The current bout of high inflation began with unprecedented price rises for gas and oil due to Russia’s invasion of Ukraine. The geopolitical unrest in eastern Europe could lead to new price surges at any time. It is fast becoming clear that the best way to protect Europe against such price shocks is to accelerate the energy transition, thereby reducing its dependence on gas and oil.
But while the tools and technology are in place or in development, rising interest rates are slowing down the transition by adding billions of euros to the price tag. In the Netherlands, a third of all sustainable energy producers report that they have already delayed or even cut projects due to high funding costs.
Sources of sustainable energy have long been in contest with fossil fuels, financially and operationally. However, the investment costs tend to be much higher as the development of sustainable energy sources is a capital-intensive undertaking. Interest rates will therefore have a considerable effect on costs.
Still, the operational costs of renewable power plants are very low. Once the wind farms, solar panels, heat pumps and electricity cables are all in place, the sun and wind show up for free. Meanwhile, fossil fuel energy production needs a constant supply of oil, gas and coal. Fossil fuel dependence means Europe remains reliant on fossil fuel-exporting countries of dubious reputation and reliability. That dependency makes Europe a pawn for geopolitical superpowers.
Such a reliance can have disastrous outcomes, causing uncertainty about the availability of energy and severe price increases. The energy transition is the best weapon against this dependency and its associated financial risks. Sustainable energy is the best investment in price stability.
With interest rate rises designed to curb inflation adding billions of euros to the price of the energy transition, this is bound to affect projects in energy infrastructure, solar and wind energy, geothermal energy and heat pumps. In the Netherlands, the capital costs for eight important technologies will rise by €17bn by 2030, according to research by the Berenschot consultancy commissioned by the Dutch Association for Renewable Energy (NVDE). Each percentage point increase in the interest rate will raise those costs by €6bn by 2030, then by as much as €55bn by 2050.
The sector is already feeling the effects. A survey of the sustainable energy sector found that more than a third of respondents were experiencing negative impacts on their funding options. Another third were anticipating those impacts to materialise soon, but more than 80% of businesses expect moderate to serious delays to the energy transition.
There is no reason to expect this will be much different in the rest of Europe, particularly in countries that have no fiscal room to compensate for higher costs with extra subsidies to keep the energy transition at speed.
The European Central Bank could neutralise this drawback of its own monetary policy, according to an analysis by the Sustainable Finance Lab. Over the past few years, the ECB has made it possible for banks to secure funding at favourable rates on the condition that they maintain a certain level of lending to consumers and businesses. This emergency intervention, known as the ‘targeted longer-term refinancing operation’, is now being wound down. It would be sensible to newly deploy this instrument for the energy transition. Banks could then pass the lower ‘green interest rate’ they secure from the ECB on to their customers for sustainable energy investments.
This lower green rate for sustainable energy investments would tackle the problem at the source and make a structural contribution to reducing inflation by reducing our dependence on fossil fuel energy sources. A green ECB monetary policy of this kind is most important for countries with high national debt and thus a low fiscal capacity.
This solution would support the main objective of the ECB: safeguarding price stability. It would make the economy less vulnerable to future price shocks related to fossil fuel energy and would mitigate the disrupting impacts of climate change. The latter is important for long-term price stability as it will prevent crop failures and other disasters. The overarching message to central bankers: safeguard price stability and introduce a green interest rate.
Source : Omfif