Mobilizing Capital for the Transition to a Net-Zero Emissions Energy Future: A systems dynamics approach to evaluating the impact of incentives on investment decision-making behavior

Abstract

Studies have shown that a transition to a net-zero emissions energy system for the U.S. by mid-century will require the rapid mobilization of unprecedented amounts of private capital for energy projects. Typically, a project developer uses their own balance sheet equity to do engineering studies, prepare permit applications, develop contractual agreements, and carry out other work to inform a subsequent financial investment decision (FID) on whether or not to proceed with a project. A developer’s pool of equity is limited and constitutes the most expensive source of capital commensurate with its higher risk profile. This constrains the number of projects that can be developed. The pool grows as projects passing FID are successfully built and operated profitably. The pool shrinks with pre-FID expenditures on projects that end up not passing FID or that are built and operate at a loss. In this research, complex systems dynamics principles were used to develop a conceptual model of how governmental funding incentives could influence the behavior of a project developer with limited equity for pre-FID work in order to facilitate (or not) their project portfolio development. This is the first time that system dynamics has been used to provide policy relevant insights of this nature. Three conclusions are reached: Policies incentivizing developers to shortcut pre-FID work are likely to produce more projects, but these projects perform more poorly, leading to poorer mitigation outcomes. Policies which prioritize investment to assure robust pre-FID work, rather than subsidizing construction and operation costs, are likely to enhance the scale and quality of the project pipeline and to result in better mitigation outcomes. Streamlining access to incentives so that they are allocated as quickly as possible is beneficial, provided that such incentives are allocated optimally between pre-and post-FID activities and that sufficient oversight of performance is provided to assure the performance of robust pre-FID work.

All of these factors should be considered when analyzing government policies and subsidies that will support the transition to net-zero emissions.