Financial mechanisms for energy transitions: a review article

Abstract

Purpose

The transition from fossil fuel-based energy systems to renewable energy sources, commonly referred to as the energy transition, is essential for combating climate change. However, comprehensive studies that thoroughly examine the financial mechanisms involved in this process are lacking. Despite the availability of various financial tools, there is a notable absence of extensive research that synthesizes and categorizes these mechanisms into broad groups.

Design/methodology/approach

A systematic literature review is used to explore a comprehensive framework for financial mechanisms related to the energy transition and their application across six stages of the process.

Findings

The framework of financial mechanisms for energy transition encompasses these six factors: public financing mechanisms, private financing mechanisms, market-based mechanisms, innovative financing mechanisms, risk mitigation instruments and institutional support and capacity building.

Originality/value

This is the first study that thoroughly reviewed the financial mechanisms involved in the energy transition process.

Citation

Long, P.D., Tram, N.H.M. and Ngoc, P.T.B. (2024), "Financial mechanisms for energy transitions: a review article", Fulbright Review of Economics and Policy, Vol. 4 No. 2, pp. 126-153. https://doi.org/10.1108/FREP-07-2024-0039

1. Introduction

The global imperative to transition from fossil fuels to sustainable energy sources has never been more urgent. The transition to sustainable energy is essential to meet the targets set by international agreements such as the Paris Agreement, which aims to limit global warming to well below 2 degrees Celsius above pre-industrial levels (Meinshausen et al., 2022; Rogelj et al., 2016). Achieving these goals requires substantial investment in renewable energy infrastructure, energy efficiency measures, and technological innovation (Huynh Mai Tram & Hoang Ngoc, 2024). According to the International Energy Agency (IEA), an estimated $4 trillion per year of clean energy investment is needed by 2030 to stay on track for net-zero emissions by 2050 (Renné, 2022; Teske, 2022). The global transition from fossil fuels to sustainable energy sources is driven by various actors, including governments, international financial institutions, and private investors. National governments provide subsidies and tax incentives, international organizations such as the World Bank and the International Monetary Fund (IMF) offer funding for sustainable energy projects, and private investors are increasingly financing renewable energy through green bonds and venture capital investments (Zhao et al., 2022).

As nations grapple with the multifaceted challenges of climate change, economic development, and energy security, the financial mechanisms underpinning the energy transition have become critically important (Ngoc & Tram, 2024). Financial mechanisms are the linchpin of this transition, determining the pace and scale at which sustainable energy technologies are developed and deployed. These mechanisms include a broad spectrum of instruments, such as government subsidies, green bonds, carbon pricing, and private investment vehicles, all of which play pivotal roles in facilitating the shift towards renewable energy and sustainable practices (Christophers, 2022; Dhakouani, Znouda, & Bouden, 2020; Neuman, 2022; Yang, He, Xia, & Chen, 2019). They are critical in addressing the inherent risks and uncertainties associated with new energy technologies, thereby making them more attractive to investors. Furthermore, well-designed financial mechanisms can help to ensure that the benefits of the energy transition are equitably distributed, addressing social and economic disparities.

While there is a substantial body of research on financial mechanisms for energy transition, several gaps and controversies remain. First, some previous studies ignored the role of finance in the transition from fossil energy to renewable energy. Chen, Xiong, Li, Sun, and Yang (2019) presented four key themes related to sustainable energy transition pathways: (1) sustainable energy economics and management, (2) renewable energy generation and consumption, (3) environmental impacts of energy systems, and (4) electric vehicles and energy storage. However, they ignored the financial factor, a golden key that contributes to the transformation. Second, although many studies have explored specific aspects of financing the energy transition (Isah, Dioha, Debnath, Abraham-Dukuma, & Butu, 2023; Wang, Sun, & Iqbal, 2022), no comprehensive review has thoroughly examined the financial mechanisms involved in this process. Most research has focused on particular types of financing, such as incentive policies (Qadir, Al-Motairi, Tahir, & Al-Fagih, 2021) or niche financing models (Neumann, 2023), but a broader synthesis categorizing financial mechanisms across the entire spectrum of sustainable energy transitions remains missing. Third, while a variety of financial tools exist, there has been a lack of research that synthesizes and organizes these mechanisms into a cohesive framework based on their impact on different stages of the energy transition. Such a framework would be valuable for understanding how diverse financial instruments jointly influence the energy transition and for identifying gaps or opportunities for more effective financial strategies. This paper builds on these prior efforts by developing a comprehensive framework that addresses the complexities of financing at each stage of the energy transition process.

Given the urgent global need for a sustainable energy transition and the critical role that financial mechanisms play, this article addresses several key gaps in the existing literature. While numerous studies have examined specific aspects of financing the energy transition, there is a lack of comprehensive research that organizes these financial mechanisms into a cohesive framework and explores their application at different stages of the transition. To address these gaps, this article seeks to answer the following research questions: (1) What are the key stages of the energy transition process? (2) What financial mechanisms are essential to support each stage of the energy transition, and how can these mechanisms be categorized into a comprehensive framework? (3) What are the current challenges and future research directions? Through systematic literature review, the primary contributions of the article are: (1) defining the stages of the energy transition process, (2) presenting a comprehensive framework for financial mechanisms related to this transition, (3) analyzing the application of these financial mechanisms at each stage of the transition, and (4) addressing existing challenges while proposing promising directions for future research on financial mechanisms in the energy transition.

The rest of this study is organized as follows: Section 2 presents the importance of energy transition and six phases of this process. Section 3 outlines the research methods employed in the study. Following that, Section 4 details the main findings, while Section 5 explores potential challenges and suggests avenues for further research. Section 6 concludes the study.

2. Theoretical background

Sustainable Finance Theory provides a useful framework for understanding the relationship between financial mechanisms and the energy transition. This theory emphasizes that financial systems should not only focus on economic returns but also incorporate environmental, social, and governance (ESG) criteria to align investments with long-term sustainability goals, such as decarbonization and renewable energy deployment (Fullwiler, 2016; Sandberg, 2018).

2.1 The importance of energy transition

The energy transition, defined as the shift from fossil fuel-based energy systems to renewable energy sources, is essential for mitigating climate change (Chapman, McLellan, & Tezuka, 2018; Davis, Moronkeji, Ahiduzzaman, & Kumar, 2020; Galimova, Ram, & Breyer, 2022). Yang, Xia, Huang, and Qian (2024) emphasizes the importance of energy transition as it impacts the economy, society and ecosystem simultaneously.

First, energy transition also significantly enhances energy security (Li & Jiang, 2019; Rodríguez-Fernández, Carvajal, & de Tejada, 2022). By diversifying the energy mix and reducing dependence on imported fossil fuels, countries can mitigate risks associated with geopolitical tensions and supply disruptions (Blondeel, Bradshaw, Bridge, & Kuzemko, 2021). Renewable energy sources such as wind, solar, and hydroelectric power are abundant and locally available, reducing vulnerability to international market fluctuations and price volatility (Owusu & Asumadu-Sarkodie, 2016). Additionally, the decentralized nature of many renewable energy systems, like rooftop solar panels and community wind farms, increases resilience against natural disasters and infrastructure failures. This distributed generation model not only stabilizes the energy supply but also empowers communities to become more self-sufficient in their energy needs. Consequently, the energy transition supports a more stable, reliable, and secure energy landscape, crucial for economic stability and national security.

Second, the energy transition brings significant economic benefits. Investing in renewable energy infrastructure creates numerous job opportunities in manufacturing, installation, maintenance, and research and development (Dvořák, Martinát, der Horst, Frantál, & Turečková, 2017; Kumar & Majid, 2020). This green economy spurs innovation and technological advancements, fostering new industries and driving economic growth. Additionally, renewable energy sources often have lower operational and maintenance costs compared to traditional fossil fuel power plants, resulting in long-term savings for both consumers and businesses. By reducing reliance on imported fuels, countries can improve their trade balances and redirect funds toward domestic investments. The decentralized nature of renewable energy systems can also lower energy costs, making energy more affordable and accessible. These economic benefits, coupled with environmental advantages, make the energy transition a compelling pathway for sustainable and prosperous economic development.

Third, the energy transition also brings numerous social and community benefits. Public health is another critical area improved by the energy transition (Seddighi, Anthony, Seddighi, & Johnsson, 2023; Yadav, Aneja, & Ahmed, 2023). Fossil fuel combustion releases harmful pollutants, including particulate matter, nitrogen oxides, and sulfur dioxide, which contribute to respiratory and cardiovascular diseases, cancer, and premature death (Maciejczyk, Chen, & Thurston, 2021; Munawer, 2018). By replacing coal, oil, and natural gas with clean energy alternatives such as wind, solar, and hydroelectric power, we can drastically reduce air pollution and its associated health risks. Renewable energy systems typically have lower emissions of toxic chemicals and greenhouse gases (Amponsah, Troldborg, Kington, Aalders, & Hough, 2014; Mac Kinnon, Brouwer, & Samuelsen, 2018), further contributing to a cleaner and healthier environment. Improved air quality can lead to fewer hospital visits, reduced healthcare costs, and enhanced quality of life. Moreover, the reduction in air and water pollution from decreasing fossil fuel use leads to healthier living environments, enhancing the overall quality of life (Anser, Hanif, Vo, & Alharthi, 2020). Access to affordable and reliable renewable energy can also address energy poverty, ensuring that all community members have the energy they need for heating, cooling, and electricity. This equitable access supports social cohesion and well-being, making the energy transition a powerful driver for social and community development.

Finally, technological innovation is another significant boost from the energy transition (Chen, Zou, Zhong, & Aliyeva, 2023; Khan, Su, Rehman, & Ullah, 2022). As countries and companies invest in clean energy solutions, there is a growing demand for advancements in various technologies, including solar panels, wind turbines, energy storage systems, and smart grids. This push for innovation drives research and development, leading to more efficient, cost-effective, and reliable renewable energy technologies. The quest to optimize energy systems also spurs advancements in related fields such as materials science, electrical engineering, and information technology. Furthermore, the integration of renewable energy with digital technologies like artificial intelligence and the Internet of Things (IoT) enhances the management and optimization of energy consumption and distribution (Ahmad & Zhang, 2021; Li, Herdem, Nathwani, & Wen, 2023). These technological breakthroughs not only improve the performance of renewable energy systems but also open new markets and opportunities for businesses. Ultimately, the energy transition catalyzes a wave of innovation that transforms the energy landscape and stimulates economic growth. Figure 1 shows the impacts of energy transition on social, economic, and ecological systems.

2.2 Phases of energy transition

The six phases of energy transitions presented in this paper are a synthesis of existing literature (Gatto, 2022; Markard, 2018; Markard & Rosenbloom, 2022) and insights from key reports by international organizations such as the International Energy Agency (IEA) and the United Nations Framework Convention on Climate Change (UNFCCC). While no prior work has fully integrated these phases into a cohesive framework, our proposed six-phase model consolidates various elements from prior studies and creates a new, structured approach to analyzing the energy transition process. Six phases of energy transition are shown in Figure 2.

2.2.1 Phase 1: awareness and initiation

The journey toward a sustainable energy future is typically categorized into several phases, with the first phase being Awareness and Initiation. This phase is critical as it sets the foundation for subsequent actions and policies. Awareness and Initiation is the stage where individuals, communities, governments, and industries begin to recognize the importance and urgency of transitioning to sustainable energy (Siriram, 2023). This phase involves a combination of education, policy-making, and initial investments that together catalyze the broader energy transition.

The journey begins with educating the public about the environmental, economic, and social impacts of current energy consumption patterns. Public awareness campaigns, media coverage, and educational programs play a crucial role in informing citizens about the benefits of renewable energy and the risks associated with continued reliance on fossil fuels (Pandey & Sharma, 2021). This awareness helps to build a supportive base of informed individuals who can advocate for and participate in the transition. Besides, accurate data and scientific research are fundamental to understanding the current state of energy systems and the potential benefits of renewable energy (Boamah & Rothfuβ, 2020). This includes studying the environmental impacts of fossil fuels, analyzing renewable energy technologies, and assessing their feasibility. Research institutions, universities, and think tanks often lead these efforts, providing essential information that informs policy and investment decisions.

2.2.2 Phase 2: early adoption

Early Adoption refers to the period when renewable energy technologies and practices begin to be implemented more widely beyond pilot projects and initial investments (Ornetzeder & Rohracher, 2013). This phase involves the early market penetration of these technologies, the establishment of initial infrastructure, and the creation of regulatory and market conditions that encourage further adoption. During this phase, renewable energy technologies such as solar photovoltaic (PV) systems, wind turbines, bioenergy, and others begin to penetrate the market (Apajalahti, Temmes, & Lempiälä, 2018). Early adopters, including progressive businesses, municipalities, and environmentally conscious consumers, start to integrate these technologies into their operations and lifestyles (Sovacool, 2016). These early adopters play a crucial role in demonstrating the viability and benefits of renewable energy, thus encouraging wider acceptance.

The Early Adoption phase involves significant infrastructure development to support renewable energy systems (Israel, Ettema, & van Lierop, 2024). This includes the construction of solar farms, wind farms, and biomass plants, as well as the upgrading of existing energy grids to handle the integration of renewable sources. Infrastructure development also encompasses the establishment of charging stations for electric vehicles and the creation of energy storage systems to address the intermittency of renewable energy.

2.2.3 Phase 3: scaling up

The phase of Scaling Up involves expanding the deployment of renewable energy technologies from early adopters to the broader market. This phase focuses on increasing the capacity and coverage of renewable energy systems, optimizing supply chains, and integrating these systems into national and global energy frameworks (Chapman & Itaoka, 2018; Naber, Raven, Kouw, & Dassen, 2017). The goal is to move from isolated projects to widespread implementation, ensuring that renewable energy becomes a major, if not the primary, component of the energy landscape (Kapsalis et al., 2024).

The Scaling Up phase is marked by a significant increase in the deployment of renewable energy technologies. Solar panels, wind turbines, hydroelectric systems, and other renewable technologies are installed on a large scale, moving beyond pilot projects and early market segments. This mass deployment requires coordinated efforts across various sectors and levels of government.

2.2.4 Phase 4: integration and optimization

The Integration and Optimization phase focuses on the seamless incorporation of renewable energy sources into the existing energy infrastructure and maximizing the efficiency of energy use (Markard, 2018; Prina, Lionetti, Manzolini, Sparber, & Moser, 2019). This phase involves enhancing grid systems to accommodate intermittent energy from sources like solar and wind, and employing advanced energy storage solutions to manage supply variability (Maia & Zondervan, 2019). The development of microgrids and distributed generation systems further supports this integration, allowing localized, independent energy management. Optimization is achieved through sophisticated energy management systems that utilize real-time data and advanced algorithms to monitor, control, and enhance grid performance. Demand response mechanisms adjust consumption based on supply conditions, while smart grid technologies and IoT devices provide granular control and monitoring capabilities.

This phase is underpinned by supportive policies and regulatory frameworks, economic considerations, and environmental impact assessments, ensuring a sustainable and scalable approach to energy transition (van Beuzekom, Hodge, & Slootweg, 2021). Continuous improvement, driven by feedback loops and stakeholder engagement, ensures that the energy systems remain adaptive and resilient, capable of meeting future demands and technological advancements.

2.2.5 Phase 5: maturity and stability

Maturity and Stability in the context of the energy transition refers to a stage where renewable energy systems and technologies have become fully integrated, optimized, and are operating smoothly and reliably as the primary sources of energy (Bolwig et al., 2019; Kanger, 2021). This phase is characterized by the establishment of a stable and self-sustaining renewable energy market, enhanced grid stability, and minimal reliance on fossil fuels.

At this stage, the energy infrastructure is fully capable of handling large-scale renewable energy inputs (Guelpa, Bischi, Verda, Chertkov, & Lund, 2019). The grid is not only smart and flexible but also resilient to disruptions, whether from natural disasters or cyber-attacks. Advanced energy storage systems are widespread, ensuring continuous energy supply even when renewable generation is low (Bussar et al., 2016). Renewable energy sources, such as solar, wind, hydro, and bioenergy, dominate the energy mix. Fossil fuel use is minimal, primarily reserved for specific applications where alternatives are not yet viable. The high penetration of renewables results in significant reductions in greenhouse gas emissions and other pollutants, contributing to improved public health and environmental sustainability.

Energy markets have adjusted to the new dynamics of renewable energy. Prices are stable and reflect the true cost of energy production and consumption, including environmental externalities. Market mechanisms effectively balance supply and demand, and consumers benefit from competitive energy prices.

2.2.6 Phase 6: sustainable future

The Sustainable Future phase represents the ultimate goal of the energy transition: a world where energy systems are fully sustainable, integrated, and optimized to support both human well-being and environmental health (Dincer & Acar, 2017). In this phase, renewable energy is universally accessible, reliable, and efficient, ensuring that energy needs are met without compromising the planet’s ecological balance or future generations' ability to meet their own needs (Gatto, 2022). Every individual, regardless of geographic location or socioeconomic status, has access to clean, reliable, and affordable energy (Siciliano, Wallbott, Urban, Dang, & Lederer, 2021). This is essential for improving living standards, reducing poverty, and enabling economic development.

3. Methodology

The research method outlined in this study adhered to the original guidelines suggested in Snyder (2019). The primary procedure includes four key phases: designing, conducting, analyzing, and documenting the review. To conduct the review, we begin by defining clear research questions and objectives to guide our investigation. These questions serve as the foundation for our search strategy and inclusion/exclusion criteria.

The research questions examined in this study are:

• (1)

  Research question 1 (RQ1): What are the framework of financial mechanisms for energy transition?

• (2)

  Research question 2 (RQ2): How are financial mechanisms applied across the stages of energy transition?

• (3)

  Research question 3 (RQ3): What are the current challenges and future research directions?

We systematically search electronic databases such as Springer, Elsevier, and Scopus for peer-reviewed articles, reports, and relevant grey literature (Table 1). Additionally, we search key journals and reference lists of identified articles to minimize the risk of missing pertinent studies.

In this study, “financial mechanisms” are defined as instruments, policies, or frameworks that facilitate the transition from fossil fuel-based energy systems to renewable energy, including green bonds, carbon pricing, public subsidies, and private equity investments in clean technologies. We include studies that explicitly discussed how these mechanisms enhance renewable energy or energy efficiency, while excluding purely theoretical models and review papers to maintain focus on empirical studies offering novel insights. To ensure relevance, we limit the scope to studies published in the last 10 years (2014–2024).

Our search strategy incorporates a combination of keywords and controlled vocabulary related to “energy transition,” “financial mechanisms,” “renewable energy,” “sustainable finance,” and other relevant terms such as “renewable energy finance,” “financial instruments,” “carbon financing,” “green bonds,” “financial policy,” and “investment in clean energy.” Boolean operators (AND, OR, NOT) were employed to refine search precision. For example, searches included combinations such as “energy transition” AND “financial mechanisms,” “green bonds” OR “carbon financing” AND “renewable energy.” Additionally, we applied filters to exclude studies not written in English or those lacking sufficient data or relevant analysis to answer our research questions.

Once the initial search is completed, retrieved articles undergo a two-step screening process. Firstly, titles and abstracts are screened against the inclusion/exclusion criteria to identify potentially relevant studies. Secondly, full-text assessment is conducted to further refine the selection of articles for inclusion in the review. Data extraction is performed using a standardized form to capture key information from selected studies, including study characteristics, methodology, findings, and conclusions. Quality assessment of included studies is also conducted to evaluate the reliability and validity of the evidence presented.

The extensive literature search yielded numerous articles, but we focused solely on those relevant to our research question based on the criteria outlined earlier. The selection criteria for our sample were as follows: (1) the article must address energy transition and include at least one financial mechanism, (2) it must have practical applications for contributing to the energy transition, (3) it must be a published research work in an international journal, and (4) conference papers were included if indexed in the Scopus database. Additionally, we excluded book chapters and research notes from our sample. Using these criteria, we initially selected 162 articles from ScienceDirect, and SpringerLink, which were further narrowed down to 111 articles after additional screening and evaluation (Figure 3).

4. Results

4.1 The status quo of financial mechanisms for energy transition

The article includes a total of 111 selected publications, highlighting a clear upward trend in research on financial mechanisms for energy transitions. Between 2014 and 2017, the number of publications was minimal, followed by steady growth starting in 2018, reflecting the growing global focus on energy transition. A notable surge in publications occurred between 2021 and 2023, likely driven by increased urgency around climate change and the need for sustainable energy solutions. The highest number of articles is recorded in 2024, suggesting that the field has reached a significant level of maturity, with research on financial mechanisms for energy transitions becoming increasingly widespread. Figure 4 illustrates the year-wise distribution of papers.

Figure 5 highlights the top 10 journals contributing the most articles on financial mechanisms for energy transitions. Among the 111 selected articles, Renewable Energy emerges as the most prominent journal, contributing nearly 20 publications to the body of research. This is closely followed by Energy Economics and Resource Policy, both of which make substantial contributions to shaping the research landscape in the field. Noteworthy journals such as “Environmental Science and Pollution Research” and “Energy Policy” have published over 10 articles each, reflecting their significant engagement with the topic. Meanwhile, journals like “Energy Research & Social Science,” “Energy Reports,” “Renewable and Sustainable Energy Reviews,” and “Energies” contribute a smaller, though important, number of publications. This distribution underscores the key role that journals specializing in energy and sustainability play in advancing research on financial mechanisms for energy transitions.

4.2 Framework of financial mechanisms for energy transition

The framework of Financial Mechanisms for Energy Transition encompasses these six factors: Public Financing Mechanisms, Private Financing Mechanisms, Market-Based Mechanisms, Innovative Financing Mechanisms, Risk Mitigation Instruments, and Institutional Support and Capacity Building. These factors collectively address the diverse challenges and requirements associated with funding the transition from traditional fossil fuel-based energy systems to cleaner and more sustainable alternatives. Each factor plays a specific role in mobilizing capital, reducing risks, and creating an enabling environment for renewable energy investments.

Public financing mechanisms are financial tools and strategies used by governments and public institutions to support and promote investments in various sectors, including the renewable energy sector (Coccia, Falavigna, & Manello, 2015; Gema, 2022). These mechanisms are essential in overcoming initial cost barriers, reducing investment risks, and incentivizing the development and deployment of sustainable energy technologies. Public financing plays a crucial role in driving the energy transition by providing the necessary financial support and creating a conducive environment for private sector participation (Qadir et al., 2021).

Private financing mechanisms are critical to mobilizing the substantial capital required for the global energy transition (Polzin, Egli, Steffen, & Schmidt, 2019). These mechanisms encompass various strategies and financial instruments that involve private sector investment in renewable energy projects (Pinilla-De La Cruz, Rabetino, & Kantola, 2022). By leveraging private financing, the energy sector can tap into larger pools of capital, foster innovation, and accelerate the deployment of clean energy technologies.

Meanwhile, market-based mechanisms play a pivotal role in the energy transition by creating financial incentives for the adoption of renewable energy and the reduction of greenhouse gas emissions (Nasirov, Agostini, Silva, & Caceres, 2018). These mechanisms leverage market forces to encourage investments in clean energy technologies and promote sustainable energy practices. Key market-based mechanisms include carbon pricing, renewable energy certificates (RECs), feed-in tariffs (FiTs), and auctions and competitive bidding processes (Burke & Gambhir, 2022; Faure-Schuyer, Welsch, & Pye, 2017). Each of these mechanisms contributes to making renewable energy economically attractive and fostering a competitive environment for its deployment.

Besides, innovative financing mechanisms include creative and non-traditional financial strategies and instruments that facilitate investment in renewable energy and energy efficiency projects (Asumadu et al., 2023). They are essential to mobilizing the substantial capital required for the global energy transition. They aim to attract a broader range of investors, reduce financial risks, and make renewable energy projects more accessible and viable. Key innovative financing mechanisms include crowdfunding, green banks, energy service companies (ESCOs), blockchain-based financing, and public-private partnerships (PPPs) (Miller, Carriveau, & Harper, 2018).

By addressing various types of risks, such as technological, financial, regulatory, and market risks, risk mitigation instruments help to create a more stable and predictable environment for investors (In, Manav, Venereau, Cruz, & Weyant, 2022; Lee & Zhong, 2015). These instruments are crucial for attracting investments in renewable energy projects by reducing the perceived and actual risks associated with these investments. Key risk mitigation instruments include guarantees, insurance products, hedging mechanisms, blended finance, and contractual agreements (Isah et al., 2023).

Ultimately, institutional support and capacity building for energy transition encompass a range of processes, policies, and mechanisms aimed at facilitating the shift from traditional fossil fuel-based energy systems to cleaner and more sustainable alternatives (Di Nucci & Prontera, 2023; Vanegas Cantarero, 2020). These initiatives involve various stakeholders, including governments, regulatory bodies, international organizations, research institutions, industry associations, and local communities (Strumińska-Kutra, Dembek, Hielscher, & Stadler, 2023). The overarching goal is to create an enabling environment that promotes the adoption of renewable energy sources, improves energy efficiency, and fosters innovation in the energy sector. Figure 6 illustrates the framework of financial mechanisms for energy transition.

4.3 Applying financial mechanisms across the stages of energy transition

The transition to renewable energy involves a multifaceted approach that requires diverse financial mechanisms at different stages. The following outlines how Public Financing Mechanisms, Private Financing Mechanisms, Market-Based Mechanisms, Innovative Financing Mechanisms, Risk Mitigation Instruments, and Institutional Support and Capacity Building can be effectively applied across these stages.

4.3.1 Stage 1: Awareness and Initiation

In the initial stage, public financing plays a pivotal role. Governments can provide grants and subsidies to support research and development (R&D) of renewable technologies (Wu, Yang, & Tan, 2020; Yu, Guo, Le-Nguyen, Barnes, & Zhang, 2016). Public funds can also be used to conduct feasibility studies and pilot projects, which are crucial for demonstrating the viability of new technologies and approaches (Diawuo, Scott, Baptista, & Silva, 2020). Meanwhile, private investors, including venture capital and angel investors, can fund startups focused on innovative renewable solutions (Hegeman & Sørheim, 2021). Corporations may also allocate funds for R&D in renewable energy, seeing potential future returns. At this stage, market-based mechanisms like carbon credits and renewable energy certificates (RECs) can provide incentives for early investments in renewable projects (Feng, Li, Zhang, Gong, & Yang, 2021). These instruments can help create a market for emissions reductions and renewable energy generation. Moreover, crowdfunding platforms and green bonds can be leveraged to attract capital from a broader base of investors, including individuals interested in supporting sustainable projects. These mechanisms can reduce the dependency on traditional funding sources. To mitigate risks associated with early-stage projects, government-backed guarantees and insurance products can provide a safety net for investors. This reduces the financial risk and encourages investment in nascent technologies. Governments and international organizations can provide the necessary institutional support by establishing regulatory frameworks that encourage renewable energy development. Capacity-building programs are essential to educate stakeholders about the benefits and feasibility of renewable energy projects.

4.3.2 Stage 2: early adoption

In the early adoption phase, Tongsopit, Moungchareon, Aksornkij, and Potisat (2016) showed that public financing can continue to support pilot projects and provide subsidies for deploying initial commercial-scale projects. Government-sponsored incentives can help lower the cost barriers for early adopters. Besides, Quas, Mason, Compañó, Testa, and Gavigan (2022) emphasized that private equity firms and venture capitalists can play a significant role in scaling up successful pilot projects. Financial institutions might start offering loans for renewable energy projects, recognizing their potential profitability. Market-based mechanisms such as feed-in tariffs and renewable portfolio standards (RPS) can create a stable revenue stream for renewable energy producers. These mechanisms ensure a guaranteed price for renewable energy, making it more attractive to investors. Furthermore, leasing and power purchase agreements (PPAs) can help reduce the upfront costs for consumers and businesses by spreading payments over time (Overholm, 2015). Impact investment funds can also be mobilized to support projects that offer social and environmental benefits. More sophisticated insurance products can be developed to cover the specific risks associated with early-stage renewable energy projects. Financial derivatives can be used to manage price volatility and other market risks. Strengthening regulatory frameworks and providing continuous capacity-building programs can support the deployment of early technologies. This includes training programs for professionals involved in the installation, operation, and maintenance of renewable energy systems.

4.3.3 Stage 3: scaling up

As projects scale up, substantial public investment in infrastructure, such as grid expansion and storage solutions, becomes crucial (Schreiner & Madlener, 2021). Governments can also continue to offer subsidies and tax incentives to encourage large-scale deployment. Institutional investors and pension funds can start investing in large-scale projects, providing the necessary capital for expansion. Project financing, which involves raising funds for specific projects, becomes more prevalent at this stage. In addition, expanding markets for emissions trading and RECs can provide additional revenue streams. These mechanisms help create a favorable economic environment for large-scale renewable energy projects. Green bonds and climate bonds can be issued to finance large-scale projects (Bhutta, Tariq, Farrukh, Raza, & Iqbal, 2022; Ye & Rasoulinezhad, 2023). Blended finance models, which combine public and private funds, can help mitigate risks and attract more investment (Rode et al., 2019). Government-backed guarantees for large projects and more comprehensive insurance options can provide the necessary security for investors. These instruments help manage the higher risks associated with scaling up operations. Enhancing institutional frameworks and regulatory support is essential to manage large-scale projects efficiently (Brunet, 2021). Continuous capacity-building initiatives are necessary to ensure that the workforce is equipped to handle the complexities of large-scale renewable energy systems.

4.3.4 Stage 4: integration and optimization

Public funds can be directed towards the development of smart grids and energy storage solutions to enhance the integration of renewable energy into the existing energy system. Investment in R&D for optimization technologies is also critical. Meanwhile, private sector funding can support grid modernization and the deployment of advanced technologies such as energy management systems. Corporate investment in energy efficiency technologies can also drive optimization efforts. Dynamic pricing mechanisms and demand response programs can be implemented to balance supply and demand effectively. Markets for ancillary services and energy storage can provide additional revenue streams for renewable energy producers. Performance-based contracts and energy service companies (ESCOs) can drive investment in optimization technologies (Kostka & Shin, 2013; Nurcahyanto, Simsek, & Urmee, 2020). Financing models that link payments to performance outcomes can align incentives and ensure efficient project implementation. At the same time, developing new insurance products that cover the risks associated with integrated energy systems is essential. Financial instruments that manage the variability and intermittency of renewable energy can also be explored. Developing regulatory frameworks that support the integration of renewable energy systems is crucial. Training programs for the operation and maintenance of integrated systems can enhance the efficiency and reliability of renewable energy projects.

4.3.5 Stage 5: Maturity and Stability

In this stage, public investment should focus on maintaining and upgrading infrastructure to ensure the long-term stability of the renewable energy system. Ongoing support for innovation and efficiency improvements is also necessary. Long-term investors such as pension funds and insurance companies can provide stable capital for mature renewable energy projects (Taghizadeh-Hesary & Yoshino, 2020). Refinancing options can optimize the capital structure of existing projects. Mature markets for energy trading and balancing services can enhance the stability and efficiency of the renewable energy system. Stable carbon pricing mechanisms can provide consistent incentives for reducing emissions (Lilliestam, Patt, & Bersalli, 2021; Pearse, 2016). Sustainable investment funds and long-term green bonds can finance ongoing improvements and next-generation technologies. Investment in circular economy projects can enhance the sustainability of the energy system (Mutezo & Mulopo, 2021; Yildizbasi, 2021). Comprehensive risk management frameworks and mature insurance markets can provide stability and resilience. Long-term financial instruments can help manage operational risks and ensure continuous investment. Strong regulatory frameworks and ongoing capacity-building programs are essential for maintaining stability. Institutions should focus on continuous improvement and adaptation to evolving technologies and market conditions.

4.3.6 Stage 6: sustainable future

Firstly, long-term public investment in sustainable and resilient infrastructure is essential. Policies that promote continuous innovation and sustainability are vital for the ongoing success of the energy transition. Sustainable investment strategies from institutional investors and private sector involvement in green technologies play a crucial role (Song, Li, & Feng, 2024). Secondly, ongoing private investment in innovation and efficiency improvements can further drive progress. Effective carbon markets and renewable energy certificates can maintain incentives for sustainability (Feng et al., 2021). Thirdly, market mechanisms that encourage continuous improvement and innovation are key. The continuous development of new financing tools for sustainability supports the long-term goals of the energy transition, and investing in projects that incorporate circular economy principles can boost sustainability. Fourthly, comprehensive risk management frameworks and climate risk insurance enhance resilience against future uncertainties. Adaptation finance can aid communities and ecosystems impacted by climate change. Finally, the continuous refinement of policies and frameworks for sustainability is crucial. Lifelong learning and adaptive capacity-building programs can ensure stakeholders remain informed and capable of supporting the energy transition.

In conclusion, the application of diverse financial mechanisms is essential across all stages of the energy transition. Each stage requires tailored financial strategies and support structures to address specific challenges and opportunities. By leveraging the right mix of public and private financing, market-based mechanisms, innovative financial tools, risk mitigation instruments, and institutional support, the global community can accelerate the transition to a sustainable and resilient energy future. Table 2 presents previous articles related to financing mechanisms for energy transition.

5. Discussion

5.1 Current challenges for energy transition

Applying financial mechanisms to the energy transition process presents numerous challenges that complicate the shift towards a sustainable and resilient energy system. One of the primary issues is the high initial capital required for renewable energy projects. Renewable energy sources, such as wind and solar power, often necessitate substantial upfront investments in infrastructure and technology, which can be a significant barrier, especially in developing economies (Do, Burke, Baldwin, & Nguyen, 2020; Painuly & Wohlgemuth, 2021). Traditional financial institutions may be reluctant to provide the necessary funding due to perceived risks and uncertainties associated with new technologies and the long payback periods. To address these challenges, literature suggests developing financial instruments that are more aligned with the risk profiles of renewable projects. For example, blended finance models could combine public and private investments to lower risks for investors (Rode et al., 2019). Successful case studies in Kenya and India, where blended finance reduced perceived risks, demonstrate how this model can be replicated in other regions.

Another critical challenge is the instability and unpredictability of policy environments. Financial mechanisms heavily rely on consistent and supportive governmental policies to thrive. However, frequent policy changes and the lack of long-term regulatory frameworks can deter investment (May & Neuhoff, 2021). For instance, changes in subsidy schemes, tax incentives, or regulatory standards can create uncertainty and diminish investor confidence. Furthermore, the absence of coherent policies across different regions and countries complicates international investment and the scaling of renewable energy projects. Recommendations from existing literature emphasize the importance of establishing stable regulatory frameworks and long-term commitments from governments. Consistent feed-in tariffs and guaranteed contracts for renewable energy can enhance investor confidence (Alolo, Azevedo, & El Kalak, 2020; Azhgaliyeva & Mishra, 2022). For example, in Vietnam, fluctuations in feed-in tariffs for solar projects led to uncertainty, stalling investments. Therefore, stable and long-term policy commitments, such as the guaranteed contracts provided by Germany’s Renewable Energy Act, could serve as a model for ensuring investor confidence.

Market maturity and the availability of reliable data are also significant concerns. In many regions, renewable energy markets are still developing, with insufficient historical data to accurately assess risks and returns (Elie, Granier, & Rigot, 2021). This lack of data makes it challenging for financial institutions to create robust models for investment, insurance, and other financial products. Moreover, the nascent state of many renewable energy markets means that there are fewer precedents and success stories to guide investment decisions. This uncertainty can result in higher perceived risks, which in turn leads to higher costs of capital for renewable energy projects compared to more established fossil fuel projects. Addressing these data gaps through collaborative platforms for sharing information and success stories can foster greater transparency and trust among investors. The success of the Climate Policy Initiative’s Global Innovation Lab for Climate Finance in fostering data-sharing initiatives offers a potential blueprint for overcoming these data challenges and increasing market transparency (Buchner et al., 2019).

The complexity of integrating renewable energy into existing financial structures is another hurdle. Financial mechanisms must adapt to the decentralized nature of renewable energy production, which contrasts with the centralized model of traditional energy systems (Wolsink, 2020). This decentralization requires new approaches to financing, such as community-based funding models, microgrids, and peer-to-peer energy trading (Ajaz & Bernell, 2021). These innovative financial mechanisms are still in their infancy and often lack the regulatory support and market recognition needed for widespread adoption. Additionally, the integration of renewable energy into traditional energy markets necessitates significant upgrades to grid infrastructure, which requires further investment and coordination between various stakeholders.

Social and environmental considerations also play a crucial role in the challenges of applying financial mechanisms to the energy transition. Investors and financial institutions are increasingly expected to consider the environmental, social, and governance (ESG) impacts of their investments. While this focus on sustainability is beneficial in the long term, it adds another layer of complexity to financial decision-making. Ensuring that investments meet ESG criteria requires comprehensive assessment frameworks and ongoing monitoring, which can be resource-intensive. To bridge the gap between financial mechanisms and the on-the-ground needs of communities impacted by the energy transition, more inclusive and participatory approaches to financial planning and decision-making are necessary. Literature suggests involving local stakeholders in the design and implementation of financing mechanisms to ensure they align with community needs and priorities (Croese, Oloko, Simon, & Valencia, 2021).

5.2 Future research directions

The future of applying financial mechanisms to the energy transition requires focused research on developing context-specific solutions that address the unique challenges faced by different regions and economies. A key area of exploration is the development of innovative financial instruments specifically tailored to renewable energy projects. These instruments must account for the diverse financial environments in which they are applied. For example, in developing countries, where access to capital is limited, instruments such as concessional loans and risk-sharing mechanisms could bridge the gap between private capital and high-risk renewable energy ventures (Dalhuijsen, Gutierrez, Kliatskova, Mok, & Regelink, 2023; Gema, 2022). Research should focus on how these instruments can be structured to not only lower risks but also attract a more diverse range of investors, particularly those less familiar with renewable energy sectors.

Another critical area for future research is improving risk assessment and management methodologies for renewable energy projects, especially in volatile markets or those with less-established regulatory frameworks. Developing sophisticated risk assessment tools tailored to the specific technological and market conditions of renewable energy can help make investments more predictable and accessible. In particular, emerging technologies like blockchain and artificial intelligence could play a pivotal role in refining risk models by enhancing transparency and traceability in financing transactions (Rane, Choudhary, & Rane, 2023). Investigating how these digital tools can be adapted to the unique challenges of renewable energy financing will be crucial in reducing perceived risks, especially in high-risk markets.

Additionally, the integration of digital technologies into financial mechanisms represents a promising research avenue. Technologies like blockchain and smart contracts can streamline renewable energy financing by improving transparency, reducing transaction costs, and facilitating peer-to-peer energy trading (Boumaiza, 2024; Khatoon, Verma, Southernwood, Massey, & Corcoran, 2019). In regions like Sub-Saharan Africa, where energy access is still a challenge, blockchain-based financing models could democratize access to energy by enabling microgrids and local energy markets. Research in this area could focus on scaling up these models and identifying the regulatory frameworks needed to support their widespread adoption.

Future research should also explore how policy and regulatory frameworks can be designed to support the deployment of financial mechanisms for renewable energy. Comparative studies of different regulatory approaches could identify best practices that foster investment in renewable energy across diverse contexts. For example, analyzing the success of feed-in tariffs in Europe compared to tax incentives in the United States could provide valuable insights for countries attempting to tailor policies to their specific economic conditions. Additionally, research can assess the impact of international policy coordination, such as cross-border carbon pricing or climate finance initiatives, on the effectiveness of financial mechanisms.

Equity and inclusion are crucial to the success of financial mechanisms in driving a just energy transition. Future research should focus on how these mechanisms impact various demographic groups and regions, particularly in developing economies. For instance, community-based financing models have shown promise in empowering local populations to participate in renewable energy projects (Ebers Broughel & Hampl, 2018; Slee, 2015). However, more research is needed to understand the socio-economic implications of these models and how they can be adapted to meet the needs of marginalized communities. Studying how different financing mechanisms affect local communities, particularly in terms of employment opportunities, energy access, and social well-being, will be essential for ensuring the inclusivity of the energy transition.

Lastly, there is a need for robust sustainability metrics and impact assessment frameworks to measure the long-term effectiveness of financial mechanisms. Standardized metrics for tracking both environmental and social impacts would enable investors to better align their financial decisions with sustainability goals. Research into developing these frameworks could draw on interdisciplinary approaches, combining insights from finance, environmental science, and social policy to ensure comprehensive assessments. For example, studies on the development of metrics such as carbon reduction per dollar invested or social equity indices could provide valuable tools for guiding future investments (Bistline, 2021; Bolognesi, Dreassi, Migliavacca, & Paltrinieri, 2024).

6. Conclusion

In conclusion, this article highlights the critical role that financial mechanisms play in driving a sustainable energy transition. Effectively applying financial tools across each stage of the transition is crucial for achieving a long-term and sustainable transformation of the energy system. The analysis underscores the need for tailored financial instruments, robust risk assessment tools, and supportive policy frameworks to address current challenges and attract broader investment. The integration of digital technologies and the development of innovative models such as green bonds and community-based financing offer promising avenues for enhancing transparency, reducing costs, and increasing accessibility to renewable energy projects. Furthermore, understanding the socio-economic impacts of the transition is essential for ensuring that it is both equitable and inclusive. Future research must continue to explore these areas, fostering interdisciplinary collaboration to build a resilient and sustainable financial ecosystem capable of effectively supporting the global shift towards renewable energy.

Figures

Figure 1

Impacts of energy transition

Figure 2

6 phases of the energy transition process

Figure 3

Procedures followed for identifying target articles in alignment with PRISMA standards

Figure 4

Year-wise distribution of papers

Figure 5

Leading 10 journals on financial mechanisms in energy transition

Figure 6

Framework of financial mechanisms for energy transition

Table 1

Electronic databases used in this research

Index	Database	URL
1	ScienceDirect-Elsevier	https://www.sciencedirect.com/
2	SpringerLink	https://link.springer.com/
3	Scopus	https://www.scopus.com/

Source(s): Table by authors

Table 2

Previous studies related to financing mechanisms for energy transition

Public financing mechanisms
Government grants and subsidies	Christophers (2022), Dhakouani et al. (2020), Neuman (2022), Yang et al. (2019)
Tax incentives	Cansino, Pablo-Romero, Román, and Yñiguez (2010), Colasante, D'Adamo, and Morone (2022), Mao and Wang (2016), Qadir et al. (2021), Shafi et al. (2023),
Public-private partnerships	Fleta-Asín and Muñoz (2021), Khan, Ali, Kirikkaleli, Wahab, and Jiao (2020), Opara, Elloumi, Okafor, and Warsame (2017), Pinilla-De La Cruz et al. (2022)
Private financing mechanisms
Equity financing	Jolink and Niesten (2021), Mormann (2019), Rezec and Scholtens (2017), Wu (2024)
Debt financing	De Marco and Mangano (2017), Tang, Qi, and Zhou (2023), Zawadzka, Strzelecka, and Szafraniec-Siluta (2021)
Green bonds	Alsmadi et al. (2023), Azhgaliyeva, Kapoor, and Liu (2020), Ye and Rasoulinezhad (2023), Zhang and Umair (2023), Zhao et al. (2022)
Market-based mechanisms
Carbon Pricing	Bartolini, Mazzoni, Comodi, and Romagnoli (2021), Lilliestam et al. (2021), Pearse (2016), Tan, Wang, Wei, and Taghizadeh-Hesary (2023), Trinks, Mulder, and Scholtens (2022)
Renewable energy certificates	Hulshof, Jepma, and Mulder (2019), Shrimali and Tirumalachetty (2013), Wang, Zhang, Li, McLellan, and Pan (2019), Zhu, Chen, Song, Li, and Shen (2022)
Feed-in tariffs	Eyre (2013), Poponi, Basosi, and Kurdgelashvili (2021), Poruschi, Ambrey, and Smart (2018), Pyrgou, Kylili, and Fokaides (2016), Tanaka, Wilson, and Managi (2022)
Innovative financing mechanisms
Crowdfunding	Appiah-Otoo, Song, Acheampong, and Yao (2022) Dilger, Jovanović, and Voigt (2017), Halden, Cali, Dynge, Stekli, and Bai (2021), Lam and Law (2016), Vasileiadou, Huijben, and Raven (2016)
Energy service companies	Kostka and Shin (2013), Nurcahyanto et al. (2020), Zheng, Lam, Hsu, and Ren (2018)
Blockchain-based financing	Ahl, Yarime, Tanaka, and Sagawa (2019), Gurrib (2019), Pop et al. (2018), Tsao and Thanh (2021)
Risk mitigation instruments
Insurance products	Bhatnagar, Özdemir, and Pathak (2023), Liao, Chang, and Cheng (2022)

Source(s): Table by authors