Determinants of cost of capital in the electricity sector

Abstract

Abstract In the electricity sector, the cost of capital (CoC) has a major impact on the competitiveness of different technologies and on overall electricity system cost. While the awareness of CoC differences between countries and technologies has increased over the past years, the understanding of the underlying drivers for these differences remains limited. In this Perspective, we present a systematic review of the literature on CoC determinants, aggregating conceptual and empirical insights from 43 academic articles. Based on the review, we then develop a holistic framework of CoC determinants on four hierarchical levels. Particularly, our framework highlights the importance of technology level drivers for the CoC, and of less-noted CoC drivers on the financial sector level. In addition, it illustrates that CoC drivers differ between corporate finance and project finance structures, and that they interact with determinants on different levels through multiple feedback channels. Drawing on our findings, we argue that policy decisions can strongly influence the CoC of energy projects, though any potential intervention to alter the CoC needs to consider all relevant determinants across sectors and policy domains. Researchers can support policymakers by addressing research gaps concerning CoC determinants in developing countries and the grid sector, and by further quantifying the effects of CoC determinants and their interactions.

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