A behavioral finance perspective on sustainable energy investment decisions
The discussion on the causes and effects of climate change together with the limited fossil fuel reserves increase the demand for renewable energies. However, insufficient technological maturity and cost competitiveness as well as lacking social acceptance hinder an effective development and a higher market penetration. Today only ~7% of Europe’s total energy consumption is covered through renewable energy sources. A further progression of the industry requires substantial investments in the near future. In this context the financial service industry plays an important role as promoter of renewable energies.
Reasons that keep institutional investors from broader investments in renewable energies are besides insufficient (cost) competitiveness of renewable sources often to be found outside of a company’s sphere of influence. Firstly, dependence on subsidies in many cases may lead to an undesired deceleration of technological progression. Secondly, as public subsidies and regulations are difficult to predict and can change quickly, uncertainty about future political decisions imposes a high degree of uncertainty on producers as well as investors.
For a sustainable development of the industry the drivers and opportunities have to be leveraged and adequate economic and political measures have to be taken. There is a need to increase the competitiveness and reliability of technologies as well as to introduce political measures that do not suppress the competitive forces. And although there is a positive trend regarding renewable energy investments this enthusiasm is currently one-dimensionally directed towards few technologies, energy sources and regions. To realize the market’s full potential, real and psychological obstacles have to be removed by addressing climate change issues, raising awareness among investors and setting up subsidiary political programs.
To better understand how investments in renewable energies can be fostered one needs to better understand financial decision making. When an investment object is chosen a variety of criteria is taken into account and the more information available the more probable investors will take an investment decision. Especially the risk-return relationship is crucial. Interviews with institutional investors showed moreover that it is seldom possible to describe a step-by-step process of investment decision making. Reasons are a large variety of relevant criteria, case sensitivity, lack of required information and the influence of instincts and intuition. In particular, external sources of information, e.g. external agencies or other investors, play an important role.
To study investment decision processes and relevant decision criteria in detail besides qualitative interviews a conjoint analysis was conducted. During the online survey participants were asked to choose between hypothetical investment objects. Seven attributes described the investment objects: rate of return, technological maturity, market growth, investment horizon, energy type, subsidies and mode of external recommendation.
The results show that besides the risk return relationship especially the type of energy and external recommendations, e.g. by other investors, are relevant for institutional investors. The degree of technological maturity and the regulatory environment are of minor relevance. The high importance of external recommendations illustrates the risk that is still associated with investments in the renewable energy sector – especially for investors that do not have experience in this area. Regarding the source of energy solar energy is most favored, followed by wind. Bio fuels and wave technologies are still seen as risky for investors. In addition, the little importance of the regulatory environment is striking. In contrary to the current practice and the opinion of many politicians and scientists in this area, regulatory support and financial subsidies are of little importance to investors.
Going forward, to attract more capital suppliers of alternative energies should take investors’ requirements into account. At first, the more information is available for investors the more detailed their assessment can be. Thereby, uncertainty and perceived risk are reduced and the investment probability increases. Open communication with investors and a transparency of company data are essential in this regard. Additionally, recommendations especially from research or consulting companies, but also from other investors, are important aspects that also reduce the perceived risk. Renewable energy producers are therefore advised to take care of their image and ensure a consistent track record of prior performance. Secondly, reliance on subsidies should be reduced to a minimum since investors favour investment objects that are as self-sufficient as possible. Investors consider company related information much more intensely than they consider regulatory aspects. Therefore, renewable energy producers should aim at proving their autonomy and profitability without dependence on political support. Thirdly, the risk associated with the technology used to produce energy needs to be reduced. This can be done by informing investors and the public about that state of the art and future developments.
As described, institutional investors play an important role for the growth of the renewable energy industry as they provide the means to finance new technological developments, advancements of existing companies and the emergence of new players. For them the results of the study indicate the following recommendations: Reliance on external recommendations certainly reduces decision complexity and is therefore an adequate measure to reduce investment risk. Nevertheless, an individual risk assessment should not be foregone to avoid herding tendencies and unidirectional influences.Master thesis by Melanie Oschlies Prix du meilleur mémoire de Master du concours européen “Finance et Développement Durable 2009″ organisé par le Forum pour l’Investissement Responsable avec le soutien d’Eurosif. . .