Net-zero spending: Europe’s capital allocation bumfuzzle

In this week’s Power Playbook, Yusuf Latief discusses how an allocation ‘bumfuzzle’ stemming from legislative uncertainties, fragmentation and framework inconsistencies in Europe has been holding capital back from the net zero account.

If I had a nickel for every time I read (and wrote) ‘record clean energy investment’… Well, I’d have a lot of nickels. And I’m about to get one more.

According to BloombergNEF in a report released last week, despite record clean energy investment, the continent remains off-track to meet 2030 targets.

What disappoints is not necessarily the news. Rather, it is the lack of surprise.

The last year has seen big strides for the continent’s energy sector, disparagingly coupled with analysis showing that yet more is needed.

BloombergNEF highlights in their New Energy Outlook that despite the continent making some of the strongest progress among major economies to reduce energy-related emissions, Europe still needs to more than double investment in energy transition-related activities.

Specifically, investment figures need to reach an average of $1 trillion every year until 2030, to close the gap on its targets and be on track for net-zero emissions by 2050.

But why is this? Why, despite clearly having immense capital resources to allocate to the net zero agenda, does the “off-track” adage remain.

Well, according to research coming from energy transition bank NORD/LB alongside European think tank Themis Foresight, it boils down to allocation.

Allocation bumfuzzle

According to their report, The Future of Capital Markets, Europe has the capital available to reach net zero, but it's in its allocation that the barriers occur.

Namely, three persistent issues recur: the age-old issue of investors not having a risk appetite, an ineffective capital allocation model, and the fragmented nature of the European capital market.

The risk issue is certainly nothing new.

Many investors still consider financing renewable energy projects too risky. To remedy this, governments will need to play a bigger role in helping to de-risk those investments, says the report, by acting as guarantors and via public-private partnerships.

But when it comes to the capital allocation model and fragmentation, the problems become more systemic.

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Jan Berger, CEO of Themis Foresight, explained to me: “As the study points out: Basel III [regulation] forces banks to increase the amount of capital they have available, in particular higher levels of hard core (CET1) capital.

“For the CET1 capital to increase, a bank either needs to earn this capital first or the capital needs to be increased by other means, such as capital injections through private or government investment.

“So, the banking sector is slow. I would at this point not argue for a significant deregulation of the banking sector. There are good reasons for Basel III. But the sheer weight (65%) of the banking sector in EU investment activities, makes the capital market very slow.

“Asset managers do not fall under the same restrictions as banks and can move in a much more agile way. They, however, are equally impacted by regulatory uncertainties of a fragmented legislation in the EU capital markets.”

This fragmentation, says the study, is a major hurdle, stemming from regulatory discrepancies, different market practices and inconsistent political framework conditions in the EU member states.

A bumfuzzle of a legislative situation, some might say.

The consequences are significant and Berger listed some notable examples of where this fragmentation has already been holding back capital flow.

Two weeks ago, for example, Power Engineering International’s Pamela Largue reported on ArcelorMittal postponing plans to invest in green steelmaking within Europe, citing policy uncertainties and a lack of supportive measures.

Said Berger on ArcelorMittal: “In total the company had planned to invest $8.3 billion in France, Spain, Germany and Belgium. As of now, all of these investments are on hold, to be fair, also because of overcapacities in China.

“Repsol halted green hydrogen projects in Spain, totalling 350MW of electrolysis capacity, due to an unfavourable regulatory environment and potential windfall taxes on energy companies. This decision impacts Spain's goal of achieving 12GW of green hydrogen capacity by 2030.

“And even on a regional level, we see halted investment in peer-to-peer energy communities citing numerous regulatory barriers. If an investor like ArcelorMittal is confronted with four sets of regulations and uncertainties regarding taxation, and financing banks or asset managers face different legislation around insolvency, investment becomes complex and burdensome.”

The competitive cost

The allocation bumfuzzle will not be self-contained.

In fact, it has a bleeding effect, hampering Europe’s competitive position.

Mario Draghi’s September report on Europe’s competitiveness called for a whopping $880 billion of additional investments a year for Europe to catch up with the US and China, alongside a new industrial strategy and a joint competitiveness and decarbonisation plan.

The report also highlighted the financing needed for the grid, the importance of which “cannot be overstated”.

Add in the allocation conundrum, and the plot thickens.

Said Berger: “The ability to profitably sell renewable energy to industry and consumers depends on the existence of sufficient grid capacity.

“In 2023, according to Statista, we witnessed €23 billion ($24.2 billion) being invested in electricity grid infrastructure. However, to meet climate objectives, the EU must increase grid expansion investments to at least €38 billion ($39.9 billion) annually by 2030, escalating to €100 billion ($105 billion) per year by 2050.

“So, the 2023 figures are €15-€77 billion ($15.8-$80.9 billion) short, depending how you want to look at it. Another study from 2023 suggests that planned budgets fall short by approximately €87 billion ($91.4 billion) for power plants, electricity grids, and rail infrastructure in the near term.”

This of course is on the EU level. There is also the international stage, with the dominant player being China.

Berger emphasized China’s control of 85% of the international battery market. Just this week, the country’s Rongke Power completed a 175MW/700MWh project, which they are calling the world’s largest vanadium flow battery project.

“These batteries are not only needed for energy storage in electric vehicles, but importantly also for storing solar and wind energy. This dependency poses risks for the renewable energy transformation of the EU.

“The EU Commission reported in October 2023 that even though venture capital investments in clean energy within the EU rose by 42% in 2022 compared to 2021, the region still lags behind the US and China in attracting substantial investments in clean energy technology firms. One year later, clean energy VC funding had dropped by 29%, to $2.5 billion, while VC investment in clean energy remained strong in the US with $5.5 billion and the Asia Pacific region with $3.6 billion.”

Bring in reform

Suffice to say, the situation is somewhat dire.

A key remedy says Berger is completion of the EU’s Capital Markets Union (CMU), which would create a single market and allow capital to be delivered more efficiently to renewable energy projects.

Specifically, the best route to unlocking capital, posits NORD/LB and Themis Foresight in their report, is that of ‘The Great Reform’, a coherent and fresh financial landscape with a comprehensive CMU, ensuring targeted flow of capital.

However, the CMU policy was launched back in 2014.

A decade since and a report by the Directorate-General for Internal Policies says the CMU project has ‘disappointed in its first decade’. Namely, the report says that ‘rhetorical support’ for the CMU failed to materialise into transformational policy and structural changes to the EU financial system.

Perhaps from next year, things might change.

Europe’s new College of Commissioners have of course entered the scene, and hopefully Brussels can push things into the next gear now that we only have five years left until 2030.

Said Berger: “There are some positive signals coming out of Brussels.

“It appears that several of the new EU Commissioners have taken the sobering findings of the Draghi report to heart.

“I can only wish them luck, a steady hand, and an abundance of persuasive power, and administrative talent to implement what they said they would.”

Indeed, as this is the last Power Playbook of 2024, we will have to wait and see what developments lie in store for us on the horizon.

Until then, happy holidays and see you in the new year.

Cheers,
Yusuf Latief
Content Producer
Smart Energy International

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