanisms with an even lower degree of international standardization and, thus, lower market liquidity^[21].

While the EU has led the way to make the financial sector’s contribution to the energy transition more ambitious and effective, the impacts of climate change and efforts to mitigate it need to be thought of on a global level. European legislation needs to prompt larger multilateral action to accelerate the energy transition and finance the associated steps. Multilateral organisation such as the United Nations, the G7 and G20, as well as financial institutions such as the World Bank and the International Monetary Fund need to invite stakeholders to the negotiations table in order to finance the energy transition on a global level before greenhouse gas emissions supported by generous financing make the objectives of the Paris Agreement unachievable.

^[1]https://ec.europa.eu/info/files/political-guidelines-new-commission_en

^[2]United Nations Framework Convention on Climate Change – Biennial Reports – Data Interface https://www4.unfccc.int/sites/br-di/Pages/GHGInventory.aspx?mode=1

^[3]https://documents1.worldbank.org/curated/en/400251468187810398/pdf/99662-REVISED-WB-Green-Bond-Box393208B-PUBLIC.pdf

^[4]https://www.irena.org/publications/2020/Nov/Mobilising-institutional-capital-for-renewable-energy

^[5]https://irena.org/-/media/Files/IRENA/Agency/Publication/2020/Jan/IRENA_RE_finance_Green_bonds_2020.pdf

^[6]https://www.iea.org/reports/world-energy-investment-2020/key-findings

^[7]https://www.ipcc.ch/site/assets/uploads/sites/2/2019/06/SR15_Full_Report_Low_Res.pdf p. 321

^[8]https://europeangreens.eu/liverpool2017/congress/greenwashing-energy-production-fossil-fuels https://www.theguardian.com/commentisfree/2019/jun/26/shell-not-green-saviour-death-machine-greenwash-oil-gas

^[9]https://ec.europa.eu/environment/enveco/sustainable_finance/pdf/studies/Defining%20Green%20in%20green%20finance%20-%20final%20report%20published%20on%20eu%20website.pdf

^[10]https://www.ifri.org/sites/default/files/atoms/files/deschryver_accelerating_energy_transition_2020.pdf

^[11]https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement

^[12]https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en

^[13]https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32020R0852

^[14]https://eur-lex.europa.eu/legal-content/EN/ALL/?uri=PI_COM:C(2021)2800

^[15]https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en

^[16]https://www.sciencedirect.com/science/article/pii/S0301421520305802 Also see notes 9 and 4

^[17]https://www.reuters.com/business/sustainable-business/eu-reassessing-role-natural-gas-green-finance-rules-commission-says-2021-05-17/

^[18]https://www.reuters.com/business/sustainable-business/eu-experts-decide-nuclear-power-qualifies-green-investment-label-document-2021-03-27/

^[19]https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/financial-reporting_en

^[20]https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/corporate-sustainability-reporting_en

^[21]https://www.reuters.com/business/energy/italys-enel-sustainability-linked-bond-pioneer-brings-record-debt-sale-2021-06-08/

---

*Aimé Boscq is an EPG Fellow. The views expressed in this paper are those of the author and do not necessarily reflect the opinions of EPG.

France’s transition from an electric mix relying on centralized production capacities based on nuclear and fossil fuels to a RES-intensive mix associated with largely decentralized production capacities is far from being an isolated example in Europe. In order to fulfil their common ambition of becoming carbon neutral by 2050, the European Union (EU) and its member states will need to bring about significant changes in their energy consumption and production patterns, electrifying several energy usages and shifting to RES to produce their electricity[2].

This major shift in electricity production and consumption will have a significant impact on the way electricity is produced, but also on the way it is provided to end-consumers through grid infrastructure. The European power grid was initially designed to provide electricity produced in large, centralized power plants to end consumers. This design involved TSOs calling dispatchable power plants online and offline in order to meet demand and provide grid stability when required[3].

However, the growing share of RES in the mix has led to a radical change in this organization, with a large part of generation now produced intermittently, geographically spread around the grid and with some grid users frequently shifting from a consumer to a generator profile as prosumers and self-consumptions are increasingly widespread. As power plants are called online and offline by TSOs based on their marginal cost, RES such as solar and wind enjoy an injection priority given their marginal cost is close to zero. This injection priority, further secured by incentivizing policies at European and national levels, is remodelling the way the European grid is dimensioned and managed by TSOs and distribution system operators (DSOs). Ensuring technical stability and balancing supply and demand now requires additional tools and services, including capacity reserves and flexibility solutions such as battery storage, requiring swift and efficient changes in the operations of system operators. Without major overhauls in its technical and financial management as well as its regulatory framework, the grid could become a major source of tension and slowdowns in the energy transition[4].

Amongst the challenges associated to the grid integration of a high share of RES, the most debated is likely to be that of security of supply. Electric grids require a constant alignment of production with demand to ensure resource adequacy and quality of service for all consumers. With the increasing capacity of non-dispatchable RES, notably solar and wind, being deployed by EU member states to reach their decarbonation targets, matching supply and demand could become a major issue for TSOs and DSOs[5]. Production from RES, while predictable to a large extent thanks to precise weather forecasts, does not always coincide with demand peaks.

In an RES-intensive mix, would households, businesses, and industries be condemned to endure power cuts whenever the wind stops blowing or the sun stop shining?

Beyond the supply-demand equilibrium, the integration of renewable production to the grid is becoming increasingly challenging from a technical point of view. First, the physical capacity of the grid to absorb extra production is increasingly challenging in areas where RES development is particularly dynamic. In some cases, a large part of this capacity may also be reserved for future developments in conventional generation capacities (such as additional nuclear reactors in the case of Romania)[6]. While the first renewable production units benefited from existing infrastructure and relatively low connection fees, existing power lines and substations can only handle a given amount of production. As such, the connection of newer production projects is often linked to soaring grid connection costs, should they be handled by end-consumers, taxpayers, or by producers themselves depending on the grid financing mechanisms in place in each state. These costs can, in some cases, offset the significant decrease in the cost of RES technologies experienced in the past decades, leading to raising concerns on the overall cost of the energy transition and subsequently to public acceptance issues. Moreover, the geographical concentration of production units can lead to challenges in voltage and frequency management, given that some RES can be limited in their capacity to contribute to these critical aspects of grid stability[7].

Major breakthroughs have been made in the past decades with regards to electricity storage as providers of grid management services in RES-intensive electric mixes. Electrons themselves are extremely complicated to store physically, implying costly and logistically challenging infrastructure. They can however be converted into potential energy, which will in turn be converted into electricity again when demand rises. Such conversion units can take multiple forms, using as many different technological solutions associated with varying roundtrip efficiencies. One of the most mature means of storing electricity are pumped-hydro-storage plants, where water is pumped up when excess electricity is produced and released through a turbine to produce electricity when needed[8]. However, this technology has become rather difficult to roll out due to environmental and public acceptability concerns over the flooding of large areas, severely affecting wildlife and local populations. Furthermore, this technical solution is also very capital-intensive, further undermining its attractivity.

The technical solution regarded as having the highest potential to meet the EU’s upcoming electricity storage needs are chemical batteries (lithium-ion technology being one of the more mature solutions, but far from the only one)[9]. This solution presents the crucial advantage of being extremely modular, able to respond extremely fast to calls from grid operators or market players and have a relatively long-life cycle. Moreover, battery costs have decreased dramatically in the past decade with major technological breakthroughs fueled by the accelerating rollout of EVs, and a large part of electric-vehicle batteries can still be used in standalone applications when they are not efficient enough anymore in vehicles[10]. The rollout of EVs represents a fantastic opportunity for grid management, as specific charging points enable electricity consumption by the battery as well as injection to the grid or to a specific consumer in a process called vehicle-to-anything or V2X.

Although less consensual, other technological solutions could also be mobilised by TSOs and DSOs in order to maintain grid stability. Among those, power-to-gas (P2G) has been the subject of heated debates concerning its potential contribution to the energy transition. P2G technologies include the production of synthetic methane and hydrogen with excess electricity and later either using these gases in peaker power plants to produce electricity or in industrial processes to produce heat[11].

Along with RES production curtailments already in use today, demand-side management could also play a significant role in enabling the grid integration of RES in renewable-intensive electric mixes. Today, end-consumers are no longer passive absorbers of electrons, as the rise of prosumer behaviours enables them to produce, store, self-consume, share the electrons they produce and even take part in grid services[12]. While large industrial consumers have been mobilized by some TSOs and DSOs to provide load reduction services for many years now, small scale consumers including households are now becoming increasingly integrated in the market mechanisms and regulatory frameworks encompassing grid stability in the context of the energy transition.

While it would be easy to conclude that the solutions described in the previous paragraphs make the energy transition’s grid-related issues irrelevant, such a conclusion would hinder a key aspect of the transition’s acceptability – its cost. Most studies show that the overall cost of an electric system compatible with the Paris Agreement, and its repercussion on the price paid by end-consumers for their access to electricity, would not be very different to the one we experience today[13]. However, in order to maintain an acceptable price tag while massively accelerating the energy transitions, infrastructure investments to ensure the connection of new capacities to the grid and increase the interconnection of national grid on a European scale will be needed as soon as possible. These investments will need to be accompanied by both a significant mobilisation of end-consumers to adapt their behaviours and strong political momentum to accelerate the integration of all actors of the energy sector, big or small, to grid services markets[14].

The European Clean Energy Legislative Package[15] and subsequent reforms have brought about significant tools for national public authorities, regulators, grid operators to adapt market designs and technical requirements to the introduction of a significant proportion of RES to the European electric generation mix. However, the implementation of these reforms on a national level has been slow and is still far from complete, years after their adoption in Brussels[16]. These reforms are essential to the energy transition as they will render the cost-efficient technical solutions available on the market available to use by grid operators. As such, the complete transposition of European legislative initiatives on a national level as early as possible seems to be a prerequisite to considerably facilitate the rollout of RES and make the energy transition as a whole a success.

[1] International Energy Agency and Réseau de Transport d’Electricité, Conditions and requirements for the technical feasibility of a power system with a high share of renewables in France towards 2050, 2021. Url: https://www.iea.org/reports/conditions-and-requirements-for-the-technical-feasibility-of-a-power-system-with-a-high-share-of-renewables-in-france-towards-2050

[2] European Commission, 2050 long-term strategy. Url: https://ec.europa.eu/clima/policies/strategies/2050_en. See also: European Commission, 2030 climate & energy framework (https://ec.europa.eu/clima/policies/strategies/2030_en) and National Energy Climate Plans of EU member states (https://ec.europa.eu/energy/topics/energy-strategy/national-energy-climate-plans_en#final-necps)

[3] Subhes C. Bhattacharyya, Energy Economics, Concepts, Issues, Markets and Governance, Springer, 2011

[4] Brigitte Knopf, Paul Nahmmacher, Eva Schmid, The European renewable energy target for 2030 – An impact assessment of the electricity sector, Energy Policy Volume 85, October 2015, Pages 50-60. Url : https://www.sciencedirect.com/science/article/abs/pii/S0301421515002037

[5] D.P. Schlachtberger, T. Brown, S. Schramm, M. Greiner, “The benefits of cooperation in a highly renewable European electricity network”, Energy Volume 134, 1 September 2017, Pages 469-481. Url: https://www.sciencedirect.com/science/article/pii/S0360544217309969

[6] https://world-nuclear.org/information-library/country-profiles/countries-o-s/romania.aspx

[7] See note 5

[8] US Energy Information Administration database

[9] Michael Child, Claudia Kemfert, Dmitrii Bogdanov, Christian Breyer, “Flexible electricity generation, grid exchange and storage for the transition to a 100% renewable energy system in Europe”, Renewable Energy Volume 139, 2019. Url: https://www.sciencedirect.com/science/article/pii/S0960148119302319?via%3Dihub

[10] Behrang Shirizadeh, Quentin Perrier, Philippe Quirion, “How Sensitive are Optimal Fully Renewable Power Systems to Technology Cost Uncertainty?”, The Energy Journal Volume 43, Number 1, 2020. Url: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3592447

[11] Ibid.

[12] Campos et al., Regulatory challenges and opportunities for collective renewable energy prosumers in the EU, Energy Policy Volume 138, March 2020. Url: https://www.sciencedirect.com/science/article/pii/S0301421519307943

[13] See notes 8 and 9

[14] See notes 1 and 11

[15] https://ec.europa.eu/energy/topics/energy-strategy/clean-energy-all-europeans_en

[16] See, for example, the transposition process of the market design directive (directive n°2019/944) into national law in EU member states: https://eur-lex.europa.eu/legal-content/EN/NIM/?uri=uriserv:OJ.L_.2019.158.01.0125.01.ENG

---

*Aimé Boscq is an EPG Fellow. The views expressed in this paper are those of the author and do not necessarily reflect the opinions of EPG.