Ideas for Leaders #243

The Green Investment Gap — And How to Close It

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Key Concept

Private investment in renewable energy technologies is increasing but remains below the level required to meet greenhouse gas emission reduction targets. Solving the problem could depend on a new approach from policy makers. Recently published research on the European market sheds new light on the ‘drivers’ of investment decisions — and suggests that financial factors and government subsidies are not the only drivers.

Idea Summary

Although global investment in renewable energy has grown significantly since the start of this century, it remains below the level needed to meet Kyoto Protocol targets for reducing CO2 emissions, according to renewable energy advocates. (Investment slightly decreased in 2012.)

Portfolios that do include renewables tend to be weighted towards ‘mature’ technologies such as onshore wind, which are more able to compete with fossil fuels on levelised cost.

Given that innovative technologies may have the greatest long-term potential, lack of diversification in renewable energy portfolios could stifle their development. (Exploitation of the ‘current best option’ could prevent the exploration of more radical and better alternatives.)

Changing both the level and ‘spread’ of investments depends partly on improved understanding of how investors make decisions: if policy makers know more about how investors make their decisions, they may be better able to ‘direct’ inflows towards clean energy.

Recently published research from HEC Paris business school and the Mediterranean Energy Observatory suggests that a number of non-financial factors, including a priori beliefs or preconceptions and peer-group pressures, influence investors.

The research, which included analysis of survey data from more than 90 European hedge funds, banks, private equity funds and insurance companies, collected in 2009, shows that confidence in the reliability of a technology matters more to investors than policy measures such as subsidies and energy taxes, which are often seen as short-term — and that a priori beliefs mean more than factual information. (The influence of specialised technology reports and technology briefs, etc, was insignificant.)

It also finds that institutional pressures such as the behaviours of peers and the opinions of outside investment consultants have a negative impact on portfolio diversification, restricting investors to a few specific technologies. (Dedicated government policy measures have a similar effect.) Younger and less experienced investors were seen to be particularly sensitive to institutional pressures.

Investors with specific industry knowledge, on the other hand, were found to be more willing to go against the ‘conventional wisdom’ and make above-average investments in riskier RE projects. “Understanding of the operating context matters, knowledge matters,” says Andrea Masini, a professor in the operations management and information technology department of HEC Paris. “If you’re not knowledgeable about the industry, you’re more likely to be swayed by others.”

Paradoxically, however, interest in radical technologies was not found to translate into a higher percentage of innovative renewables in portfolios. This finding can be explained by investors’ need to offset risks: even a low percentage of ‘radical renewables’ has to be balanced by a higher percentage of more conservative investments.

The main results of the research are in line with behavioural economics and institutional theory, which hold that decisions are driven by social and psychological factors as well as purely rational assessments. ‘Leveraging’ these non-financial factors could be important for the future of renewable and alternative energy — and for the transition to a low-carbon economy. 

Business Application

The research has important implications — not only for European policy makers but also for European businesses in the renewable energy sector.

It suggests that European governments should focus on creating a stable environment for renewable energies (rather than introducing short-term policy measures and subsidies) and redirect public money into efforts that reverse preconceptions and increase knowledge of the industry. By supporting R&D programs in the public and private sectors, promoting demonstration projects and further disseminating information on renewable energy systems to relevant business circles and to energy users, policy makers may be more successful in encouraging inflows to renewable energy innovations. (The more convinced people are of the reliability and long-term cost competitiveness of alternative energy, the lower the adoption and investment barriers.)

The results also suggest that managers need to find better ways to communicate the long-term potential and the acceptable risks of innovative projects to investors.

Ultimately, the future of renewable energy depends on concerted action by policymakers and business. Collaboration between governments and industry bodies such as the European Photovoltaic Industry Association and The European Wind Energy Association could be key.

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Authors

Institutions

Source

Idea conceived

  • June 2012

Idea posted

  • October 2013

DOI number

10.13007/243

Subject

Real Time Analytics