Understanding the Impact of the EU Taxonomy on the Energy Sector

Written by Ike Okafor - Editor: Anastasia Eginoglou

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Introduction‍

The summer of 2023 saw record-breaking heat waves across the globe, with temperatures soaring to unprecedented levels. From wildfires raging in North America to devastating floods in Asia, the impacts of climate change are becoming increasingly evident. These extreme weather events remind us of the urgent need to do more to transition to a more sustainable world. However, the amount of investment needed to achieve climate neutrality is staggering: The European Commission estimates that achieving the current 2030 climate and energy targets will require €390 billion of additional annual investment. More importantly, it is critical that these investments genuinely support sustainable activities and not simply perpetuate "greenwashing"—the practice of misleadingly marketing products or services as environmentally friendly. This is where the EU Taxonomy comes in.  

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What is the EU Taxonomy?

The EU Taxonomy is essentially a rulebook for defining which economic activities can be considered environmentally sustainable. Within the framework of the European Green Deal and the EU’s Sustainable Finance Action Plan, the EU introduced several measures to improve transparency in how sustainability criteria are used in investment decisions. Key among these are the Corporate Sustainability Reporting Directive (CSRD), the Sustainable Finance Disclosure Regulation (SFDR), and the EU Taxonomy for Sustainable Activities (EUT). 

The EUT is designed to steer private investment towards activities that contribute to achieving the EU’s ambitious climate and environmental targets. It serves as a common language and, thus a reliable framework for investors to assess the environmental performance of their investments. Central to the EUT are the six environmental objectives represented here:

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For an economic activity to be considered environmentally sustainable under the Taxonomy, it must meet three key criteria described in the diagram below:

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To determine whether an activity meets these conditions, the EU has developed detailed technical screening criteria (TSC), with specific thresholds and requirements set for different economic activities. They provide concrete metrics for assessing whether an activity substantially contributes to an environmental objective and does no significant harm to others. These criteria are regularly updated based on the latest scientific evidence and technological advancements. The TSC addresses 13 key economic areas, such as Agriculture and forestry, Manufacturing, Energy, Transport and Construction & real estate, among others. 

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The Impact on the Energy Sector

According to recent data, the energy sector is responsible for the majority of greenhouse gas emissions, contributing around 77% of total GHG emissions in the EU. Given this significant percentage, the energy sector is naturally an important focus of the EU Taxonomy. Therefore, to accelerate the energy transition, The EUT creates a framework to mobilize and direct investments toward energy-sector activities that support climate change mitigation and other environmental objectives. Specifically, here are some key ways the EU Taxonomy impacts the energy sector:

  • Fossil Fuel Phase-Out: The EU Taxonomy generally discourages investments in fossil fuel-based energy generation. It sets strict criteria for any fossil fuel activities that can be considered transitional, such as natural gas, and focuses on emissions thresholds as a limiting factor to ensure they contribute to a pathway towards climate neutrality. These criteria include for example, that the gas plants must replace existing coal plants, there must be a national coal phase-out plan, and the new plant cannot exceed the replaced facility's capacity by more than 15%. To generate electricity or heat also, the plant must obtain a permit before 2031. It also needs to significantly cut emissions by at least 55% and comply with strict emission limits of either 270g CO2e/kWh or an annual limit of 550kgCO2e/kW over 20 years. These criteria are strict, and so because it is expected that only a small number of gas projects will qualify for investments. This is a way of incentivizing investments to kickstart a gradual shift away from fossil fuels towards renewable energy sources. 
  • Renewable Energy: The EUT considers activities in the renewable energy sector to be a key component of sustainable activities. Therefore, it prioritizes investments in renewable energy sources like solar, wind, and hydropower as a primary focus to achieve climate neutrality. The idea is to direct greater capital flows toward renewable energy projects as a way to speed up the transition away from fossil fuels. Projects aligned with the Taxonomy may, therefore get higher priority from lenders and also benefit from lower financing costs (e.g., lower interest rates on loans, better terms for green bonds) as they are perceived as less risky from an environmental perspective.
    The EUT sets a threshold of 100 grams of CO2/kWh for various renewable technologies which contribute to reducing emissions and do not cause significant harm to other environmental objectives. Take the hydropower plants, for instance; it is to ensure they do not negatively impact river ecosystems or biodiversity. It is also on this basis that solar energy is considered taxonomy-compliant because its lifecycle emissions are very low, typically in the range of 20 to 50 grams of CO2/kWh.
  • Natural Gas and Nuclear Power: The inclusion of natural gas within the taxonomy has been a contentious topic. Electricity and heat generation from natural gas was not initially included because natural gas is a fossil fuel. However, many consider natural gas as a bridging fuel with lower emissions in comparison with coal and oil. Thus, certain stakeholder groups demanded its inclusion since it significantly supports the transition to a more sustainable energy supply. It was then included but with new conditions (see note on fossil fuel phase-out). Nevertheless, another stakeholder group opines that the inclusion of fossil gas in the EUT risks delaying the phase-out of fossil fuels by legitimizing new investments in gas infrastructure. 

Nuclear power is also a much-discussed activity. On the one hand, nuclear power represents a low-emission form of electricity generation and thus potentially supports the goal of climate protection. On the other hand, electricity generation from nuclear power violates the DNSH criterion. This is due, for example, to the negative environmental impact of uranium mining and the storage of the resulting nuclear waste. It has only been recently included with new criteria such as compliance with certain existing European regulations on nuclear energy.

  • Energy Efficiency: Improving energy efficiency is another key area targeted by the EUT. It sets criteria for activities that reduce energy consumption in buildings, industry, and transportation in order to encourage investments in building renovations, energy-efficient appliances, and industrial processes. This way, the Taxonomy helps to reduce overall energy demand, thereby decreasing heavy reliance on fossil fuels.

One major condition set for the construction sector is that new constructions must have a Primary Energy Demand (PED) at least 10% lower than the threshold set for nearly zero-energy buildings (NZEB). For buildings larger than 5000 m², additional requirements include testing for air-tightness and thermal integrity and the disclosure of the building's life-cycle global warming potential (GWP)

  • Impact on Utility Companies: Energy utilities are required to assess whether their activities, such as electricity generation, transmission, and distribution, align with the technical screening criteria defined by the Taxonomy. They are required to disclose the proportion of their activities that are taxonomy-eligible and taxonomy-aligned and must report on 3 key performance indicators (KPIs): the share of taxonomy-aligned activities contributing to turnover, capital expenditures and operating expenditures 

Cauthorn et al. (2023) demonstrated that investments in renewable energy portfolios that aligned with the EU Taxonomy tend to perform better than those focused on conventional energy portfolios. This suggests that as investors prioritize environmentally sustainable investments, companies demonstrating compliance with the Taxonomy may become more attractive and receive greater investment.

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Conclusion

To achieve the EU's climate targets and ultimately mitigate the escalating consequences of climate change, relying on government finances alone can never be enough. The EUT provides the necessary framework to mobilize significant private investments in genuinely sustainable projects and prevent greenwashing. It will likely become an increasingly influential force shaping the energy landscape in the coming years. Further refinements and expansions of the criteria are anticipated as technology evolves and scientific understanding of environmental impacts deepens. This will likely lead to even stricter requirements and greater emphasis on emerging sustainable technologies. The stakes are undeniably high, as the energy transition is a fundamental imperative for the preservation of the earth and the well-being of future generations. Failure to invest adequately towards sustainable activities may lock the world into a high-carbon pathway, worsen the climate crisis and lead to irreversible environmental damage. Therefore, all stakeholders must ensure that the aims of the EUT are achieved.

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References

7 key points about the EU Taxonomy’s 100g emissions threshold; Briefing On The Eu Technical Expert Group’s Recommendation For The Eu Taxonomy Electricity Generation Threshold. (n.d.). Climate Bonds Initiative. https://ecostandard.org/wp-content/uploads/2021/12/EUTaxonomy_100g_7points.pdf

A User Guide to Navigate the EU Taxonomy for Sustainable Activities. (Jun, 2023). EU publications office. https://ec.europa.eu/sustainable-finance-taxonomy/assets/documents/Taxonomy%20User%20Guide.pdf

Cauthorn, T. et al. (Dec 2023). Portfolio benefits of taxonomy-orientated and renewable European electric utilities. Journal of Asset Management, 24, 558–571. https://doi.org/10.1057/s41260-023-00325-0

Commission Delegated Regulation (EU) 2022/1214. (Mar 2022). Regulations. Official Journal of the European Union. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32022R1214

Commission Notice on the interpretation and implementation of certain legal provisions of the EU Taxonomy Climate Delegated Act establishing technical screening criteria for economic activities that contribute substantially to climate change mitigation or climate change adaptation and do no significant harm to other environmental objective to other environmental objective. (Oct 2023). Office Journal of the European Union. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ:C_202300267

EU Taxonomy fossil gas criteria: not exactly a free pass for gas. (Oct 2022). Climate Bonds Initiative. https://www.climatebonds.net/2022/10/eu-taxonomy-fossil-gas-criteria-not-exactly-free-pass-gas

EU Taxonomy. (Jun, 2019). EU Technical Expert Group on Sustainable Finance. https://finance.ec.europa.eu/system/files/2019-06/finance-events-190624-presentation-taxonomy_en.pdf

Jan Niewold. (Oct, 2023). Why organizations should stay the course with their EU taxonomy reporting. Ey Insights. https://www.ey.com/en_ps/insights/assurance/eu-taxonomy-report .

Neitz-Regett A., Wohlschlanger D., & Westphal P. (Jan, 2024). Info: What is the EU Taxonomy for Sustainable Activities? (Jan, 2024). FFE Publications. ttps://ffe.de/en/publications/info-what-is-the-eu-taxonomy-for-sustainable-activities

Speeding up European climate action towards a green, fair and prosperous future. (Nov, 2021). EU Climate Action Progress Report. https://climate.ec.europa.eu/system/files/2021-11/policy_strategies_progress_com_2021_960_en.pdf

Summer 2023: the hottest on record. (Sep, 2023). Copernicus Climate Bulletin. http://climate.copernicus.eu/summer-2023-hottest-record#:~:text=The%20June%2DJuly%2DAugust%20(,warmest%20for%20the%20summer%20season

Sustainability Reporting. (n.d.). European Securities and Markets Authority, ESMA. https://www.esma.europa.eu/esmas-activities/sustainable-finance/sustainability-reporting

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Further Reading

Bjoern, S. et al. (2024). EU Taxonomy Reporting 2024 – Analysis of the financial and non-financial sector. PricewaterhouseCoopers GmbH. https://www.pwc.lu/en/sustainability-and-climate-change/docs/eu-taxonomy-reporting-2024.pdf

Menges, A. (2021). Impact of EU climate taxonomy on the energy market. TaylorWessing Insights. https://www.taylorwessing.com/en/insights-and-events/insights/2021/09/auswirkungen-der-eu-klimataxonomie-auf-den-energiemarkt

Reith, L., Schmidt M., & Warth, R. (2021). EU sustainable finance taxonomy case study Application, experience and recommendations. https://www.enbw.com/media/bericht/bericht_2020/downloads/broschuere_eu_taxonomie.pdf.

Tonnarello, F. et al. (2025). The Impact of EU Taxonomy for Sustainable Activities on European Utilities' Performance. Business Strategy and the Environment 34, no. 3: 2848–2862. https://doi.org/10.1002/bse.4128

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