Presented by ESMT Berlin
The G7 recently adopted a landmark agreement to phase out coal in the next decade. Nicolaus Ascherfeld, Partner at A&O Shearman and Head of M&A for Germany, dives into the legal and policy frameworks required to turn this commitment into a reality.
Interviewed by Klara Marie Schroeder
Coal remains the largest source of global emissions. Rapid decline and, ultimately, phase-out is essential to the energy transition. I would see three major challenges: the increased cost of capital and supply chain issues make investment into renewable energy projects less attractive, the rising consumption and emissions in the developing world, and the intermittency of renewables combined with insufficient storage and grid capacity.
On the first point, the framework for renewable energy investments has shifted. Rising interest rates and increased construction costs have affected the financial viability of renewables projects. Capital has left the energy transition market and, as a result, projects were cancelled. But despite these setbacks, there is room for optimism. For regulated returns, regulators and investors will need to find some common ground and settle on investment returns that make these investments attractive, even in the current interest environment. For merchant projects, I expect that the global surge in the supply of new projects over the coming years should lessen competition for projects, thereby driving down investment costs and enhancing returns through standard supply and demand dynamics.
The second challenge lies in the coal phase-out in fast-growing emerging markets and developing economies. This can be attributed to several factors: demand for electricity is rapidly rising in most of these countries and attracting sufficient capital for the phase-out in these economies is much more challenging and expensive than in the developed world. In addition, the coal energy infrastructure of many of these economies is relatively new, and owners are reluctant to discontinue profitable operations prematurely. Finally, the socioeconomic consequences (e.g. job losses) of a coal phase out in communities dependent on coal will be disruptive. To address all these challenges, support from the Global North is essential. Concepts of just transition and their political backing, e.g. through Just Transition Partnerships, will be helpful.
The third challenge is the intermittency of renewable energy sources (i.e., the fact that electricity is only produced when, e.g., the wind blows or the sun shines). Intermittency will continue to require fossil-fuelled energy to balance this intermittency for as long as we do not yet have sufficient storage and grid capacity. For example, China's uptick in coal-fired power plants is partly a response to its rapid expansion of renewable energy and the need to stabilize the grid against increased intermittency. Unless utility-scale storage solutions become widely available, the construction of coal-fired power plants may persist. But the decrease in costs of utility-scale battery storage projects and the boom in battery production capacity are encouraging signs. In fact, the cost decline in batteries is one of the fastest declines ever seen in energy technologies.
Harmonization of regulatory frameworks and processes is crucial for accelerating the energy transition and eliminating inefficiencies for investors operating across different jurisdictions. Through international agreements, policymakers can establish common organizational and technical standards. Good examples of such impact from international agreements are the new ISO standards for hydrogen adopted at COP28 or the EU-wide standardization of planning laws for renewable energy projects in the EU Renewable Energy Directive III in 2023.
Another key aspect is foreign investment protection under international agreements. The success and speed of the energy transition is highly dependent on activating the maximum possible amount of private capital for energy transition projects. Energy transition projects are characterizedby high upfront investment costs and slow but steady returns over many years or even decades. Therefore, investors rightfully demand robust legal protection when deciding on the feasibility and cost of their investments. Recently, the investment protection system under the existing global network of bilateral and multilateral investment treaties has come under political pressure, as evidenced by resignations from the Energy Charter Treaty. While we acknowledge that investment protection must be carefully balanced with states’ sovereign freedom to set its energy policy, foreign investment in energy transition projects requires protection under international agreements. This is particularly true for investments outside the developed world. International agreements should help to encourage them.
Where electrification is not an option to replace fossil fuels, hydrogen is likely to become a relevant alternative. There may be a tendency to overstate the role that hydrogen could play for the energy transition, but it will surely be critical for decarbonizing hard-to-abate sectors, e.g. the production of steel and cement, aviation, and shipping. To assist industry actors in changing to decarbonized operations, they need the security of hydrogen supply and competitive procurement prices as well as the ramp-up of core hydrogen transport and storage infrastructure. Lawmakers will play a crucial role in providing the conditions to achieve these things, including sufficient funding and incentives as well as the necessary regulatory aid to ensure the decarbonized sectors’ competitiveness in the global markets.
However, such funding programs must be easy to access and as bureaucracy-light as possible. The existing programs are too complex. We have seen application procedures with hundreds of pages of documents, long application consideration periods, and complicated pay-out mechanisms. This complexity limits the impact such funding programs can have – especially for small- and medium-sized enterprises. Large portions of the German Mittelstand would be very much willing to abate their CO2-emissions but may not have the human resources available to navigate through the current funding application and tender procedures.
A further bottleneck for the large-scale roll-out of green hydrogen is the development of corresponding hydrogen transport infrastructure. Industry actors will only commit to investments in decarbonized facilities if the available infrastructure guarantees unhindered hydrogen supply. Private investment into such ramp-up projects will only flow if sufficient security is given for the expected return on investment. We need high-quality incentive regimes that identify and address those risks to the degree necessary to make them bankable. These dynamics are visible in the current discussions around the financing mechanism of the planned German hydrogen core network. Many actors have raised concerns about leaving too much risk for private investors and about return profiles that do not adequately reflect that risk. As said in answer to the previous question, policymakers need to be aware that hydrogen infrastructure (as much as all other renewable energy infrastructure) is in global competition to attract capital. A 7% IRR, as currently envisaged for the German hydrogen core network, may be insufficient to draw private investment in the current interest environment.
As an alternative to Hydrogen, carbon capture technology will play a role. The technology for the separation of CO2 from fossil-fuel based industrial processes and its subsequent usage in e.g. synthetic fuel, cement or concrete production and in and many other processes across various industries is ready – now we need to roll it out.
Well-designed regulatory frameworks and policies acknowledge the realities under which private capital is invested and reduce regulatory impediments to investment where possible.
Markets do respond to incentives. Take, for instance, the renewable electricity financial support schemes within Germany's EEG and comparable initiatives across Europe or the tax incentives provided by the Inflation Reduction Act in the United States. These regulations have drawn billions of Euros and Dollars into renewable energy ventures. After a successful scale-up, the industry should then become cost-effective enough to draw private investment without subsidies. German offshore wind would be a good example of that (even though that may have been helped by certain unique features, such as offshore wind’s countercyclicality to other renewable generation assets). Upon the expiry of subsidies, policy needs to set the framework to ensure sufficient price signals for continued investment in renewables through a well-thought-through market design.
Other important private investment drivers are simplifying planning requirements and permitting procedures.The surge in solar farms across Europe is partly the result of such planning and permitting reforms. The rise of solar generation in Texas is also widely attributed to a lean and investor friendly regulatory framework. This should encourage policymakers to persist in their efforts to reduce regulatory obstacles. The latest European initiatives to simplify planning and permitting for renewable energy projects, as part of the EU Renewable Energy Directive III in 2023, are a step in the right direction.
At the same time, it is essential to maintain public support for the energy transition by ensuring that regulations strike a balance between the energy transition and other concerns, such as environmental conservation. Changes to regulations should, therefore, primarily address the simplification of processes rather than so much a more forceful prioritization of renewables over other goods.
The JETPs which have been concluded with South Africa and Indonesia, amongst others, provide billions in funding to energy transition projects in those countries. The volume is significant. For example, the 8.5 billion Euros made available under the JETP with South Africa in a first period set to run until 2027 equal the value of almost double the renewable energy capacity currently installed in South Africa.
However, the true value of those JETPs does not lie in the funding alone. The value includes detailed development plans on how to build up a whole decarbonised energy value chain. This includes the expansion of renewable energy capacity, investments into electric mobility infrastructure, and large educational programs to train the countries’ workforces for the energy transition. This is a critical element of success for JETPs. They must create new industries and business models in developing economies for the long term and not just add to their debt burden or increase dependence on the developed world.
It should also be noted that countries like South Africa or Indonesia were already attracting energy transition investment before JETPs were put in place. Future JETPs need to include the energy transition of the less- or least-developed economies where the energy transition is still in its infancy. These investments could be crucial to prevent such economies from first expanding their fossil energy capacities and then changing to green energy, but rather aid them in developing renewable energy ecosystems from scratch.
“Just transition” has many aspects to it, but to focus on just one particularly important item here: there is insufficient funding for the energy transition in developing countries. Currently, funding for energy transition in developing economies is totally disproportionate to their share of the global population, their expected rising contribution to carbon emissions (by 2030, they are estimated to be contributing the majority of global carbon emissions), and the fact that the cost of reducing emissions in these countries is typically low. Cooperation between the public and private sectors is essential to overcome this. Currently, investment into energy transition in the developing world mostly comes from the public sector. We all know that this will not be sufficient.
In light of this, global policies need to set a framework that mobilises private capital for the just transition. Policy needs to set rules that allow private capital to view just transition as a viable business opportunity and not just as the right thing to do or another ESG compliance requirement. One way to do that most effectively, in my view, would be to focus on a smaller number of countries with high emissions that are ready to implement policies attractive to private investment.
Such frameworks may include protection of private ownership, hedging poor creditworthiness of local counterparties, mitigating currency risk, regulatory adjustments to channel investment to clean energy, training of a skilled local workforce to install and operate the renewables infrastructure, or a new framework for development banks to spend their climate finance effectively. To address these issues, policy needs to take the lead and private investment needs to be prepared to seek the opportunity in just transition projects and fund projects in those countries that have demonstrated a commitment to accommodating private investment. Berlin Global Dialogue is the forum to discuss and advance precisely these frameworks.
Nicolaus Ascherfeld is a partner at A&O Shearman and serves as Head of M&A and Head of Energy/Infrastructure of A&O Shearman in Germany.
He has more than 20 years of experience in advising on a broad range of corporate transactions with a focus on private M&A and joint ventures.
Nicolaus is an industry expert in infrastructure and energy and has advised on the most complex transactions, frequently with significant multijurisdictional aspects.
