Authors: Celine McInerney, Conor Hickey, Paul Deane, Joseph Curtin and Brian Ó Gallachóir
Summary: The European emissions reduction policy is clear and calls for the energy sectors, particularly the electricity sector, to be carbon neutral before 2050. The objective of this study is to examine how the decarbonisation of the power system will impact the investment case for both electricity generation and infrastructure assets.
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European emissions reductions policy points to achievement of carbon neutrality by energy sectors, particularly the electricity sector, by 2050 at the latest. Gas has been promoted as the “transition” fuel in this process; however, the financial viability of gas generation assets is no longer guaranteed. The transition to a low carbon energy system has significantly altered the financial risk and return for energy sector investors. The increasing penetration of low carbon generation, with zero operating
costs (i.e. the fuel cost for renewables is zero) and priority dispatch in most liberalised electricity markets, has led to significant changes in price volatility and operational regimes for thermal generators and, hence, network assets. Stakeholders in the finance and banking industries, including central banks, regulators and credit rating agencies, have warned of the financial risk associated with being locked into fossil energy systems and have called for collective action to facilitate the role of the finance sector in achieving the goal of the Paris Agreement of ensuring that finance flows are consistent with low emissions and climate resilient development.
Energy system pathways for Ireland and Europe suggest that power generation will have to be carbon neutral by 2040, which means that fossil fuel generators may have to be shut down prematurely, creating stranded asset risks. This means that owners of these assets may suffer financial losses. This may have implications for security of supply in the short term as fossil fuel
generators currently provide back-up and balancing services for intermittent renewable generation. The investment case for fossil infrastructure assets is also likely to be undermined. The gas network is remunerated under a regulatory asset base (RAB) regime and is therefore dependent on the size of the customer base to pay fees. In a low gas consumption world, the RAB will come under pressure as a lower customer base will result in higher fees. The financial viability of Ireland’s gas network in a fully decarbonised system remains an open question. The concentration of bank debt and insurance in these sectors may also have wider implications for the banking and finance industry.
Our report identifies a significant potential stranded asset risk for both generation and infrastructure assets in Ireland. Under deep decarbonisation scenarios (80% reduction in emissions by 2030 relative to 1990 levels), returns to owners of generation and transmission and distribution assets will no longer be sufficient to attract capital. For security of supply to be maintained and for continued investment to be made in infrastructure assets, new approaches to incentivising long-term investment and “out-of-market payments” for generation adequacy and reliability services will be required. Policymakers, in considering future policy changes, need to review the effect of decarbonisation on power sector investor returns. This may require new approaches to remunerate investors in generation capacity, ancillary services and network assets. A key theme that emerges from our investor survey is the need for policy certainty to attract long-term investment in the energy sector. Investment in renewable technologies is typically characterised by higher capital costs and much lower operating costs than those for fossil technologies. A high carbon price would assist in creating greater incentives to invest in low carbon assets. This will be necessary to achieve Ireland’s low carbon transition.https://www.epa.ie/media/epa-2020/publications/research/Research-302-thumbnail.JPG