SustainaWeekly - Europe’s grid problem

Economist: Coordinating the speed of progress of different components of the energy transition is essential to avoid bottlenecks. The increase in grid investments needs to run before those of renewables or electrification as the time required to plan and execute network extensions is longer than other clean technologies. The slowdown in investment of grids and network expansions could therefore delay the pace of transition.

Strategist: We assess whether interest coverage at issuers which have printed ESG bonds will end-up being more affected than the interest coverage at non-ESG issuers. We find that the effects on coverage seem to be more severe for the ESG issuers. However, these ESG issuers have a slightly better coverage to begin with and therefore the higher interest rates are only equalizing the aggregate ICR between ESG and non-ESG real estate issuers.

Sector: The number of heat pumps installed in the built environment has risen sharply. However, to achieve the set climate targets, further scaling-up is necessary during this year and next, while the higher installation pace would need to be maintained thereafter. Several policy measures should give scaling-up traction in the coming years. But currently there are still too many obstacles to overcome.

ESG in figures: In a regular section of our weekly, we present a chart book on some of the key indicators for ESG financing and the energy transition.

Transition Speed and Capacity Building

• There is an increase in all renewable and electrification deployments in Europe

• Coordinating the speed of progress of different components of the energy transition is essential to avoid bottlenecks and achieve a smooth transition

• The increase in grid investments needs to run before those of renewables or electrification as the time required to plan and execute network extensions is longer than other clean technologies

• A slower transition because of insufficient grid capacity is magnified because of the mismatch in the timeframe for deploying grid extensions versus that needed for electrification or renewable deployments

Energy transition

The energy transition at its core is driven by policy, technological progress, or a change in preferences. These drivers are envisioned to facilitate the switch towards renewable resources for electricity generation, along with the electrification and efficiency improvements for final consumption and production activities.

The dynamic nature of the energy transition makes it quite a complex process as it involves many factors changing at the same time. One important factor in accelerating the transition is through increasing the speed of deployment of clean technologies to build up the needed capacity as quickly as possible. However, such increase in the speed of investments could turn to be ineffective if the associated infrastructure is absent or does not grow at a faster speed. For example, all transition channels will lead to a rise in electricity supply and demand. This would also mean that grid capacity should be raised to avoid any mismatch between supply and demand.

Challenges for a smooth transition

There are many issues that affect the pace of deployment for clean energy investments which could be considered as bottlenecks that hinder the transition process, such as: policy and price uncertainties in the associated markets; issues with permitting; challenging and complex supply chains; high financing costs; the long term horizon of renewables projects; grids and electricity networks.

In the subsequent sections, we zoom in some of these bottlenecks especially those related to the speed of progress of different components/factors of the energy transition. We focus on the electricity market for Europe and contrast the current capacity building for renewable technologies, electrification, and the capacity of electricity networks (grids).

Where do we stand in terms of investments in clean technologies in Europe?

The left hand panel in the figure above shows an increase in investments in clean technologies for all components of the power market, with electrification reflecting a proxy for the demand side. While the right hand side panel reflects the growth rate of these investments, which has been positive and rising over the past 5 years.

At a first glance, the panels above deliver positive news for the transition as all transition channels seem to work and money is flowing in the required direction. However, this rosy picture should be seen with an eye of caution especially in the medium and long term. More precisely, the right hand panel highlights some worrying trends. In particular, the growth in investments for supply and demand of the power market outpace that of grids and network expansions. Such trends if continued show that grid capacity will inevitably form a bottleneck that hinders the speed of transition.

Inefficiencies could rise due to grid congestions, and could create issues beyond national electricity markets at a European level by limiting the potential of trading electricity between non-neighbouring states. Grid congestions would also lead to higher electricity prices, which reduces the attractiveness of clean technologies, postpone/mitigate investments in electrification, and increase of the cost of the transition, leading to a slower transition. The problem of limited grid capacity and its effect on the transition is already starting to come to the surface for many European countries. In the Netherlands, plans for an energy tax on fossil fuels are objected by businesses, with the argument that the rise in fossil fuel costs will be associated with a limited capacity of electricity grids to meet the surge in demand by industrial electrification. Similarly, the limited German electricity grid transmission capacity is insufficient to match the imbalanced demand between the Northern and southern states, nor does it allow for electricity trading between its neighbouring countries. All in all, these trends highlight the importance of coordinating the speed of progress for different components of the power market (supply, demand, and the grid), which is essential to avoid bottlenecks and achieve a smooth and efficient transition.

Timeframes for grid expansions

One would ask the question: why are grid expansions lagging behind other clean investments? One answer to this question is related to the complexity of the grid expansion process, which involves many stakeholders (public and private) on a national and regional level, which in turn requires coordination on several levels. Moreover, there are long lead times for permitting grid projects because of inefficiency in permitting procedures, along with the extra time needed to adjust and adhere to new regulations. All these aspects contribute to the extension of the timeframe needed for planning and executing grid projects. More precisely, and according to an IEA representative, the time needed for grid extension projects (4 years on average) is almost double that of other renewable projects, for example.

This is an alarming sign: a slower transition because of insufficient grid capacity is magnified because of the mismatch in the timeframe for deploying grid extensions versus that needed for electrification or renewable deployments.

Transition speed for electricity demand and supply

Abstracting from the grid capacity problem, another mismatch in the speed of transition could arise between the growth in the supply and demand of electricity, or even across power demand sectors, which also risk hindering the transition. That is, if growth in the demand of electricity outpaces growth in supply, electricity prices will rise inducing lower incentives to electrify or switch away from dirty technologies. Similarly, within sectors that use electricity for consumption or production purposes, if one sector is transitioning at a faster rate than others, transition could be slowed down through intersectoral feedback loops (spill-over effects). For example, if electrification deployments take place in the transportation sector at a faster pace than other sectors, assuming everything else remains constant, transportation’s demand for fossil fuel goes down while that for electricity goes up, which make fossil fuels relatively cheaper and more attractive to be used by other sectors, reducing incentives to speed up the transition in these sectors.

All these mechanisms and possible transition impediments highlight the need for coordinating transition speed across different components of the system. Governments could play an essential role in this regard by providing a comprehensive vision and timeline for the transition of different sectors, streamlining and standardizing permitting procedures, and facilitating coordination between different stakeholders.