Institutional Governance Quality as a Determinant of Energy Investments: Evidence from a Panel of 17 EU Countries

Abstract

The European energy transition requires the mobilisation of capital flows estimated at more than €1 trillion annually, highlighting the importance of institutional governance quality in attracting and sustaining energy investments. The ability of states to provide credible regulatory frameworks, governance effectiveness, and institutional stability has become relevant for financing energy infrastructure and supporting long-term investment decisions. Underscoring the institutional theory, this study investigates the relationship between institutional governance quality and energy sector investments for a balanced panel of 17 EU member-states over the 2010-2023 period. The analysis employs gross fixed capital formation in the energy sector (Energy GFCF) as the primary dependent variable, complemented by net foreign direct investment inflows (Net FDI). Institutional governance quality is measured using the Worldwide Governance Indicators (WGI) and an original OECD Composite Convergence Index (OCCI). The empirical analysis relies on two-way fixed effects and random effects panel models with country-clustered robust standard errors. The findings indicate that institutional governance quality is associated primarily with structural differences in energy investments across economies rather than with short-term annual variations within countries. While fixed effects estimations do not identify significant annual governance effects across EU countries, random effects models reveal a positive and significant structural relationship between governance quality and energy investments. Government effectiveness exerts a positive association on energy investment dynamics, suggesting that predictable and credible regulatory environments play an important role in energy capital allocation. Particular results are underscored for Central and Eastern European economies characterised by significant infrastructure needs and persistent institutional gaps. For Romania and Bulgaria, in process of joining OECD, institutional convergence is positively associated with both Energy GFCF and FDI inflows, suggesting that OECD accession reforms may function as a signalling mechanism for institutional investors. Overall, findings highlight the importance of institutional convergence for mobilising the investments required to support the European energy transition.