Is the Global Energy Transition Simply Too Expensive?

• Funding the global energy transition, which is estimated to cost over $100 trillion by 2050, would require 1.3% of projected global GDP.
• High interest rates are only making the task more daunting, with the cost of capital potentially putting off those that would fund it.
• Challenges in the EV market and offshore wind troubles are only adding to concerns over the global energy transition.

The energy transition has been estimated to cost more than $100 trillion by 2050. In fact, according to the calculations of the Energy Transitions Commission, a grouping of business leaders, it will cost $110 trillion.

That would translate into $3.5 trillion annually and represent 1.3% of the projected global GDP for the period. As a percentage of GDP, the figure does not look particularly impressive or frightening—a Deloitte estimate pegs the transition cost at $5-7 trillion annually.

There are many estimates of the transition cost and different outlooks for global GDP, but it is safe to say that when we talk about the transition, we are talking about trillions that need to be spent every year. And it seems that many investors and most regular consumers are unwilling to shoulder the burden.

Ahead of this year's COP28, which began in Dubai on Thursday, Reuters reported that transition advocates were worried about high interest rates, which made the cost of capital more expensive, threatening to shrink transition enthusiasm among potential funders. 

"I'm very worried. What used to be available at Libor plus 50 (basis points) or Libor plus 100 is not available at those rates anymore," Gauri Singh, deputy director general at the IRENA, told Reuters.

Indeed, higher interest rates have been blamed by wind and solar companies for their higher costs and increasingly problematic economics, especially in offshore wind. They have also been blamed for companies asking for higher subsidies from governments and also higher prices for their electricity—higher rates have made it a challenge to turn in a profit on many of these.

Capital will be discussed copiously at COP28. Whether the parties involved in the discussion would be able to come to an agreement remains highly uncertain. Meanwhile, the different wheels of the transition seem to be acting like the wheels of a defective shopping cart.

In the U.S., carmakers are losing money on EVs because demand is weaker than expected. In Europe, the industry is optimistic, anticipating a surge in EV sales thanks to the launch of many new affordable models. On the other hand, a phase-down of EV subsidies in Germany from January 1st has led to warnings of lower EV sales, and Consumer Reports just came out with a report that found EVs are less reliable than ICE cars. Both could affect the sales outlook.

In offshore wind, as already mentioned, troubles abound. The more expensive form of wind power generation enjoyed several years of significant interest from transition-oriented governments, not least because project developers promised cheap electricity. Now, this is no longer the case. Instead, offshore wind developers are booking billions in impairments, canceling projects, or, as noted, asking for higher prices.

It appears that higher interest rates—as well as expected shortages in some key materials—have affected the wind and solar industries more significantly than they have affected oil and gas. Oil and gas executives are also complaining about higher interest rates in the U.S., at least, but they seem to be managing to squeeze a record production out of oil fields despite that.

The list of examples is long. The short of it is that the transition is turning out to be more expensive than most can stomach. For investors, the above developments are worrisome from a return perspective. For consumers, until those cheap EVs roll off the line, the switch from ICE to electric is not really something they'd gladly do. And when you see news such as this report saying German grid operators would be able to limit power supply to heat pumps and EV chargers, the switch begins to look even less appealing.

Speaking of the above report, the supply limits would be necessitated by insufficiently large grids. Grid investment is a major element in the transition price tag. And people are already opposing new transmission lines in evidence that besides expensive, the transition is going to be problematic in other ways as well.

"By putting a price—financial or implicit—on a free resource (the climate), the transition increases production costs, with no guarantee that the reduction in energy costs will eventually offset them, while the investments it calls for do not increase productive capacity but must nevertheless be financed."

That's according to French economist Jean Pisani-Ferry, who is a senior fellow at energy think tank Bruegel, as quoted by the Wall Street Journal. Pisani-Ferry added, in a recent report, that if the switch to EVs and heat pumps to support the transition cost more than their hydrocarbon versions and if the government raises taxes to pay for heat pump and EV subsidies, the end consumers would end up worse off. It would be hard to spark enthusiasm about the transition in such a context.

What would be even more challenging is to convince investors that there would be no change in climate policies as governments come and go. So far, the evidence, at least in Europe, points to the opposite. Sweden's new government went back on the climate commitments of the previous one. Elsewhere, conservative parties are gaining popularity, not least with anti-climate policy rhetoric. The transition advocates really do have their work cut out for them.

By Irina Slav for Oilprice.com

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