PARIS, France, June 6, 2007.
The future supply of electricity around the world cannot be assured unless substantial investment takes place, and one “critical uncertainty” is the future form and stringency of climate policy which could affect investment behaviour in the power sector.
“Climate policy uncertainty poses a threat as any other uncertainties, but it can be reduced with predictable policies,” concludes the International Energy Agency in ‘Climate Policy Uncertainty & Investment Risk.’ The book presents results of an IEA study quantifying the cost of uncertainty in the process of climate policy evolution and initial policy conclusions to illustrate the choice between coal and gas (with and without carbon capture) as well as nuclear reactors.
IEA estimates that the investment in power facilities to meet projected demand between 2005 and 2030 must exceed US$3.1 trillion under an alternative scenario if there are policies to reduce CO2 emissions. A number of risks could cause the delay of necessary investment, it adds, but global reports on climate change stress that policy is needed to significantly reduce GHG emissions while the timing of the precise policy measures that will implement those reductions remains unclear.
The 144-page book says risks from climate policy may be brought down to modest levels compared to other risks, if policy is set over a sufficiently long timescale into the future. Longer commitment periods (beyond the current five-year period) will lower the risks from climate policy and increase investment in climate-friendly technologies.
If all other premises are equal, the uncertainty over climate policy “slows down the introduction of new technologies when compared to conventional ones because it adds an additional risk to other large existing ones,” with risk premiums for new technologies as high as 40% of capital investment cost for a power plant and 10% of price surcharges for electricity consumers. Even in an uncertain environment, “companies will generally be confident in committing capital to projects as long as they can establish a competitive advantage over other market players,” it argues. “When it comes to regulatory risk, this requires that policy makers establish clear rules, which should be applied consistently to all market players, irrespective of ownership structure; then companies will feel less uncertain and more confident in power investment.”
“Our climate is changing; this is certain,” it states. “Less certain, however, is the timing and magnitude of climate change, and the cost of transition to a low-carbon world. Therefore, many policies and programs are still at a formative stage, and policy uncertainty is very high.”
The book identifies how uncertainty over climate change policy may affect investment behaviour in the power sector. For power utilities, where capital stock is intensive and long-lived, risks are large and can create an incentive to delay investment.
“Business routinely deals with risk and uncertainty in decision making and will continue to do so in the face of climate change policy uncertainty,” it adds. “Risk is not inherently a bad thing; it is by taking calculated risks that companies aim to make profits in excess of their cost of capital. Nevertheless, sustained additional risk raises the cost of capital, and will alter investment decisions.”
“Climate policy uncertainty does weaken investment incentives for low-carbon technologies” and can lead to investment choices which appear sub-optimal, such as extending the life of existing plants rather than investing in more efficient new plants, modest increases in electricity prices, and the creation of investment cycles that may exacerbate short-term peaks and troughs in generation capacity, it warns. “It is certain that, in the long run, we will have to find ways of satisfying our energy needs with near-zero net emissions of GHG in order to avoid the worst damage from climate change. This will require an almost complete turnover in the world’s energy infrastructure.”
