28th Nov 2023


Is the ECB sabotaging Europe's Green Deal?

  • European Central Bank president Christine Lagarde started her mandate with a strong emphasis on the climate — but has since shifted focus to inflation (Photo: Council of the EU)
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The European Central Bank (ECB) recently raised interest rates to their highest point in the currency's existence.

With an increase of 4.5 percentage points in little over a year, the Frankfurt-based bank's governing council has — wittingly or unwittingly — engaged in what is essentially an experiment: can the EU green transition succeed even when money is made so expensive?

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  • Not a single investment in an offshore wind farm in Europe was made in 2022 (Photo: www.CGPGrey.com)

"Procrastinating is likely to increase the bill we will end up having to pay," said ECB president Christine Lagarde at an event on Friday (29 September).

But let's consider a simple example: the European Commission estimated that it annually costs about €620bn in clean energy investment to achieve climate targets.

Increasingly high interest rates on these investments makes the transition vastly more expensive — which in turn could test the limits of what governments and companies are willing to pay to go green.

Billions and billions

How big the impact has been is not precisely known.

What doesn't help is that the ECB modellers project such a wide range of real-world outcomes of their policies that even the most seasoned ECB watchers wonder if the bank has a clear idea of what the effects actually are.

The bandwidth of model estimates is so "astonishingly wide," financial historian Adam Tooze recently said, "[it is] essentially an admission of ignorance."

ECB executive board member Isabel Schnabel has said high rates "insure" against possible future inflation. But one only has to look at past inflation projections to be reminded that an exact science central banking is not.

In an interesting analysis of the impact of interest rates on the bottom line of renewables, Dutch consultancy agency Berenschot in May estimated the transition cost for eight major climate technologies—including solar, wind, geothermal and e-boilers.

It turns out that costs for these technologies, needed to reduce emissions, have ballooned by €17bn up to 2030, compared with the 2021 prices when interest rates were still below zero.

That means the impact of the country's 2030 climate fund of €35bn has been significantly reduced due to the ECB's rate hikes. The cost increase until 2050 is even higher at an estimated €163bn.

These estimates were based on a three-percent rate scenario. Since then, borrowing costs have risen a further 1.5 percent. The models used are roughly linear, so by adding another 50 percent to the estimates, we may come to a more accurate picture.

However much that is, it's fair to say the impact of interest rates on transition costs is not negligible.

It's the cost of money, stupid

Nobel-prize-winning economist Joseph Stiglitz previously told EUobserver that if energy is the problem, the focus should be on facilitating "the entry of new clean-energy firms, not make it harder for them to compete with entrenched fossil fuel companies by increasing borrowing costs."

Because wind and solar require relatively higher upfront investment than gas and oil installations — and are more often funded with borrowed money — costs and prices go up, which in turn negatively affects the underlying business case.

The incredible rise of renewables as a viable, affordable, and even cheaper power source (compared to fossil fuels) has been made possible by the rapid cost reduction of solar and wind power over the last decades.

It is often assumed the downward trend of renewable power prices is a result of innovation alone.

However, researchers at ETH Zürich found that past price reductions to a "substantial" degree were made possible due to ever-lower interest rates.

And the authors warn that a turnaround in ECB monetary policy could "adversely affect" Europe's energy transition over the longer term.

However, the effects of monetary policy on renewables are hard to pin down. Not all market sectors are affected equally across territories, and information about borrowing costs is commercially sensitive and often hard to find.

A few weeks ago, shares of the world's largest offshore wind company, Danish multinational Ørsted A/S, suddenly fell by 25 percent in a single day — marking a 70 percent decline from its peak value in 2021.

It was a response to the company's management announcement that it expects to write down the value of its offshore wind portfolio by DK16bn [€2bn]. One-third of the write-down was caused by higher interest rates driving up financing costs.

Solar power investments remained "extremely attractive," CEO of SolarPower Europe Walburga Hemetsberger wrote in an open letter addressed to EU Commission president Ursula von der Leyen.

But she warned that cheap Chinese solar panels and high domestic interest rates were "contributing" to a 25 percent drop in demand for European-made photovoltaics (PVs).

This points to another effect of interest rates: it threatens to undermine the reshoring of 30 gigawatts of solar production, as stated in the bloc's Net Zero Industry Act, which she said is at "serious risk" of failure before it has begun.

Blind spot

Most policymakers are unaware of the implications of higher interest rates on cost of capital (CoC) because the "models they typically use for energy and climate-related decision-making ignore interest rate dynamics," ETH Zurich professor Bjarne Steffen told EUobserver.

The International Renewable Energy Agency (IRENA) has launched a project to collect reliable data on capital costs.

But so far, these are based on "generic" aggregates "differentiated only by large groupings of countries."

"The lack of granularity in CoC estimates [is] clearly undesirable," the report notes.

Even minor discrepancies in data can result in "significant misrepresentations of renewable energy costs" and lead to "poor policymaking," it adds.

To address the data gap, Steffen and his team have analysed the effects of interest rates on the unit cost of renewable electricity and found that under a four-percent rate hike, the cost of solar power would increase by 11 percent, and 25 percent for wind.

The unit cost of offshore wind power would likely increase even more because upfront prices are higher, averaging €2.4bn, compared to €51m and €16m for onshore wind and large-scale solar power projects, respectively.

Looking at it from this angle also helps explain why not a single investment in an offshore wind farm in Europe was made in 2022.

A logical solution (from the 1970s)

So, where does this leave us? Governments could offer developers better deals or increase subsidies. But relying on governments alone may be a risky bet as higher cost of debt is already leading to spending cuts. Higher costs could also fuel the resurgent right-wing backlash against green legislation, which is already underway in Europe.

A potential solution is to treat clean energy-related loans and assets differently from other investments.

By allowing lower-interest loans to green investments, they are effectively shielded from the tightening of monetary policy, as has been argued by economists Jens van 't Klooster and Eric Monnet. Plus, a speedier deployment of renewables could lower inflation.

"Higher green investments reduce the reliance on fossil fuels," which is one of the chief causes of inflation in the past years, Rutger Bianchi, lead author of the Berenschot study, told EUobserver.

Last June, the International Energy Agency estimated EU consumers will save €100bn on their power bills during 2021-2023 thanks to newly installed solar and wind power.

This week, the agency calculated clean energy investments could save $12 trillion [€11.3 trillion] in fuel expenditure until 2050, reducing the overall energy cost (and thus lowering inflation).

(Photo: IEA)

ECB policymaker and Belgian central bank chief Pierre Wunsch argued that it was down to governments to combat climate change and that talk of monetary policy financing the green transition was a "misunderstanding of what our role is" — which is guarding price stability. "The most important contribution we can make [to the energy transition] is to maintain price stability," said Lagarde on Friday in a similar vein.

This is not without merit. Uncertainty scares away investors. So, to be predictable is good for business, the thinking goes. "Being boring is best" because it reduces the "see-saw" of financial markets, deputy governor of the Bank of England Mervyn King said back in 2000, in what may be the most-quoted speech by other central bankers.

While being boring may have been the right attitude in the 1990s, one wonders whether it is suitable in a world increasingly destabilised by global warming.

As van 't Klooster and Monnet explain, a "failure to implement environmental policy may undermine an orderly transition", which could "negatively affect" financial stability. They also show that in a previous era of central banking predating even King, policymakers did prioritise cost-saving energy investments to battle inflation.

In 1974, for example, in response to the oil shock, the Banque de France allowed low-interest loans for energy-saving investments. The German Bundesbank during the same period exempted certain industrial sectors from high rates to keep costs down—a policy that lasted until the 1990s.

The idea that monetary policymaking should be limited to "setting a single interest rate" is a "fairly recent one," they add.

For now, Schnabel, otherwise a proponent of green central banking, also remains opposed to loosening credit for green investments while inflation is high, fearing it could boost demand for resources, which could potentially fuel inflation in those markets.

"They understand the dilemma very well," said Bianchi. "But they are very reluctant to meddle with interest rates. The burden of proof, I would say, is on them."


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