Energy shocks and the climate transition

We present a two-sector growth model in which a representative agent invests in fossil fuel-based energy and renewable energy. These differ in capital intensity and project duration: fossil fuel investments require lower upfront investment and have shorter duration, whereas renewables are more capital-intensive with longer-lived assets. We show that a negative economic shock (such as an energy supply shock or recession) leads to both cuts in total investment and to a shift in the composition of the remaining investment toward fossil fuel projects. This delays the clean energy transition, even if renewable energy is cost-effective on a levelised cost basis, implying a role for policies to sustain clean investment during recessions. We discuss how this mechanism can be amplified by higher interest rates, pro-cyclical climate policies, perceived risk, and financial frictions, and we relate our findings to recent empirical episodes (e.g. the 2022-23 energy crisis and post-2008 recession).