How to finance the European Union’s building decarbonisation plan

4 Europe’s new carbon price is a revolutionary step

In May 2023, EU countries agreed to introduce a second emissions trading scheme (ETS2). This will put a price on emissions from direct fuel combustion, including gas and oil boilers in private homes, and fuel combustion in road transport

. Taking effect in 2027, ETS2 will require upstream fossil-fuel suppliers to surrender carbon certificates equivalent to the emissions generated by consumers of their fuels. These suppliers are expected to pass through the cost of certificates in the form of higher fuel prices. 

Carbon pricing could impact energy bills significantly, making it more attractive to renovate buildings by adjusting relative prices. The extent of this impact will depend on the prevailing market price for carbon permits, which is influenced by supply and demand dynamics.

The European Commission has suggested that from 2027 to 2030, efforts will be made to keep the ETS2 price below €45 per tonne of CO2

 (in 2020 prices, or €60 in 2027 prices)

. Although the market will determine prices, a reserve will be established to manage price volatility by releasing more carbon allowances if prices rise too quickly or too high. The reserve will hold 600 million allowances, or 18 percent of the ETS2 emissions cap between 2027 and 2030. European Commission (2021) estimates suggest the price could range between €48 and €80 if the EU plan to cut emissions by 55 percent by 2030 compared to 1990 is fully implemented. However, if countries do not act to decarbonise ETS2 sectors more quickly, prices could skyrocket to between €200 and €300 (Fotiou et al, 2024; Müller and Nesselhauf, 2023), indicating that the allowance endowment of the reserve may be insufficient to contain prices.

Such high carbon prices would have a similar impact to the 2022 energy crisis. Our calculations suggest that an ETS2 price of €200 would increase the energy bills of the average EU household with a gas boiler by more than they rose during the 2022 energy crisis (Figure 5), calling into question the viability of the whole mechanism. During the energy crisis, governments earmarked €540 billion in energy subsidies for final consumers (Sgaravatti et al, 2023), suggesting that the revenues obtained from high ETS2 prices would also be returned to households as compensation.

Figure 5: Yearly financial impact (additional heating cost in €) on the average EU household with a gas boiler

^{Source: Bruegel. Note: the figure does not include support to households that might be provided by governments through the use of ETS2 revenues in case of high ETS2 prices.}

The introduction of ETS2 will help in decarbonising buildings. However, it could lead to very high carbon prices, undermining its social and political acceptability and jeopardising both building decarbonisation policies and the European Green Deal more generally.

Implementing the decarbonisation and energy efficiency in buildings legislation is fundamental because it will directly tackle high energy prices. EU laws on emissions reductions in non-ETS sectors, renewable energy and energy efficiency, alongside the EPBD, set targets and standards that incentivise energy efficiency, increase the use of renewable energy and provide technical support for renovation. Collectively, these policies should lower energy bills, stabilise costs and improve living conditions, particularly benefiting households struggling with high energy prices.

5 Missing money: the need for more investment

5.1 The investment gap

We estimated that, from 2024 to 2030, meeting the EPBD targets will requires annual investments of €297 billion (for details see the online annex)

. Reaching this target requires doubling renovation rates from the current 1 percent. The overall (public and private) investment gap would therefore be €149 billion per year.

Two European instruments fill some of this gap. First, the Recovery and Resilience Facility, the EU’s post-COVID-19 economic recovery fund, is estimated to provide €12 billion annually until 2027. Second, if half of the ETS2 revenues are reinvested in energy renovations

, an additional €30 billion could be made available from 2027. This leaves an annual investment gap of €134 billion up to 2027, and €119 billion thereafter, or approximately 0.7 percent of EU GDP. A substantially larger sum is currently spent on building renovations – though not necessarily aimed at cutting emissions (for example, extensions). In most countries with available data, the required additional energy-efficiency investments are substantially less than overall renovation expenditures. For instance, overall building renovations in Germany in 2023 amounted to €145 billion, compared to a €42 billion investment gap for energy renovations (see table A.6).

Figure 7 shows the required investments by country to meet EPBD targets. Germany requires the most additional investment in absolute terms at just over €40 billion annually. In relative terms, Portugal has the largest investments gap at 1.6 percent of GDP. Figure 7 also shows that the EPBD targets place the greatest renovation burden on non-residential buildings.

Figure 7: Additional annual investment needs for energy renovations, € billions and % of GDP

^{Source: Bruegel. Note: See the online annex for a detailed explanation.}

5.2 EU financing

The Recovery and Resilience Facility has increased funding for energy-efficient improvements, providing €73 billion for 2021-2027 (Baccianti, 2023, in which figures are in current prices). This is the first European policy instrument with such a significant volume of funding dedicated to buildings energy efficiency and renovation. However, the overall impact of this funding on energy renovations remains unclear.

The EU budget, the European Regional Development Fund, the Cohesion Fund, and the Just Transition Fund contribute to these efforts (Ivanova et al, 2023). Funding for building renovations and energy-efficiency projects was slightly increased in the most recent EU budget for 2021-2027, totalling around €17 billion (Baccianti, 2023). This amount is not included in our calculation of the investment gap as it does not represent a significant change from previous periods.

5.3 New funding: ETS and ETS2 revenues and the Social Climate Fund

Carbon prices have increased significantly in recent years and revenues from auctioning carbon allowances rose from €5 billion in 2017 to €30 billion in 2022 (EEA, 2023b). Over the past decade, EU countries reported allocating 76 percent of these revenues to climate, renewable energy and energy-efficiency initiatives. This increased stream of public revenues and its claimed allocation to energy efficiency raises hopes for increased funding for energy renovations in the future. However, reporting and accountability on the use of these revenues are considered poor, with several counties categorising compensation for high carbon prices given to industrial firms as climate action (WWF, 2022; Branner et al, 2022). Reporting and accountability shortcomings make it difficult to gauge the role that ETS revenues could play in fostering energy renovations.

Auctioning of ETS2 allowances will also generate substantial revenues, ranging from €50 billion annually at a carbon price of €45 to €217 billion annually at a carbon price of €200. A maximum of €65 billion of these revenues from 2026-2032 will fund the Social Climate Fund

, which is intended to support vulnerable households, micro-enterprises and transport users who face higher costs. This fund will not receive additional top-ups if carbon prices exceed target levels. To access the SCF, by June 2025 EU countries must develop social climate plans that outline how they will use these funds to support vulnerable communities. Countries must contribute at least another 25 percent of the costs of their social climate plans, increasing SCF resources to at least €87 billion (Cludius et al, 2023). 

The remaining ETS2 revenues will be managed by national governments. Assuming an ETS2 carbon price of €60, overall revenues managed at the national level will be €275 billion, about two-thirds of the total expected revenues of €362 billion (Figure 8). Governments must use this revenue for deployment of low-emission solutions in transport and heating, or to mitigate social impacts. This creates a trade-off between compensating consumers and encouraging low-carbon investment, and between support measures for decarbonisation of heating and cooling or transport. Efficient use of this nationally-managed funding will be crucial for social acceptance of ETS2 and achieving climate targets.

If just half of the ETS2 revenues are used for energy renovations (or €30 billion/year), the investment gap could be reduced to €119 billion annually after 2026. If every €1 of government subsidy was able to leverage €3 in private finance, the gap could be reduced to just €29 billion annually.

5.4 Progressive distribution by country

The ETS2 carbon price will be a single price across the EU, despite wide differences in income levels in EU countries. To address this, the Social Climate Fund will redistribute about a third of ETS2 revenues from high-income to low-income countries, based on factors including gross national income per capita, shares of the population at risk of poverty living in rural areas and the percentage of households at risk of poverty with arrears on their utility bills.

Figure 8: Per country expected revenues from ETS2, € billions, 2026-2032, carbon price of €60

^{Source: Bruegel based on Regulation 2023/955 and EEA.}

 

6 Policy options, trade-offs and recommendations

Annual investments in renovating European buildings need to increase by around € 149 billion or 1 percent of EU GDP. The challenge for policymakers is to ensure that the additional annual €149 billion investment in building renovation happens, that it happens in a way that society deems fair and that it does not threaten fiscal stability. This is particularly challenging when governments currently face borrowing costs at their highest level since 2008. The EU’s fiscal rules framework also restricts the ability of countries with high debt (above 60 percent of GDP) to invest (Darvas et al, 2024).

Traditionally, for supporting building renovation, European countries have relied on grants and tax incentives, soft loans and regulations (EIB, 2020; Bertoldi et al, 2021). Four-fifths of 2021-2027 EU budget funding for energy efficiency and renovations comes in the form of grants (Ivanova et al, 2023). In the previous EU funding cycle (2014-2020) the European Scientific Advisory Board for Climate Change found that the cost-effectiveness of EU spending on energy efficiency in buildings was low because of inadequate targeting of investments through grants that crowded out private investment that would probably have happened anyway (Bredahl et al, 2024).

The magnitude of the challenge means a wide range of policies should be employed to cut buildings-related emissions. A portfolio of measures will help mitigate the impact of policy trade-offs. For example, with zero-interest green loans, a trade-off exists between maximising cost-effectiveness and ensuring distributional fairness, because such loans are primarily taken up by richer households. Maximising cost-effectiveness often involves targeting policies at wealthier households, which are more able to invest, while ensuring fairness would require focusing on poorer households

.

Another trade-off is simplicity versus complexity. Simple policies, such as bans on fossil-fuel boilers, are easy to understand and communicate but may fail to allocate resources efficiently and can create backlash. Policymakers must address such issues, especially when using ETS2 revenues, which should be allocated effectively and equitably.

Frontload investment support for the vulnerable to limit future compensation spending

For low-income countries, the Social Climate Fund (SCF) will likely suffice to both fully compensate vulnerable households

 for the carbon price and support investment in fuel-switching (Braungardt et al, 2022). However, if countries do not decarbonise at the pace they have committed to, and the carbon price is not contained, the capped SCF funding will not be enough to cover increased costs for vulnerable households in major countries including Germany, France and Italy (Braungardt et al, 2022).

A fine balance must be struck between compensation measures and encouraging investment in decarbonisation solutions. If progress in energy renovations does not gain pace, the ETS2 price shock might be similar to that experienced during the energy crisis, during which €540 billion were earmarked to compensate consumers (Sgaravatti et al, 2023). This is equivalent to providing 35 million households with €15,000 each, or covering more than half of our overall estimated investment gap for energy renovations up to 2030.

Governments should frontload investment support for vulnerable consumers to encourage energy renovations and reduce the need for compensation after ETS2 takes effect. Accelerating energy renovations in advance will help contain the ETS2 carbon price. Compensation measures must preserve the price-incentive to renovate. Typically, this involves using lump-sum transfers, rather than reducing consumer fossil-fuel prices. 

Reduced energy demand also reduces the EU’s dependency on energy imports and improves resilience against economic shocks, which is critical given that 40 percent of the energy used for heating homes comes from natural gas (European Parliament, 2024), making the residential sector Europe’s biggest gas consumer. 

The social benefits of targeted intervention

Untargeted and poorly designed policies can be fiscally unsustainable, lead to renovation works that would have happened anyway and provide little return on investment to the state. Financial support needs to be targeted by income level and building type. The worst-performing buildings are prime candidates for grants and tax incentives because of their high energy and emissions-saving potential, offering a bigger return on investment compared to more energy-efficient buildings (European Commission, 2021). Renovating these buildings could significantly reduce the ETS2 carbon price. We estimated that deeply renovating 10 percent of the worst-performing buildings would cut total buildings-related emissions by 20 percent and lower ETS2 emissions by 8 percent

.

Targeting support at the least energy-efficient buildings addresses fairness considerations and is politically justifiable. Low-income households typically occupy these buildings, and renovating them could reduce heating bills – which in Germany are up to 30 percent of the earnings of low-income households (Behr et al, 2024). Targeting these buildings would help alleviate energy poverty, which currently affects 50 million Europeans and leads to public health costs of €167 billion annually – from heating with smoky fuels, for example (Ahrendt et al, 2016). Accelerating energy renovations could lift seven million Europeans out of energy poverty each year (ITRE, 2017), progressively reducing the need for public support to help vulnerable households with energy bills.

The EPBD’s broad definition of residential worst-performing buildings (43 percent of the building stock) allows for tailored policies suited for different local needs. For example, central and eastern European countries have large shares of multi-apartment blocks built from the 1960s to the 1980s. While these buildings are energy-inefficient, in terms of energy per square meter, they perform better than energy-inefficient single-family houses because they have proportionally fewer outer walls and smaller unit sizes (Gerőházi et al, 2023). However, renovating communist-era panel buildings could be a more cost-efficient strategy than single-family houses because of their high population density and the potential for standardised, scalable renovation projects.

An important issue for the worst-performing and multi-apartment buildings is the impact on rental prices. Half of EU households below 60 percent of the median income are tenants, compared to only 30 percent overall. Landlords may put up rents after energy renovations, forcing vulnerable households to move and reducing the positive social impacts of energy renovations. Therefore, controls on rental prices need to be attached to access to generous state subsidies. Similarly, to create incentives for energy renovation, the costs of the ETS2 carbon price might be shared between tenants and landlords. The higher the emissions per square meter, the greater the share of the costs that should be borne by landlords.

Change relative fuel prices and reduce price uncertainty

Only a third of the retail electricity price paid by households and small enterprises reflects actual electricity production costs. The rest is taxes, network costs and subsidies for renewables or nuclear plants. As electrification is crucial to meet climate targets and can be considered an important societal goal, electricity taxes and subsidies could be shifted to the general tax burden, similar to education and public health funding.

Uncertainty around future fossil fuel and electricity prices also complicates the optimisation problem for investors. Governments have extensive experience designing tools to hedge against price volatility for renewable energy providers, such as contracts for difference. Similar schemes could be implemented for deep energy renovations, involving energy utilities or new competitors as aggregators. Governments or public development banks could hedge future energy price risks by guaranteeing fixed payments to households based on defined electricity, fossil fuel and carbon prices (McWilliams and Zachmann, 2021). If fossil fuel or carbon prices are lower than expected (reducing the savings for investing households), governments would provide an annual payment. If not, nothing would happen.

Little progress has been made in phasing out fossil-fuel subsidies in the EU. The current policy framework, including the more than two-decades-old Energy Taxation Directive (2003/96/EC) and EU state aid regulations, permits subsidies for fossil gas and oil. Between 2015 and 2021, fossil-fuel subsidies remained stable at around €50 billion per year, but in 2022, they more than doubled to €120 billion as governments shielded consumers from the energy crisis. Only eight EU countries

 have set dates for phasing out subsidies for fossil-fuel heating in buildings, or have restrictions on installing new fossil fuel-based heating systems. Fossil-fuel subsidies distort competition, hinder the energy transition and can lead to long-term emission lock-ins. As energy commodity prices have fallen, governments should shift subsidies from fossil fuels to clean technologies and electricity. It is critical to phase out these subsidies before 2027 when ETS2 takes effect, impacting final consumers and making the phase-out politically challenging. 

Leverage future energy savings

The benefits of energy renovation investments are accrued over decades through lower energy bills and increased property values. We calculate that meeting the EPBD targets would imply annual savings of €81 billion by 2030 (Table 2). In other words, more than half of the investment gap can be met through direct economic returns. 

Table 2: Annual investment gap to achieve the 2030 targets and potential energy savings, € billions per year

^{Source: Bruegel based Eurostat. Note: See the online annex for a detailed explanation.} 

Households and small enterprises heavily discount the future and are typically risk averse. They face a disincentive to invest because of the heavy dependence of the returns on renovation investment on uncertain future energy and carbon prices. Governments can create certainty around future pay-offs and possibly bring them forward in time

.

Pay-as-you-save (or on-bill finance) schemes involve repaying energy-efficiency investments through the utility bill. Households could repay renovation expenses over time, limiting or removing completely the need for upfront capital (Bertoldi et al, 2021a).

Another idea is energy-performance contracts, via which companies guarantee clients (households or firms) a certain level of energy savings. Payments are linked to actual energy savings achieved, and the company compensates the client for any shortfall (Bertoldi et al, 2021a). These contracts often involve a mix of funding sources, including revolving funds from the energy service company, the client, local and national subsidies and third parties. These types of contracts have already been used across Europe for large industrial sites, public administration buildings, large multifamily apartment buildings and social housing (Bertoldi et al, 2021a). Public funding to scale up energy-performance contracts can reduce the need for upfront capital, reduce borrowing costs and link renovations to actual energy-efficiency gains.

Policies such as these can alleviate consumer concerns about future energy savings and provide visibility around the expected cash flow from renovations, offering more investment certainty. Pay-as-you-save financing and energy performance contracts have emerged in recent years in Europe but so far have been too limited in scope and available funding. Governments need to involve banks, utilities and local authorities in tackling this financing challenge, as only public-private partnerships can deliver the desired results.

Provide access to cheap money: the role of banks

EU governments should shoulder most of the energy-renovation costs for vulnerable consumers. However, to meet the EPBD targets, most consumers will have to pay for their own energy renovations. Energy-performance obligations will therefore be essential, while governments can offer subsidised mortgages, collaborating with banks to create attractive, long-lasting financial products accessible to a wide range of beneficiaries. These loans must cater to various risk profiles and offer low interest rates.

Banks will only participate in such schemes if they provide guarantees and are financially appealing. The market value of properties themselves could be one main source of collateral. EU residential buildings, of which 71 percent are occupant-owned and most (58 percent) have no outstanding mortgage, are worth around €20 trillion (Sweatman and Yrivarren, 2023). For high-risk profiles, governments or public development banks need to provide additional guarantees, ensuring the state will cover non-performing loans. This is vital for those with existing mortgages and the elderly, who may struggle to secure long-term loans.

The second pillar of an effective financial product would be a zero interest rate. Repaying the debt-servicing costs of an investment is generally cheaper than directly covering the investment principal. Countries could design mechanisms that socialise the debt-servicing costs generally paid by clients. Assuming interest rates fall in the coming years, covering only the financing costs of the €1,041 billion investment gap through the years could require €14 billion annually between 2024 and 2040, or 23 percent of the investment principal

. 

The French zero-interest loan programme (Box 1), which mobilised ten times the initial public investment, demonstrated the effectiveness of such schemes in incentivising middle-income uptake while reducing public financial strain. Public development banks, such as KfW in Germany, can provide preferential loans and act as intermediaries between governments and retail banks. KfW already offers households preferential interest rates, flexible repayment terms and up to 40 percent debt relief based on energy-efficiency gains. Investment in construction and energy renovations has surpassed KfW’s commitments threefold (Macfarlane and Mazzucato, 2023). This scheme has proved to be budget-positive, as value-added tax revenues have exceeded the government’s allocation for the KfW programme (Macfarlane and Mazzucato, 2023). Both schemes were rolled out on a multiannual basis, which was also beneficial to increase awareness among citizens and provide positive feedback effects. 

At the EU level, the European Investment Bank’s ELENA facility launched in 2009 provides technical assistance for buildings energy-efficiency investments. However, with less than €300 million awarded, mobilising an estimated €9.5 billion over 15 years, the impact has been limited

.

Other policy options are energy-efficiency obligations and mortgage portfolio standards. These are more stringent types of regulation that force the market to move towards improved energy performance. Energy-efficiency obligations target utility companies, forcing them to promote energy efficiency savings to their consumers. Mortgage portfolio standards require lenders and financial funds to gradually increase the energy performance of their real-estate portfolios (Bertoldi et al, 2021). The EPBD rightly encourages greater use of mortgage portfolio standards at national level. 

One-stop shops to simplify energy renovations and collect data

One-stop shops (OSS) are private or public entities that act as points of reference for companies and citizens willing to make energy-efficiency investments. OSS serve as intermediaries between final customers and the entire supply chain for energy renovations, providing administrative, financial and legal support, while monitoring renovation progress and delivery.

OSS can also help pool projects, creating an investment case for contractors that would be lacking for projects in isolation

 (Bertoldi et al, 2021b). This function of matching demand and supply can be particularly useful to create public-private partnerships. 

OSS can also help fill data gaps by collecting information on prices, types of renovations and efficiency gains post-renovation. For example, OSS could help expand the adoption and improve the quality of energy-performance certificates (EPCs), the main tool at EU level to certify a building’s energy efficiency rating, grading building from A (best performing) to G (worst performing). While useful, EPCs have been criticised for inaccuracy, often because of self-reporting and unreliable energy audits (European Commission, 2021). EPCs often provide ratings based on the physical assets of buildings or real energy consumption, but fail to give an actual representation of energy performance in kilowatt hours per square metre (Jenkins et al, 2017). As a result, EPCs sometimes fail to inform households about the energy efficiency of their homes, leading many to mistakenly believe renovations are unnecessary (Römer and Salzgeber, 2023).

More broadly, the lack of useful data on buildings is alarming and should be addressed as a priority

. Detailed information on heating systems across local communities can help local authorities make informed decisions on which heating systems to promote and whether district heating is a viable option.

7 Conclusions

Bridging the investment gap in buildings energy renovations in the EU to meet the 2030 EPBD target requires national governments to roll-out cost-effective policy tools, shielding vulnerable consumers from the high upfront costs, leveraging future energy savings, lowering administrative burdens, correcting relative energy prices and crowding-in private capital. 

Even for the worst-performing buildings, for which governments will need to allocate the biggest share of public support (estimated at 60 percent), leveraging future energy savings can close the remaining investment gap. This can be done by blending subsidies with pay-as-you-save or energy-performance contracts. For other private buildings, preferential loans, tax incentives and energy-efficient mortgages can be used. Doing this would lower the new public finance needed to €50 billion per year (Table 3). Finally, deploying one-stop-shops, mortgage portfolio standards, energy efficiency obligations, revolving funds and contracts for difference have the potential to greatly speed up energy renovations.

Table 3: estimated investment gap and suggested relevant instruments by type of building

^{Source: Bruegel.}

However, even if public funds and ETS2 revenues – estimated at €30 billion/year for energy renovations – are deployed most efficiently, a gap of €20 billion per year persists. EU institutions should therefore leave enough margin for fiscal manoeuvre for EU countries to make the required investments.

 

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