Managing power transition risks in a dynamic political environment

The changing political environment, especially from 2022, is reshaping the priorities of the energy transition, according to S&P Global analyst Ludwig Heinz. As national risks increase and changes in government spending, several countries, including the UK and other EU members, have changed their stance on environmental laws, such as those relating to heat pump regulations and the emissions of petrol and diesel vehicles.

Heinz said public sentiment in Europe has changed, with voters now focusing more on national risks and cost of living issues than climate change. This change in priorities was reflected in the European Parliament elections, where the leading parties moved away from the recent focus on climate initiatives.

The European Commission's new strategic agenda, which was passed in June 2024, also reflects this change, with less focus on the green transition compared to previous plans.

Heinz suggested that Europe's dependence on energy imports, which now account for 60% of available energy, could accelerate the energy transition. The terms of the 2022 trade shock, marked by a sharp increase in the price of exports compared to imports, had a significant impact on the growth of European countries and financial stability. The shock in the price of fossil fuels has also emphasized the need for the expansion of renewable energy, especially for those who import energy from foreign countries.

Governments are now facing many challenges as financial constraints are becoming more pressing, according to Heinz. The increase in government debt from 2020 to 2022, driven by efforts to reduce the economic effects of the COVID-19 pandemic and rising energy prices, has reduced the fiscal space of many governments.

Although borrowing costs in advanced economies remain very low, rising interest rates from 2022 have added to fiscal pressures, making it more difficult for governments to manage deficits without a major deterioration in financing conditions.

The cost is large regardless of the speed of the energy change

Heinz pointed out that regardless of the pace of energy change, governments will face huge costs. If they slow down the transition, continued spending on fossil fuel subsidies may be necessary. These subsidies, along with the loss of VAT and other revenues, represent a significant financial cost.

The recent electricity price shock, in which government subsidies lowered fuel prices and reduced the incentive to drive the electricity transition, is a recent example. However, speeding up the transition by reducing fuel subsidies could risk voter dissatisfaction, especially given the large disparity in subsidies across regions, with Europe seeing the highest increase in public debt.

The shift in government priorities is also reflected in the increase in defense spending, particularly in Europe, in response to the war in Ukraine, Heinz said. In emerging and frontier markets, economic development remains a major challenge. As their energy demand begins to converge with that of developed economies, the need to increase the availability of clean energy is growing.

However, barriers such as finance, infrastructure gaps, and limited access to technology limit change, especially given the limited financial space in these regions.

Rising energy prices have intensified structural pressures on other European industries, according to Heinz. Energy-intensive sectors in Europe have lost competitiveness due to high energy costs, while European electric car manufacturers and solar panel manufacturers are facing increasing competition from China.

This situation has brought political challenges, as the possibility of job losses in the European manufacturing sector raises concerns about political stability and social cohesion.

What affects government ratings?

Heinz noted that high inflation and the rising cost of living are impacting government approval ratings. The affordability challenges posed by these factors, especially for low-income families, have influenced recent election results and may affect the progress of power transitions, depending on how policies are made and whether the impact is distributed evenly.

In some Eastern European countries, high inflation has been accompanied by falling government approval ratings, reflecting concerns about the cost of living.

Balancing energy affordability with security of supply and sustainability remains complex, according to Heinz. The increase in energy prices since late 2021, exacerbated by the Russia-Ukraine war, shifted the focus from energy transition to energy procurement and security of supply. The effects of the distribution of energy changes become more important as the process accelerates.

Social factors related to climate policy are increasingly visible, with low-income families, who spend a large proportion of their income on energy, disproportionately affected by rising costs.

The threat of less competition in Europe, especially in energy-intensive industries, has raised concerns about job losses, Heinz highlighted. The experience of previous job losses in the manufacturing sector, which contributed to increased inequality and political polarization in several developed countries, could lead to increased protectionism or decreased energy transition from developed sources.

Developing countries may cite this economic slowdown as a reason to prioritize economic growth over climate action, especially in regions with limited fiscal budgets and access to basic services.

Different methods for different governments

Countries are taking different approaches to financing high-energy transition investments, according to Heinz. EU governments rely heavily on carbon emissions, while the US and China pursue more efficient industrial policies.

These mechanisms create different incentives for companies to develop green technologies locally. Instruments like the US Inflation Act, which represents the largest investment in carbon reduction in US history, affect global trade by redirecting the flow of money to US companies. At the same time, Chinese companies are increasing the pressure to compete in global markets.

Heinz said the recent rise in energy prices has highlighted the importance of a stable energy supply at affordable prices, which may slow the energy transition in the short term. However, Europe's reliance on energy imports and the growing energy needs of developing countries could ultimately accelerate this transition.

High fossil fuel prices have encouraged governments to improve energy efficiency and use social media, especially since subsidies may become financially tight in the long run. The pressure for higher investment in renewables became more visible when electricity prices in Europe rose, as policymakers sought to increase Russia's energy independence. In developing countries, the rapidly growing demand for electricity indicates the need for large investments to ensure adequate supply.

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