24 Oct 2022
24 October 2022, Energy transitions are complicated, expensive, and geopolitically disruptive in the short to medium term – even when the long-term goal is a global energy system that is simpler, cheaper, and less vulnerable to geopolitics. While there is a tendency to fixate on the European energy crisis, we must remember that this is “Africa’s COP” and that according to the central United Nations Framework on Climate Change (UNFCC) principle of Common But Differentiated Responsibilities (CBDR), this is a universal problem which needs a holistic and fair solution.
That said, let’s start with Europe. Energy markets were upended by the Russian invasion of Ukraine in February and the subsequent disruptions to energy supply from the region. The concerted move away from Russian oil and gas (Russia previously supplied 40% of Europe’s natural gas and 10% of global oil) represents the largest structural shift in global energy markets for decades. Europe has subsequently become the pre-eminent buyer of Liquefied Natural Gas (LNG) cargoes on the global spot market, dramatically driving up gas prices. This has resulted in increased consumption of coal, not just in Europe, but also in Asia, where coal is now more economically attractive than expensive imported gas in several key consuming countries.
The invasion and ongoing conflict on Europe’s border has also severely impacted the financing of the energy transition. Rising inflation and increased defence spending in Europe have created a fiscal and budgetary environment in which accelerated investment in renewable energy infrastructure is politically difficult. Food prices and rising heating costs heading into winter, combined with escalating interest rates and some chaotic political decision-making in the UK, have led to a febrile socio-economic climate in which politicians, central banks and regulators are treading a very high wire.
Consumers recognise the environmental imperative to reduce emissions and stay within clearly defined global temperature parameters but in the near-term this has been overtaken by the cost of living and the harsh economic realities that many are facing. Nevertheless, the ambition of both REPowerEU in Europe and the Inflation Reduction Act in the US are laudable.
Of course, the irony here is that the events of 2022 have made renewable energy a more attractive proposition than ever. The levelised-cost-of-energy economics of solar and wind, when compared to hydrocarbons are significantly improved following the spike in oil, natural gas, and coal prices. The move towards renewable energy globally needs to accelerate; countries responsible for well over 70% of global carbon emissions have now set Net Zero targets and there is a much clearer understanding of both the urgency and the enormous capital requirements, supported by the updated IPCC report from earlier this year, as well as the work of the International Energy Agency.
Looking at the second pillar of the energy trilemma (economics of supply, security of supply and environmental impact of supply), the events in Ukraine and the response to them have laid bare the historic dependence of the global energy system on geopolitically unstable regions. There is every reason to expect that as the energy transition accelerates and renewable energy displaces fossil fuels so the security of supply problem will diminish. Stepping back from the market volatility and the blizzard of headlines, as we try to understand the implications of the Ukraine crisis on the energy transition, it increasingly becomes a question of time horizon – bad news for the foreseeable future, but very supportive of the transition looking further out.
Looking more specifically to COP27 in Egypt, we expect to see a continuation of many of the prevalent themes from Glasgow. Emerging markets and heavy-emitting sectors are likely to be at the centre of many of the discussions; that is where the emissions problem sits and this needs to be tackled head on. We expect to see more debate around Transition Finance and broader exploration of how governments, regulators and investors should think about the five areas of economic activity (power, mobility, buildings, industry, and agriculture) which are currently responsible for 90% of global emissions. Many of the current taxonomies and investor frameworks which have been developed since COP21 in Paris in 2015 have steered capital away from these areas but this is not going to solve the problem – if anything it will compound it.
In the context of energy systems and supply, we also expect to hear more at COP27 about the role that natural gas can play across the African continent. After Nigeria and Algeria, Egypt is the third-largest natural gas producer in Africa – and the events of 2022 have shone a bright light on the role that natural gas ex-Russia needs to play.
There is no established playbook for the collision of an energy transition with a commodity or energy supply shock, which explains some of the extraordinary price action and volatility we have witnessed in the market since February. But amid the hiatus, we can be very clear that the climate emergency and the imperative to move away from Russian energy supply will force policymakers, regulators and ultimately consumers to focus their efforts on expediting the energy transition, even if we are living through an inescapable near-term setback.
COP27 should bring fresh impetus and focus to these endeavours.