De-risking the energy transition in Europe

The energy transition is not just a climate imperative—it’s also the investment opportunity of our age. We believe the drive to net zero is the largest, longest-term and most fundamental demand signal in the history of market economics. Europe, which has already decreased its share of global emissions from 33% in 1991 to under 14% today, is in many ways the frontline of the transition and the resulting investment opportunity. The EU’s European Green Deal, passed in 2021, sets further transition goals: reducing net greenhouse gasses by 55% by 2030 and becoming the first climate-neutral continent by 2050.

At PwC, we have identified a number of substantial global gaps that need to be bridged in order to transition the global economy’s energy systems and connected infrastructure. The financing gaps are particularly acute. BloombergNEF estimates that Europe’s net-zero transition requires more than €29 trillion (US$32 trillion) of cumulative investment to 2050; the value of 2023 investments must triple each year between now and 2030 to be able to meet this trajectory in investment. Because Europe has many attractions as a climate investment market, it should provide a good landscape for capital to be deployed. The EU Green Deal, which includes many climate-spending initiatives and incentives, provides a healthy measure of regulatory stability. The macroeconomic risks of investing in Europe are relatively low. And policies like the Sustainable Finance Disclosure Regulation require financial institutions to make transition plans and report their progress.

In theory, there is no shortage of investment capital looking for opportunities. According to Preqin, the private capital industry had total global assets under management (AUM) of US$13.3 trillion in 2023, and this represents only one pool of capital that is available for investment into energy transition. The energy transition creates opportunities for a variety of investment portfolios, covering the full range of different investment mandates: asset-intensive, asset-light, services-based or technology-focused. All points on the risk spectrum are covered, from university spin-outs, private start-ups and corporate R&D to large and established businesses.

But as participants in a PwC roundtable in London discussed, investors face significant obstacles to investing in the energy transition that are not as prevalent in other sectors. There’s a considerable mismatch between climate investment needs and private capital’s traditional strengths, boundaries and operating models. Risk capital is in short supply, especially for vital early-stage investments. As a result, it is critical for governments and the private sector to collaborate in order to maximise the scale of private capital being put to work in this exciting and critical sector.

As the chart below shows, not all climate investments carry the same risk profile, and not all are appropriate for all investors. For the purposes of this article, we have defined the market as ‘net-zero solutions’—the assets, services and technologies needed to drive decarbonisation in all segments of the economy. Based on our work with investors, we have divided this market into four broad segments.

The Frontier segment is the earliest stage. It contains technologies that are still in development, such as nuclear fusion, as well as solutions in which the focus is on developing a market proposition (for example, consumer solutions regarding personal carbon footprints). This is in the realm of venture capital and corporate venturing—high-risk, high-reward investing in which the game is to back the next ‘breakthrough technology.’ The Developing segment contains technologies or solutions that are proven to work, but that have not yet been adopted at scale, owing to high costs or other barriers to penetration such as consumer scepticism. Fuel cells, battery recycling and heat pumps (in some markets) are good examples of Developing segment opportunities. The natural financiers of such opportunities are private equity firms and core-plus infrastructure funds that are willing to finance the rollout and scaling of good propositions. The Maturing segment includes technologies and solutions with proven business models and reliable cash flows and returns that have already achieved significant penetration, such as electric vehicles (EVs), charging infrastructure and grid-scale renewables. This segment is the natural domain of core infrastructure funds and patient private equity and can include very large deals. For completeness, we include the Sustaining segment to reflect the importance of responsible stewardship of high-carbon assets, and the ‘brown-to-green’ investment mandate that decarbonises critical industries such as metals, cement and refining.

The game for investors—and for society as a whole—is to move technologies up the curve. Moving a technology up the curve unlocks larger pools of capital that can invest at lower cost, providing attractive returns for those who took the early risk and unleashing investors with deeper pockets to scale the technology further.

The interests of the public and private sectors are therefore aligned. De-risking investments and removing obstacles to investment provides returns for all stakeholders.

Three major barriers keep investment from flowing to where it’s needed in the European energy transition.

First, risk capital is scarce and is misaligned with the energy transition’s needs. PwC analysis shows that in the UK, 56% of decarbonisation will need to be delivered by technologies or solutions that are not yet commercially mature. But Europe is underweight in higher-risk-taking capital when compared with regions such as North America. According to analysis of Preqin data, the total value of assets managed by European venture capital funds represents 0.8% of the region’s GDP; in North America, venture capital represents 3.8% of the region’s GDP, nearly five times greater. What’s more, current early-stage investments are too focused on sectors that are easy to abate. PwC’s State of Climate Tech 2023 report shows that 74% of climate-related venture funding goes into energy and mobility, sectors in which the transition is well underway, rather than into the sectors that need it most, such as buildings, food, agriculture and heavy industry.

For Frontier solutions, long time horizons and the uncertainty of success can deter investment. Net-zero solutions in the Developing segment present problems of their own. Although they are shown to work, they aren’t yet commercially competitive with their high-carbon equivalents. Driving down costs requires investing in scale production, but building a first-of-its-kind manufacturing plant is an investment that’s both big and risky—much bigger than venture funds are accustomed to making, and much riskier than private equity firms typically make. Blended finance can play an important role in getting these types of investments off the ground.

The second obstacle is that technologies can move up or down the risk curve quickly, or even get stuck. Dynamic, fast-moving and imperfect ecosystems can be impacted by rapid changes in costs, consumer demand, regulation and subsidies. This uncertainty can further deter investors—especially those accustomed to reliable, long-term returns. In Europe, public rapid-EV-charging infrastructure moved from the Frontier segment in 2018 to the Maturing segment by 2022. Such swift compression of the cost of capital forces fast decision-making on investors. Those who wait for the perfect opportunity—ticket size, risk appetite and cost of capital—are in danger of missing out. Sarah Lane, managing director of the sustainable infrastructure team at Denham Capital, first invested in EV-charging infrastructure in the UK in 2016, when fewer than 40,000 EVs had been sold in the country. ‘Now there are over a million on the road,’ she says. ‘But we had to decide how we were going to monetise this future asset. We based our early decisions on what manufacturers were investing into EV drivetrains, because that’s a significant capital commitment.’

The third obstacle is that decarbonisation business models do not always neatly fit into one capital type. For example, we have worked with compelling businesses in the fleet-charging market that have elements of infrastructure, technology and services all wrapped up in one. Because of the way that the private capital market has developed, many funds specialise by asset class, financing type and sub-sector, making it difficult for them to invest into blended business models. Although it may be possible to model each area separately, few funds can apply a different cost of capital to different parts of the same business.

Given the substantial obstacles described above, it is clear that the level of private capital investment into the energy transition isn’t yet maximised. Government policy and collaboration has a vital role to play in setting targets and providing support, in three specific areas.

Tailoring policies to reduce risk in specific technologies. European investors are comparatively risk-averse and require a level of certainty that many Frontier technologies do not yet offer. It is here that governments must step in strategically. Technologies including carbon capture (Developing), hydrogen-powered shipping (Frontier) and small modular reactors (Frontier) are all important to the transition. But each faces different technological and financing challenges on the path to maturity, and each requires a tailored set of incentives and regulations. With carbon capture, for example, the creation of a commercial model (e.g., a regulated asset base) to compensate investments in the shared infrastructure required for transportation and storage can help crowd in further investments and drive network benefits.

Clarity, an essential part of risk reduction, is typically provided only for a single regulatory period of a few years. Investors need clarity for the life of an asset, which could be as many as 50 or 60 years. By providing long-term commitments, governments can offer much-needed reassurance that will unlock early-stage financing. With small modular reactors, for example, a stable policy commitment on the technology’s role in the future energy mix can give a demand signal to investors and original equipment manufacturers (OEMs) that the long timelines associated with commercialisation merit further investment and effort.

Bridging the gap with public–private capital. The scale and pace of the opportunity—and the need—mean governments may also have to provide liquidity and absorb some of the risks of early-stage investments. This set of strategies is known as blended finance. For example, decarbonising hard-to-abate industries will likely require long-term hydrogen storage. But the uncertainties surrounding hydrogen are too great for the sector to attract much private investment. If governments want to accelerate renewable grids, then hydrogen investments must be de-risked by the public sector. In Germany, for example, the government has launched funding of what are known as ‘carbon contracts for difference,’ which help offset the added costs of investing in transitional technologies for 15 years. In another variety of this approach, Decarbonization Partners, a fifty-fifty joint venture between private equity firm BlackRock and the Singapore government–owned investment firm Temasek, has a mandate to take on riskier investments in the second column of the risk curve illustrated above.

The European Investment Bank (EIB), whose own mandate is to finance areas in which the private sector cannot yet invest, provided funding for Europe’s offshore wind sector when the market was in its infancy. As the sector matured and risk profiles became attractive to private capital, the EIB began to exit. In 2019, the EIB board of directors increased its climate and environment commitment, transforming EIB Group into ‘the EU climate bank.’ With an ambitious target of investing €1 trillion (US$1.1 trillion) in green projects over the critical decade to 2030, it is now pursuing higher-risk opportunities in floating offshore wind, EV batteries, green hydrogen and green steel.

But the EIB cannot possibly finance all of Europe’s early-stage transition projects. It is estimated that an additional €400 billion (US$440 billion) will need to be invested annually in order to reach the EU 2030 climate targets. Although private capital needs to play a key role in the energy transition, the EIB can catalyse progress. ‘Transformational investments require both risk capital and patient financing,’ says Elina Roine, deputy director general of operations at the EIB. Today, however, ‘the risk capital usually isn’t patient, and the patient capital is often risk-averse. We need to try and marry these two poles in order to accelerate and redirect financial flows to the energy transition.’

Capital recycling is also an important strategy. If governments get this right, not only can they accelerate the development of decarbonisation solutions, but they can make money in the process. Government funds can fill the gap in early-stage investments or markets. And as the assets and technologies mature, those investments can roll over into lower-risk funds—freeing up new capital to be invested in the next generation of riskier projects. In July, the UK government announced a plan to align the UK Infrastructure Bank and the British Business Bank under the supervision of a new National Wealth Fund, which will start providing public capital to catalyse private-sector investments in vital areas, including green hydrogen, industrial decarbonisation, and battery gigafactories and ports.