{"id":26850,"date":"2025-09-03T10:35:38","date_gmt":"2025-09-03T15:35:38","guid":{"rendered":"https:\/\/blogs.law.columbia.edu\/climatechange\/?p=26850"},"modified":"2025-09-18T11:10:36","modified_gmt":"2025-09-18T16:10:36","slug":"reviewing-energy-transition-ratios-the-reliable-revealing-and-risky","status":"publish","type":"post","link":"https:\/\/blogs.law.columbia.edu\/climatechange\/2025\/09\/03\/reviewing-energy-transition-ratios-the-reliable-revealing-and-risky\/","title":{"rendered":"Reviewing Energy Transition Ratios: the Reliable, Revealing, and Risky"},"content":{"rendered":"
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This blog is the second in a three-part series<\/a> on sustainable finance metrics that better evaluate corporate climate risk, opportunity, and impact, and make metrics more relevant to financial decision-making.<\/span><\/i><\/p>\n

In the last decade, financial market participants have begun to grapple with the risk and opportunity posed by the transition from today\u2019s fossil fuel-based economy to one with greatly reduced and net-zero greenhouse gas (GHG) emissions. Ratios comparing investment in high- versus low-carbon energy systems \u2013 \u201cenergy transition ratios\u201d \u2013 have emerged as a clear and workable new transition metric of rising popularity. For good reason: transitioning away from today\u2019s high-carbon economy will require substituting the carbon-intensive energy system with a clean energy one. Tracking only one side, high- or low-carbon, only reveals part of the picture. Track both, and you get a sense of whether the clean energy system is being built out faster than the fossil system, and where that build-out is merely keeping up with new demand or fast enough to erode high-carbon market share.\u00a0<\/span><\/p>\n

This blog endorses the value of these ratios, exploring the merits of a few alternative approaches to constructing them, and then discussing how best they are applied as a transition finance metrics for portfolio, sector, and company-level analysis.<\/span><\/p>\n

Which ratio?<\/span><\/h2>\n

These energy transition ratios can take various forms. The best articulated one is the \u201c<\/span>energy supply investment and banking ratio<\/span><\/a>\u201d (ESBR) created by <\/span>Bloomberg New Energy Finance<\/span><\/a> (BNEF), which tracks financing the build-out of fossil supply versus clean energy supply. It is an intuitive measure built on a familiar frame: to shift to the net-zero economy, we need to substitute the supply of energy coming from the combustion of fossil fuels with the supply of clean electrons and zero-emission fuels. BNEF has done a thorough job of attribution, <\/span>mapping financial facilitation<\/span><\/a> \u2013 in its many varieties across a financial portfolio \u2013 to the facilitation of energy supply by companies in the material economy, an inherently fraught task.<\/span><\/p>\n

Environmental Defense Fund<\/span><\/a> does an <\/span>excellent breakdown of ESBR<\/span><\/a>, showing how it reveals new insights when comparing different bank portfolios and approaches, and pointing to some of its pitfalls (they use the term \u201cenergy supply finance ratio\u201d or ESFR, reflecting <\/span>JP Morgan Chase Bank<\/span><\/a>\u2019s iteration on the concept) . For those with experience in green finance metrics, the challenges are familiar and perhaps inherent to the discipline. For example, different banks may use different taxonomies for high- and low-carbon energy supply, or tag and attribute financial <\/span>activities differently, reducing comparability. There are also trade-offs between the improved accuracy and business relevance of using internal proprietary data, versus the transparency that comes with using publicly available sources. Despite these pitfalls, ESBR reveals a different perspective on bank transition performance, and one that they are finding useful and practical.<\/span><\/p>\n

ESBR is useful, but it is also unnecessarily narrow. The transition to a net-zero economy will require not only the transformation of capital stocks supplying dirty versus clean energy, but also the transition from capital stocks <\/span>demanding<\/span><\/i> dirty versus clean energy. Capturing only energy supply in the ratio reveals only part of the transformation taking place in the economy and market, and only part of the relevant exposures of a financial portfolio. Ideally, the ratio would also capture the capital investment in the technologies that demand fossil fuels, or manufacture products that demand those fuels. It does not make sense that investment in a gas-powered turbine engine is captured by the ESBR if it is used in a power plant, because it supplies energy, but not if <\/span>effectively the same type of engine<\/span><\/a> is placed in a plane: both demand fossil fuels. Internal combustion engines are the primary source of demand for oil in the same way that coal-fired power plants are the primary source of demand for thermal coal supply, but coal power is included in an energy supply ratio and not internal combustion engines.<\/span><\/p>\n

A better alternative would be a capital investment ratio that captures capital investment in high-carbon real assets versus low-carbon substitutes, for both fossil fuel-supplying and demanding assets. In the previous blog in this series<\/a>, I sang the praises of understanding decarbonization through the lens of capital planning and investment, and especially CapEx. In a way, this is an extension of that logic. Tracking capital investment reveals how a portfolio enables the high- versus low-carbon system, and provides a forward-looking indicator by showing how companies are preparing to meet future demand for their products. It is also more grounded in microeconomics, since supply follows demand.<\/span><\/p>\n

The International Energy Agency\u2019s (IEA\u2019s) <\/span>World Energy Investment Report<\/span><\/a> provides a good basis for such a metric (BNEF\u2019s <\/span>own investment trend<\/span><\/a> analysis looks only at the clean energy side of the ledger). It analyzes global energy investment trends across both supply and demand-related technologies and businesses, distinguishing between fossil and clean energy systems, and revealing the pace of the clean energy transition and whether it aligns with global climate goals. The IEA\u2019s analysis captures the fundamental truth that the clean energy system is replacing fossil supply and demand technologies with clean ones, and the value chain must be viewed as a system.\u00a0 The analysis has been tremendously revealing: immediately following the COVID-19 pandemic, it showed clean energy capital investment exceeding fossil investments for the first time, a trend that has held to date.<\/span><\/p>\n

Using the IEA\u2019s metric would also still leave the knotty task of attribution, mapping financial investment in portfolio companies to the capital investments they make. This is no small task, although it’s effectively been <\/span>done before by the Paris Agreement Capital Transition Assessment (PACTA)<\/span><\/a> and the BNEF\u2019s own attribution approach provides a ready methodology that could be tweaked to a greater range of capital investment.<\/span><\/p>\n

How to use capital investment ratios<\/span><\/h2>\n

That capital investment ratios are a useful diagnostic tool begs the question of how to use them. They are great at the portfolio and sector level, but require more caution at the company level.\u00a0<\/span><\/p>\n

Capital investment ratios show the big picture<\/span><\/i><\/h3>\n

One of the best use cases for these ratios is for investors and banks who want metrics that can reveal something about the relationship of their financial portfolio to the net-zero transition.\u00a0<\/span><\/p>\n

The underlying economic reality of the transition should be reflected in a portfolio-wide ratio and in individual sectors. As the economy shifts from high- to low-carbon goods and services, so too should portfolio composition and exposure. For example, financial exposure to the automotive sector inherently meant exposure to the fossil economy not long ago, whereas now the public markets include pure-play EV companies like BYD, Tesla, Rivian, Polestar, along with a more complex picture of incumbent automotive companies at varying states of transformation. At the portfolio level, a capital investment ratio helps investors better understand how the transition is unfolding in their portfolio. Does the portfolio\u2019s ratio track that of the wider economy, or is it leading or lagging? Are they capturing growth opportunities in the net-zero economy? Are their high-carbon supply-side investments at risk of being undercut by their low-carbon demand-side investments?\u00a0<\/span><\/p>\n

ESBR already tends to be applied at the portfolio level, since its financial attribution methodology makes it difficult to apply at the sector or company level. In principle, though, an energy transition ratio could be downscaled. Individual sectors will also have their own ratio as they shift at varying rates, as technologies compete for market share. The ratio reveals how the industry is preparing to meet demand for its product, and whether the industry\u2019s products and assets demand, produce, or enable fossil fuels consumption, or provide a substitute.\u00a0<\/span><\/p>\n

Company-level transition ratios require caution<\/span><\/i><\/h3>\n

More care would be required to apply transition ratios to company-level data. Financial institutions often focus \u201ctransition finance\u201d activities on enabling the transition of incumbents. <\/span>Climate Action 100+<\/span><\/a>, for example, engages with the most \u201csystematically important emitters,\u201d and other Net Zero financial alliances similarly emphasize engagement with large corporates. This may be because incumbent, already-successful companies have the balance sheets to deliver transformational change. It may also be because incumbents have the marketing budgets to focus attention on them. It is also surely in part because large financial institutions do a lot of business with large, public companies. Institutional investor portfolios are dominated by liquid, lower-risk listed equities, and corporate banking leans heavily on loans and bonds for the most mature companies.\u00a0<\/span><\/p>\n

But it may be unwise to believe that today\u2019s successful companies must be tomorrow\u2019s. An individual company need not transform for the sector to do so.\u00a0 It may participate in the <\/span>transformation or simply be left behind by it. <\/span>Nearly 30%<\/span><\/a> of the S&P\u2019s value came from oil and gas companies back in 1980; by 2024, the figure was closer to 3%.\u00a0<\/span><\/p>\n

Applying a transition ratio for an individual portfolio company may imply that the company is in the best position to reallocate revenues from its legacy capital assets into new low-carbon substitutes. This is not always the case. <\/span>Indeed, low-carbon companies capturing market share of high-carbon ones would reveal a transition to a net-zero economy, even if the high-carbon ones don’t transform.<\/span><\/p>\n

The point can be better understood with an example. Let\u2019s take Shell, which has, <\/span>on<\/span><\/a> and <\/span>off again<\/span><\/a>, made clean energy capital investments. It may not be wise to expect Shell to take its balance sheet and shift from investing in oil exploration and production to developing and acquiring renewable energy assets, which is what a capex or energy supply ratio would track. That is only relevant <\/span>if <\/span><\/i>Shell is asserting that it is becoming a clean energy business as a transition plan from oil to clean electrons. Even the most climate hawkish, though, should be equally fine with Shell giving its free cash flows to creditors and shareholders instead of recycling it into expanded CapEx. Shareholders can then invest that cash in the net-zero economy (e.g., a SunRun) or the effectively “net-zero irrelevant” (e.g., Coca-Cola). Shell\u2019s specific capital investments would be less revealing of the transition than the allocation of capital across energy or the financial system as a whole.<\/span><\/p>\n

Focusing on incumbent capital investment ratios seems, at least in part, to represent a lack of faith in the market\u2019s ability to allocate capital efficiently. In many cases, recycling a company\u2019s free cash flows to its investors and lenders allows it to be diverted to other productive uses, including low-carbon technologies. <\/span>The whole idea of a market is to reallocate financial capital, and we should be indifferent as to whether the company reinvests cash flows into the net-zero economy or the market does it. We <\/span>do<\/span><\/i> want the portfolio and each relevant sector tracking toward the right ratio, and it can be enormously beneficial for incumbents to genuinely put their financial and technical weight behind net-zero technologies, but any individual company doesn’t have to be the one to do it.<\/span><\/p>\n

Capital investment ratios are useful at the company level in a different way, however. Comparing company to sector trends can reveal whether the company is leading or lagging those trends. This can be revealing not because laggards are likely to go from ugly duckling polluters to black swan clean energy disrupters, but because it reveals where laggard capital investment may be misallocated. This can help investors push for dividends, and lenders to price debt and manage risk.<\/span><\/p>\n

Less a silver bullet than a bird\u2019s-eye view<\/span><\/h2>\n

In some ways, transition ratios respond to the demand from financial institutions for a clearer, easier-to-calculate portfolio-level metric of climate progress, risk, and opportunity. A key strength of these ratios is their ability to capture transition \u2013 from high- to low-carbon \u2013 rather than only one side of the ledger. Metrics that only focus on whether financial institutions are retreating from high-carbon industries fundamentally miss that financial institutions are in the business of financing. They need to see how the financial capital can be put to work creating the net-zero economy, just as they need to see where they are maintaining the fossil economy.<\/span><\/p>\n

Financial institutions have often turned to financed emissions as providing a portfolio-level picture. But the financed emissions metric becomes less reliable as it aggregates more disparate information into a single number, capturing different types of corporate footprints that represent different risk, opportunity, and impact profiles, and combining different financial relationships to those companies (with further analysis of these issues <\/span>here<\/span><\/a>, <\/span>here<\/span><\/a>, and <\/span>here<\/span><\/a>). In contrast, energy transition ratios are somewhat more useful in the aggregate, at the sector and portfolio level.\u00a0<\/span><\/p>\n

Just as in conventional finance analysis, no single metric provides a perfect encapsulation of a company’s past, present, and future. The key to transition analysis, as with financial analysis, is understanding what each metric is and isn\u2019t good for. The rise of transition ratios, and particularly capital investment ratios, provides one powerful new tool.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

    This blog is the second in a three-part series on sustainable finance metrics that better evaluate corporate climate risk, opportunity, and impact, and make metrics more relevant to financial decision-making. 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