24 April 2007 – How does climate change uncertainty affect investment behaviour in the power sector? The International Energy Agency (IEA) tries to answer this question in its new book ‘Climate Policy Uncertainty and Investment Risk’. One of the key findings is that companies will generally be confident in investing in projects, even in an uncertain environment, as long as long they can establish a competitive advantage over other market players. 

“The timing and magnitude of climate change and the cost of transition to a low-carbon world are uncertain. Therefore, many policies and programmes are still at a formative stage, and policy uncertainty is very high,” the IEA writes its flyer on the recently published book. For power companies, where capital stock is intensive and long-lived, those risks rank among the biggest and can create an incentive to delay investment. The IEA-analysis shows that the risk premiums of climate change uncertainty can add 40% to power plant construction costs and 10% of price surcharges for the electricity end-users.

‘Climate Policy Uncertainty and Investment Risk’ tells what can be done in policy design to reduce these costs. Policy makers are warned that climate policy uncertainty poses a threat as would any other uncertainties. The good news is that this threat can be reduced with predictable policies, if policies are set over a sufficiently long timescale into the future. Commitment periods longer than the usual 5 years will lower the risks from climate policy and thus increase investment in climate-friendly technologies.

Another key finding is that companies are generally confident to invest in climate projects, as long as they can establish a competitive advantage over other market players. Policy makers should establish clear rules, which are applied consistently to all market players. Then, companies will feel less uncertain and more confident in power investment.

Furthermore, the publication shows the sensitivity of different power sector investment decisions to different risks. It compares the effects of climate policy uncertainty with energy market uncertainty, showing the relative importance of these sources of risk for different technologies in different market types. It also assesses the implications for policy makers, allowing the key messages to be transferred into policy designs.

This book explains to governments how to improve climate policy mechanisms and thus create more certainty for power investors.

More information:

IEA Online Bookshop to order the publication