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EU set to channel sustainable finance to gas, nuclear power with new taxonomy regulation

07 July 2022 Max Tingyao Lin

The EU cleared a major hurdle for natural gas and nuclear power firms to access the growing pool of sustainable finance, with its lawmakers backing controversial plans to include the two energy sources in its green taxonomy.

In February, the EU's executive branch—the European Commission (EC)—proposed to extend its criteria for sustainable activities to certain gas and nuclear projects in the Complementary Climate Delegated Act despite opposition from environmentalists and some member states.

When voting on a motion to reject the inclusion on 6 July, 278 members of the European Parliament (MEPs) were in favor, 328 against, and 33 abstained. An absolute majority of 353 MEPs was needed to veto the EC's proposal.

The Council of the EU can reject the proposed act by 11 July with a reinforced qualified majority, equivalent to at least 20 member states representing 65% of the EU population. But observers say this is unlikely to happen.

"Gas and nuclear will now be included in the taxonomy as transitional activities … This aligns with our pathway to net-zero, where they are recognized as steppingstones in the transition towards more renewables," the EC said in a statement after the vote. "Targeted investments in both are still needed in the medium term."

The EU Taxonomy Regulation, which aims to establish a classification system for sustainable activities, became effective in 2020. Since then, the EC has been introducing complementary regulations to flesh out the taxonomy's technical details.

The proposed act, also known as the second delegated act of the Taxonomy Regulation, is due to come into force in January 2023. The first delegated act, defining green activities from sectors such as energy, chemicals, and waste, entered into force on 1 January.

With the set of rules, the EU's stated goal is to guide private-sector investors to route their capital into the decarbonization activities that can help it cut GHG emissions by 55% from 1990 levels by 2030 and achieve net-zero emissions by 2050.

EU asset managers and financial advisors are required to disclose their financial products' alignment with the taxonomy. Moreover, sustainable fund managers must reveal how they use the taxonomy to determine their investment activities.

European sustainable funds' total assets reached nearly $2.28 trillion as of 31 March, or 82% of the global total, according to financial services provider Morningstar.

Peter Gardett, an ENR research and analysis executive director at S&P Global Commodity Insights, said the inclusion of gas and nuclear power in the taxonomy could reap decarbonization benefits down the line.

"Allowing for sources of baseload [electricity] supply could actually accelerate the deployment of renewables and cleantech across the rest of the economy, since the baseload backs up renewables," Gardett told Net-Zero Business Daily. "While it eases emissions cuts pressures in the prompt period, it potentially allows for greater cuts to emissions in the five- to 10-year period."

However, think-tank E3G Policy Advisor Johannes Schroeten cautioned that the inclusion could crowd out investment in renewable energy, with the taxonomy also playing a strong role in public financing.

In practice, the taxonomy generally serves as a reference for how the EU, its financial institutions, and member states plan their green finance activities.

For example, the European Investment Bank (EIB) has closely followed the taxonomy in its decarbonization roadmap. After halting new financing for fossil fuel projects since January, the bank has seen intense lobbying in favor of gas since Russia's invasion of Ukraine.

"There is a chance that, in particular, shareholders from Eastern European countries will now push for the EIB to weaken their own standards and align with the taxonomy," Schroeten told Net-Zero Business Daily.

Gas' role

Critics said gas, as a fossil fuel, has limited decarbonization effects and methane leakage issues, but supporters believe it can be a transitional fuel to a low-carbon future due to its well-established supply infrastructure.

Commenting on the MEP vote, trade body Eurogas Secretary General James Watson said the taxonomy will now be able to provide a "decent" finance framework to gas projects.

"The parliament's decision on taxonomy sends a clear signal, in line with that already seen from the commission, that gas will play a central role in our decarbonization journey," Watson told Net-Zero Business Daily. "It is very important that we stay the course on coal and oil to gas switching."

But Stephanie Pfeifer, chief executive of the Institutional Investors Group on Climate Change, whose members oversee €50 trillion ($50.8 trillion) in assets, suggested the inclusion of gas could fail to put the world on a decarbonization trajectory that could avert climate disasters.

"Whilst there may be a legitimate role for natural gas as a 'bridge' during the energy transition, this should not be interpreted as gas equating to green," Pfeifer said in a statement 6 July.

"For institutional investors, the inclusion of natural gas sends mixed messages … The signal to channel capital towards investments that restrict the increase in global temperatures to 1.5 degrees [Celsius] is weakened," Pfeifer added.

In its proposal, the EC said new gas-fired power or heating assets must have life-cycle emissions below 100 grams CO2-equivalent per kWh to be classified under the taxonomy. This is not deemed possible without carbon sequestration.

Otherwise, they need to obtain a construction permit by 2030 and keep their emissions below 270 grams CO2e/kWh or cap their annual emissions at an average of 550 kg CO2e/kW over 20 years. By the end of 2035, they will need to fully switch to renewable or low-carbon gases.

The criteria will leave "the window pretty wide for natural gas access to sustainable finance in the short term, but narrows that window over time," Gardett said.

Schroeten said some investors' appetite could be curbed by the "relatively strict" criteria. "It will be interesting to see how far private investors are actually willing to go to get that taxonomy label," he said.

Nuclear finance

The EC set relatively looser criteria for nuclear power. The taxonomy will cover extension projects for existing reactors approved by 2040, new Generation III+ projects approved for construction by 2045, and research and development of advanced technologies promoting safety and minimal waste.

World Nuclear Association, a London-based trade body, said the taxonomy will help promote private-sector investment in nuclear energy.

"The European Parliament's positive vote sends a clear endorsement of nuclear energy to the financial community," said Sama Bilbao y León, director general of the association. "Now governments, investors, and industry must act urgently and accelerate the deployment of new nuclear capacity to achieve this goal."

"Nuclear energy helps secure energy supplies by reducing demand for imported fossil fuels and will be the foundation of a clean and reliable net-zero electricity mix," Bilbao y León said in a statement 6 July.

Nuclear power is the world's second-largest source of low-carbon electricity after hydropower, but European private investors have shown little appetite for it due to long delays and cost overruns at some projects in recent years. Critics argue its low-carbon credentials are offset by waste management issues, and risks from accidents and terrorist attacks.

The taxonomy inclusion could be actually aimed at channeling public finance into nuclear power plants, said Paul Schreiber, a campaigner on financial regulations at nonprofit Reclaim Finance. Led by France, which has the world's highest share of nuclear in its power mix, a group of 10 EU countries publicly endorsed nuclear power as a low-carbon energy source last October.

"The potential use of the EU taxonomy for EU funds is one of the main reasons for the mobilization of pro-nuclear states," Schreiber told Net-Zero Business Daily. "Nuclear is largely funded thanks to public funds. This could mean massive public support, notably in France."

Uncertain outlook

Looking forward, the proposed act is expected to face some court challenges due to its alleged conflicts with EU climate laws and the Paris Agreement.

Austria and Luxembourg have announced they will launch an annulment suit at the European Court of Justice. Some NGOs, including ClientEarth and the World Wide Fund for Nature (WWF), have vowed to study legal means to block the inclusion.

"Gas and nuclear are not green, and labeling them as such is blatant greenwashing," WWF European Policy Office Director Ester Asin said in a statement 6 July. "We believe that this act is inconsistent with the Taxonomy Regulation, so together with other organizations like ClientEarth, WWF will explore all potential avenues for further action."

With the legal uncertainty and backlash from civil society, some observers expect fund managers may need to explain the degree of their exposure to gas and nuclear power when disclosing their taxonomy alignment.

"If they fund gas and nuclear through taxonomy aligned activities, they may be targeted for greenwashing by their clients and civil society," Schreiber said. "For them, the safest path is to exclude these energies from their sustainable products."

Others said the act might set an example for other countries to include gas and nuclear power in their taxonomies. The EU has a large community of sustainable investors and prescriptive, wide-ranging taxonomy rules, so its policymaking in green finance is often referenced by other countries.

Calling the EU's inclusion "a dangerous precedent," Arjun Flora, energy finance director for Europe at the Institute for Energy Economics and Financial Analysis, said European politicians "are held hostage by the vested interests of the incumbent gas and nuclear industries."

"The decision fails to protect the European investor community and consumers alike from the financial risks inherent in polluting fossil gas or toxic nuclear projects," Flora said in a statement 6 July. "The EU will now be more vulnerable to greenwashing."

Posted 07 July 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability



This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.

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