Are energy transition efforts decoupling?

The world is on the cusp of a new industrial revolution that will be powered by greener, renewable energy sources. Yet, as with previous industrial revolutions, change does not follow a linear pathway.

An energy crisis – triggered by the ongoing aftershocks of the pandemic, Russia’s war in Ukraine and unexpected climate events – is wreaking havoc with energy transition plans. In order to deal with the crisis, nations are turning to polluting fossil fuel sources as a quick fix to fill the energy gap.

While this turn of events is undoubtedly a backwards step for the decarbonisation agenda, are there also reasons to be positive?

All hands on deck approach
The energy supply crunch is being driven by numerous factors. While the outbreak of war in Ukraine, and the resulting efforts by governments to diversify their fuel imports away from Russia, is the primary source of the crisis, other factors are playing a part.

Notably, a summer of major heatwaves neatly illustrated how climate change can exacerbate energy supply problems. Excess levels of sunshine may have boosted solar energy production, but it also forced many people to turn on the air conditioning and use far more power than usual. Low water levels resulted in a huge shortfall of hydroelectric power and the water needed to cool nuclear reactors; while a wind drought limited the output from wind farms.

The scale of the crisis demanded an immediate response from governments and necessitated the greater use of all energy sources – including fossil fuels – to meet energy needs this coming winter. But such an all hands on deck approach does not equate to a capitulation in the climate fight – in fact there’s good reason to suggest it may actually accelerate the transition to clean energy sources in the medium term.

Crisis is powering the energy transition

Firstly, the crisis has forced everyone – even climate sceptics – to acknowledge that the need for diversified energy sources is more acute than ever. Even if the conflict in Ukraine was resolved tomorrow, the strategic implications of a nation being beholden to another for energy are now better understood and has prompted more countries to seek energy independence. This desire for a secure energy future clearly points towards renewables.

Secondly, it has forced nations, businesses and individual households to think about how they use and consume energy. The energy transition is not just about cleaner sources of energy, greater energy efficiency and lowering overall consumption are also vital to achieving decarbonisation goals.

Finally, the connection between climate change, energy security and inflation has become increasingly apparent. While the price of fossil fuels is moving ever higher, the sun and wind are free (once the relevant infrastructure is in place) and greater scale is bringing these upfront costs down quickly.

Yet, while the direction of travel towards clean energy is clear, the regions leading this journey are becoming increasingly disconnected in their transition journeys.

Europe’s backwards step
Europe has been one of the leaders in the fight against climate change. The EU’s Fit for 55 plan aims to reduce reliance on fossil fuels, expand its use of renewable energy sources, accelerate the development of electric cars and spur clean-energy options for aviation and shipping.

However, given its historic dependence on Russia for fuel supply, it has been forced to adopt emergency measures to ensure forthcoming energy needs are met, especially this winter. This has resulted in a new shorter-term strategy – RePowerEU – which details how Europe can reduce and ultimately end its reliance on Russian fossil fuel through three pillars:

  • energy conservation.
  • diversifying supplies.
  • accelerating its clean energy transition.

While this plan has a significant renewables component, it also commits to building new liquefied natural gas infrastructure. In fact, analysis suggests European governments will spend EUR 50 billion this winter on fossil fuel infrastructure and supplies, more than four times the EUR 12 billion earmarked in RePowerEU1.

While such measures are characterised as stop-gaps, they do raise concerns that such significant investment in new fossil fuel infrastructure will warrant longer-term usage.

US: taking the lead
In contrast, the new US Inflation Reduction Act is expected to supercharge its energy transition.

Billed as the most important piece of climate legislation in US history, the USD 369 billion package aims to help boost clean energy supplies; decarbonise agriculture and industry; increase investment in new green technologies; increase investment in energy efficiency; and help lower-income communities adapt to climate change. Initial analysis suggests that the measures would reduce net greenhouse gas (GHG) emissions by 31%-44% on 2005 levels by 20302 – a significant improvement on the previous policy.

This new legislation and accompanying tax incentives aim to encourage more green infrastructure to be made in or sourced from America, which could lead to more manufacturing facilities being set up in the US as well as a greater roll out of clean energy products. It also underscores the wider trend towards onshoring that was initiated when Covid disrupted supply chains and has been amplified by fears that relying on a foreign state can impact trade flows – as Russia has shown by suspending gas supplies through its Nord Stream 1 pipeline.

The US Inflation Reduction Act is rightly being seen as a game changer. Not only is it well-timed in terms of the world’s current energy security concerns, but with COP27 taking place later this year it has restored the US as a credible partner for the climate change agenda which should have a positive effect on global action.

China’s raised ambitions
China has been beset by its own energy challenges.

While relatively shielded from the Russian-related supply issues – it has actually taken advantage of discounted Russian fuel prices to become one of Russia’s top oil purchasers3 – extreme weather during the summer impacted its own energy security. Hydropower levels were down in the water-stressed southwest region, which resulted in more coal being burned for power generation as well as factories shuttering4.

Furthermore, China has suspended its collaboration with the US on global warming announced just last year at the COP26 event.

That said, China appears ready to continue with its decarbonisation commitments. The 14th Five-year Plan approved last March contains ambitious goals to reduce carbon emissions: peak carbon is expected by 2030 and carbon neutrality (or net zero emissions) by 2060.

This this is a tall order given its carbon emissions are expected to peak at a much higher level than in the US and carbon neutrality is due only 30 years after the peak, which is a much shorter timeframe than that of Europe and the US. However, investment in key technologies, including renewables, electric vehicles and charging stations, energy storage and green projects, have been strong. And China has recently raised its ambition of generating 33% of power from renewable sources by 2025, up from 28.8% in 20205.

Investors can dictate the decarbonisation agenda
The energy transition is at a critical juncture. In the short term, there’s been an unfortunate, but necessary boost for coal, gas and nuclear given the scope of the energy crisis. Yet in the medium term, the crisis has increased recognition of the need for renewable energy.

Perhaps more worrying for net zero aims is that the world’s major powers are decoupling in their climate fighting efforts. The upcoming COP27 may be a time to reunite these efforts, but investors also can play a key role in helping progress the decarbonisation agenda by seeking out climate positive investment strategies.

At BNP Paribas Asset Management, our Environmental Strategies Group believes it is vital to consider the past as well as the present when evaluating the long-term investment opportunities of the future. Ending the world’s reliance on fossil fuels is key to the next industrial revolution. Renewable energy will boost economic growth, in the same way that petroleum’s replacement of whale oil in the 19th century accelerated growth. Using an expert and holistic historical lens that reflects both the past and the future helps us to identify the businesses that could prove to be the long-term winners.

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