What drives firms’ investment in climate action?

Climate change remains at the top of the political agenda in the European Union and beyond. At the COP26 in Glasgow, countries responsible for 99% of carbon emissions agreed to reduce emissions to net-zero. However, the war in Ukraine  is complicating those intentions.

Prices for oil, electricity and particularly natural gas spiked to unprecedented levels following the re-opening of economies after pandemic lockdowns. Part of the price rise stemmed from supply constraints, but the trade disruptions and sanctions provoked by the war in Ukraine aggravated the situation. These developments threaten to derail Europe’s recovery, strain household incomes, affect the financial viability and investment plans of firms and ultimately create new obstacles for the energy transition. The current energy crisis, which stems from a mixture of temporary and structural problems, is expected to be prolonged and could worsen.

The energy crisis is a lesson for the future. To effectively pivot its economy away from fossil fuels, the European Union needs massive and sustained investment in clean energy production and infrastructure. It also needs to step up investments in energy efficiency. Businesses themselves are a crucial part of the green equation. They will need to invest heavily in climate measures and make energy efficiency a priority. The pandemic, however, weakened their ability to invest and to prepare for the energy transition.

From extreme heatwaves and wildfires in western North America to the deadly flooding in Western Europe and Asia in 2021, the dramatic rise in catastrophic weather events has repercussions for firms. While climate change will affect every country in the world, its impact will not be felt equally across all regions, industries or even firm sizes. But overall, climate change will result in increased maintenance and materials costs, as well as higher prices that will influence firms’ competitiveness and the economy as a whole.

• Some 58% of European firms say their business is affected by the physical risks of climate change.
• In the United States, 63% of firms are concerned about the physical risks of climate change, a substantial increase of 11 percentage points from the previous year. 
• Nevertheless, one-fifth of EU firms think that extreme weather events had a major impact on their business in 2021 compared with around one-tenth in the United States.

 

 

Business models will need to be transformed if the world is to reach the goal of limiting global warming to well below 2°C compared to pre-industrial levels, as outlined in the Paris Agreement. Firms will need to adapt to new regulations, changing market preferences and new standards as countries embark on decarbonisation. While US firms largely view the transition as a risk to their business, EU firms are more nuanced in their view and many even see the transition as an opportunity.

• In 2021 only 41% of firms said the transition would not affect their business, compared with 51% the previous year.
• For firms that expect the transition to pose a risk to their business, 85% cite energy costs as an obstacle to their investment plans.
• By contrast, US firms overwhelmingly say the transition represents a risk to their business. Only 20% say they are in a position to gain from the transition.

 

The share of European firms investing in climate measures changed marginally in 2021, to 43% from 45% a year earlier. The COVID-19 pandemic is likely responsible for the drop-off as firms put investment plans on hold. Firms in Western and Northern Europe continue to lead for climate investment, while Central and Eastern European countries are gaining ground. The future of climate investments, however, looks brighter.

• Overall, the share of EU firms investing in climate measures remains significantly higher than the United States, where the share dropped to 28% from 32% in 2020.
• About 46% of EU firms report that they have plans to invest in climate measures in the future, a significant increase from 2020.

 

 

Several barriers are putting a brake on climate investments: the availability of finance, high energy costs and uncertainty about the future. The share of EU firms that say high energy costs are impeding investment rose to 60%. The share has been steadily increasing across all industries, although manufacturing firms show the greatest concern.

• In 2021, almost 70% of manufacturing firms said energy prices were limiting investment, 5 percentage points higher than the EU average.

 

Energy efficiency investments slowed during the pandemic, on both sides of the Atlantic. However, the share of EU firms investing in energy efficiency decreased less than in the United States. Once again, the COVID-19 crisis ate into investment. Firms in Western and Northern Europe were more likely to invest, but they also recorded the biggest drop in the share of firms investing. Energy efficiency investments by firms from Central and Eastern Europe also continued to lag, with 36% of firms investing, although the share has shrunk since 2016. Investment by firms in Southern Europe follows a similar trend.

Energy efficiency investments also varied among industries and firm sizes. Large firms and manufacturing firms, which are considered more energy-intensive, are the most likely to invest in energy efficiency. Large firms invest substantially more in energy efficiency than small and mid-size firms.

• Manufacturing also has the highest share of firms investing in energy efficiency, followed by infrastructure. Yet, on average, infrastructure directs 11% of total investment to energy efficiency, while manufacturing only dedicates 7%.
• Services and construction have the lowest share of firms (32%) investing in energy efficiency, and energy efficiency accounts for the lowest portion of total investment (7%).

 

Firms are waking up to the reality of climate change and the green transition. An increasing share of EU and US firms say their business is exposed to the physical risks of climate change, such as flooding, wildfires and heatwaves. A growing number of firms also believe that the transition to a low-carbon economy will affect their business.

To offset the increase in energy prices and retain their competitiveness, EU firms need to improve their energy efficiency, by using less energy per unit of production. To encourage climate investments, policymakers could prod firms to take into account the energy transition and climate change risks when making investment decisions.

The good news for Europe is that the future looks brighter for climate investments. But for Europe’s green transition to succeed, perceptions of climate change need to be aligned across industries, countries and various participants. Otherwise, the effectiveness of EU climate policies could be undercut and climate action could stall.