Assessing the Determinants of Renewable Energy Investments in Nigeria Energy Sector: A VECM Approach

Abstract Nigeria's energy sector remains heavily reliant on fossil fuels, a dependency that perpetuates environmental degradation, economic instability, and energy insecurity despite the country's vast renewable energy potential. This imbalance is influenced by macroeconomic challenges, such as fluctuating exchange rates, high inflation, and prohibitive interest rates, alongside insufficient policy frameworks and a lack of affordable financing mechanisms. As the largest economy in Africa, Nigeria's inability to attract significant investment in renewable energy hinders progress toward achieving energy diversification, and addressing critical energy access challenges for its growing population. The window to transit to cleaner energy sources holds a great future for our developing economy (Oyegbile et al., 2024). This study assesses the determinants of investment in Nigeria's renewable energy sector using a Vector Error Correction Model (VECM) framework, analyzing short- and long-term dynamics between key indicators such as Gross Domestic Product (GDP), inflation rate, foreign direct investment (FDI), exchange rate, interest rate, energy consumption patterns, electricity access rate, and renewable energy policies. The research employs time-series data from 1990 to 2022, sourced from reputable institutions including the World Bank, International Energy Agency (IEA), and the Central Bank of Nigeria (CBN). Augmented Dickey- Fuller(ADF) stationarity tests confirm the properties of the data, while the Johansen Cointegration Test establishes long-term equilibrium relationships. The VECM framework is supplemented with impulse response functions (IRFs) and variance decomposition analysis (VDA) to uncover dynamic interactions among the variables. The findings revealed that GDP growth (+1.31, p < 0.01) significantly drives renewable energy investment, while unfavorable exchange rates (−0.49, p < 0.05) and high-interest rates (−0.58, p < 0.05) hinder progress. Renewable energy policies emerge as critical enablers, while inflation (−0.35, p < 0.05) exerts a dampening effect. Impulse response analysis reveals that a 1% positive shock in FDI inflows results in a 0.91% increase in renewable energy investments over five years, with variance decomposition attributing 47% of forecast errors in investment trends to GDP shocks and to policy changes. These findings thereby underscore the urgency for stable macroeconomic policies, targeted financial incentives, and robust policy frameworks to drive investment in Nigeria's renewable energy sector while also providing critical insights into the pathways for transitioning Nigeria toward a sustainable energy future, addressing key economic, social, and environmental challenges while contributing to the global discourse on energy economics and investment strategies.