Transition risks and sovereign debt costs: a premium on fossil resources?

This paper examines the impact of low-carbon transition risks on sovereign borrowing costs. Using two unbalanced panel datasets covering 125 countries from 1995 to 2019, we estimate extended models of the macroeconomic determinants of short- and long-term sovereign debt costs. We include key indicators capturing exposure to transition risks, such as fossil resource abundance, the carbon intensity of GDP, and the share of renewable energy in total energy consumption. Results show that fossil resource abundance and a higher renewable energy share are associated with lower borrowing costs, whereas greater carbon intensity raises sovereign debt costs. Financial markets therefore appear to reward fossil resource endowments while penalizing carbon-intensive uses of these resources. This reveals a contradictory signal: fossil resource wealth lowers the cost of public borrowing, as it is perceived as a form of implicit collateral, while the actual use of these resources increases borrowing costs, reflecting a carbon risk premium.