The changing cost of capital for energy sector: While trends are positive in Europe, a lot more needs to be achieved in North America and China.

Central to achieving the goals of the Paris Agreement is channelling large amounts of capital into low-carbon energy, and the price to deliver renewables depends critically on the cost of capital. The cost of capital is a major determinant of the total cost of different energy technologies and reflects the risks financial markets perceive, for example, how quickly coal might be displaced by renewables. It acts as a key transmission mechanism between the financial system and the real economy, affecting the investment decisions of both financial institutions and corporates, thereby requiring a fall in the cost of capital for clean energy.

We just published the most comprehensive analysis of cost of capital trends across the global energy sector over the past two decades. This report tracks the changing cost of capital across the global energy sector including for oil and gas production, coal mining, refining, offshore & onshore wind, and solar, among others. This large-scale and robust approach provides a broader vision of changes in the global energy system’s cost of capital, to inform policymakers about changing market sentiments and risk preferences by region and asset class in the carbon-intensive industries. This is a sequel to the first report released in 2021 tracked the cost of debt in the energy sector, and this updated version expands to equities, corporate bonds, and accounting data in addition to syndicated loans.

We find that renewable electric utilities with a higher share of solar and wind power capacity have a lower cost of equity and debt than fossil fuel focused peers on a global scale. This trend is particularly pronounced in Europe, showing that climate-friendly policies and actions have been successful at making investments in clean energy generation a highly cost-effective energy source. However, this trend varies considerably by region. In Europe, low-carbon electric utilities have a lower cost of capital than high-carbon counterparts. But the opposite is true in China; and in America, the report found no consistent trend.

We find that the cost of debt of renewable electric utilities is at 6%, compared to 6.7% for fossil fuel electric utilities. Similarly, utilities focused on renewables have a cost of equity (15.2%) lower than those relying on fossil fuel (16.4%). In Europe, the cost of equity gap between lower-carbon electric utilities and higher-carbon peers has been widening over time. This suggests that the more forward-looking equity investors in Europe foresee that transition risks embedded in fossil fuels investments will rise soon.

Examining energy production, we show that globally, coal mining has the highest cost of capital, with the cost of debt increasing to 7.9% in 2021 while the cost of equity increasing to 18.2%, followed by oil and gas production and renewable fuels. Since 2016, the cost of debt to raise capital for renewable energy and technology has been on a downward trajectory, while that of coal mining has risen. Similar to electric utilities, trends vary considerably by region, and in a similar way. Furthermore, in Europe, oil and gas production has the highest cost of equity.

The findings also show that it is becoming increasingly risky to invest in carbon-intensive operations as well as in capital intensive upstream activities in the oil and gas industry. Against the backdrop of Russia’s invasion of Ukraine, oil and gas prices have been driven to their highest levels in a decade, further spurring economies to wean themselves off fossil fuels and shift capital flows to clean energy.

The Europe precedent shows that environmental policies matter in asset pricing, which can serve as a model for North America and China, where climate action has been less consistent. In North America, as a result, we don’t see a consistent trend in the cost of capital for renewable versus fossil fuel power. What remains to be seen is whether the policy landscape can shift, particularly with big changes such as the recent Inflation Reduction Act.