The energy transition has barely begun, and its ultimate destination is today unknowable. But several authoritative reports* released recently by the likes of BP, DNV GL and Morgan Stanley offer insights into the forces driving the overall direction of travel. Long-term forecasts and scenario modelling do not lend themselves to concrete conclusions—rather, they tend to offer semi-speculative perspectives into how things might pan out under various contrived circumstances and assumptions. This article seeks to synthesise a few of the core narratives, with added context and discussion.

It is hard to overstate the sheer complexity of the energy transition, the myriad factors at play, how they interact, and the scope for major exogenous wild cards to derail even the most robust predictions. Think macroeconomics, deglobalisation, trade wars, demographics, (geo)politics and climate policy, all of which are evolving during a pandemic. And then there is the fallout from climate change itself.

The world will probably see multiple misaligned transitions occurring simultaneously across different regions and at different velocities over the coming decades. Each country will take its own path, depending on its specific set of circumstances. Change will bring threats and opportunities; spotting these early will require local expertise and insight, and a lot of lateral thinking.

The energy transition means very different things to people in Bangladesh or Indonesia compared to those in Canada or Sweden. Coal-dependent Asian economies account for the vast majority of growth in global energy demand that is projected to manifest over the next three decades. As young Asian populations mature and seek to improve their living standards, they will demand more (and better) access to energy. By contrast, the ageing populations of post-industrial advanced economies will demand ever-cleaner solutions, as the volume of energy they consume crumbles in the face of greater efficiency and digitalisation of everything.

The transition will be unjust; the entire continent of Africa will be largely left behind. BP sees around a quarter of the world’s population living in Africa in 2050, yet the continent will account for less than 10% of total energy demand by then. This happens regardless of how close the world comes to achieving ‘net zero’ emissions by mid-century.

Resource nationalism and the wider phenomena of populism and deglobalisation, all accelerated by Covid-19, are pushing energy security concerns up the domestic agenda of import-reliant countries. Against this backdrop, carbon-heavy domestic resources such as coal could be prioritised over cleaner alternatives from abroad (i.e. biomass, natural gas), particularly if imports attract a geopolitical risk premium.

Conversely, import-reliant countries blessed with strong wind or solar resources could seek to harness these with renewed vigour for the same reason. This could finally vanquish the perception that renewables undermine energy security, particularly as energy storage technologies advance down the cost curve.

Meanwhile, the shift to cleaner energy carriers—electricity and hydrogen—will fragment energy markets. Electrons and H2 molecules are more difficult and expensive to ship over long distances, meaning localised hubs will emerge, denting global trade of fuels. Yet simultaneously, one of the strongest-growing energy supply segments is expected to be liquefied natural gas (LNG), which is rapidly commoditising the global trade of fossil-based methane.

How these competing market forces play out will be a function of price and regulation. European markets will be the first to curb gas consumption in any scenario, but their embrace of hydrogen and electrification will both diminish and heighten reliance on natural gas. Imported gas and LNG could provide feedstock for European hydrogen production, or it could be restricted if the EU sets tough methane and carbon emissions standards, as examined previously in Energy Flux.

Image: A still frame from a simulation showing the chaotic motion of a pendulum under the influence of gravity and three magnets © Ingo Berg, www.BeltofOrion.de

An energy glut

Another emerging megatrend: the world is entering a period of unparalleled energy abundance and diversity, characterised by heightened competition for market share both between fuel types (e.g. coal versus gas, or gas versus renewables) and between producers within each fuel segment. With the exception of coal, the global supply capacity of all primary energy sources is forecast to continue growing (or at least remain steady) out to the mid-2030s, the moment when some aggressive climate scenarios see global demand for energy plateauing.

The net effect of rising global energy supplies against a flat demand profile is over-capacity. The Covid-19 hit to energy demand provided a dress rehearsal for what a climate-induced ramp-down might look like. Over-capacity in refining and in the upstream is already shifting market power from producers to consumers.

Supply-side competition can only intensify as resource-rich countries race to monetise untapped hydrocarbons, spurred on by the narrowing window of opportunity to sell carbon-intensive energy products into decarbonising end-user markets. Prices will be structurally weak and spikes muted by the number of available suppliers ready to undercut each other.

Managed decline

So energy supply must reduce, starting with the most carbon-intensive fuels. But how? Today’s energy industry has no experience of transitioning away from any particular global energy source. Previous energy transitions have in reality been energy additions: the shift from coal to oil as the world’s dominant primary energy source came decades before global coal demand peaked in 2013. Coal consumption last year was just 2.5% below its all-time high, according to Morgan Stanley.

Climate change and market pressures are therefore driving the energy industry into an entirely new chapter: selective managed decline. Peak demand for coal, oil and (lastly) gas, whenever they occur, will require these segments to be slowly decommissioned. Yet private and public investment continues to flow into maintaining or expanding supply capacity of all fossil fuel sources. Since peak demand is open to conjecture, climate risks are open to interpretation. It is not clear how much weighting is being given to stranded asset risk; investment committees rarely disclose this.

Oil and gas investment risks were thrust into the spotlight in the first half of the year when energy companies wrote down the carrying value of operational assets to the tune of hundreds of billions of dollars. These impairments were ostensibly triggered by the pandemic-induced hit to near-term global energy demand, although there is a cynical view that Covid-19 provided convenient cover to unload bad news that had been years in the making.

Either way, while the blood-letting did hammer oil and gas capital expenditure, it did not altogether halt investments in hydrocarbons projects prone to climate risks. Combine this with legacy assets that have still not accounted fully for climate exposure in net present value calculations, and it seems hard to conclude that the energy sector is not priming itself for another wave of painful asset revaluations early next decade—or maybe sooner.

Image: A two-dimensional cross-section of a 6-D mathematical manifold known in string theory as the Calabi-Yau quantic © Andrew J. Hanson

Endemic short-termism

A rapid and profound shift in investment away from fossil fuels and into renewables and other low carbon energy solutions would defuse some of that risk. But this is not happening anywhere near fast enough to avoid locking in catastrophic feedback loops of planet-heating emissions. Climate change and extreme weather events will render inhospitable entire regions below the Tropic of Cancer, so some of those booming emerging Asian economies that oil and gas companies are banking on selling into in the 2030s might not materialise.

BP is rather coy on this topic. The British oil major does not foresee the fallout from climate change eroding wealth and prosperity under a ‘business as usual’ energy transition scenario until post-2050. This is not encouraging when contemplating that humans are hard-wired to act according to short-term interests, but provides succour to anyone with a bullish view on oil demand.

The trouble for industry is that the net economic costs to society as a whole are much greater in a BP scenario where decarbonisation is delayed and then rushed in a chaotic manner to make up for lost time. Among other things, this would lead to the premature scrapping of productive assets, BP warns. This implies that investors in fossil energy assets should be concerned, rather than encouraged, by today’s lack of definitive climate action. It could come back to bite them before yesterday’s investments pay off.

Of course, investment returns are not the only thing at stake. Humanity as a whole stands to lose everything from runaway climate change. DNV GL’s forecast implies that a world devastated by wildfires, coastal flooding, droughts and hurricanes is likely this century.

The world will exceed its Paris-aligned ‘carbon budget’—the amount of CO2 that can be burned within any given temperature rise scenario—long before net zero emissions is achieved. The carbon budget required to keep global warming at 1.5 degrees Celsius above pre-industrial levels will be blown in 2028, and that of 2 degrees will be exceeded in 2051.

This puts the world on track for a 2.3 degrees temperature rise by the year 2100, “a level considered dangerous by the world’s scientific community” with “very high risks of severe impacts”, DNV GL said.

Image: A two-dimensional cross-section of the Calabi-Yau three-fold quantic © Wikimedia Commons

While hard conclusions are in short supply, one thing is a given: turmoil. Oil traders and international oil companies (IOCs) with sophisticated trading operations thrive on volatility by leveraging fleeting arbitrage opportunities that pure-play suppliers cannot access. Energy traders are already delivering counter-cyclical returns during the downturn. BP last week revealed its trading operation boosts its returns by around 2%, or USD 2.5 billion, every year. This has helped offset steep declines in revenue in other parts of the business, particularly in the upstream and refining segments.

This is palliative for integrated IOCs, but of less help for companies with most or all of their business activities concentrated in one part of the energy value chain. As competition squeezes margins, independent energy producers and suppliers will come under increasing pressure to consolidate.

In summary, the energy transition is full of contradictions. The pace of system change is both accelerating beyond expectations and falling way short of what is needed to avert climate meltdown. The world must curb consumption of the cheapest, dirtiest fuels while increasing access to energy. Natural gas is both a bridge fuel to decarbonisation and major growing source of today’s emissions that must be tackled urgently. Electrification and hydrogen will atomise markets, even as the commoditisation of natural gas surges. Geopolitical tensions could boost consumption of both the cleanest and dirtiest domestic energy resources.

This confusing panorama has been muddled further by the Covid-19 pandemic and our responses to it, accelerating slow-burn societal trends and pushing human behaviour in unexpected directions. The energy transition thus reflects humanity’s own transition into a strange new chapter of post-pandemic history. Adaptability will be key to survival, and not just for those working in the energy space.

Seb Kennedy | Energy Flux | 21 September 2020

* The forecasts referenced in this article are BP’s Energy Outlook 2020, DNV GL’s Energy Transition Outlook 2020, and a Morgan Stanley research paper entitled Energy & Climate Change – a Story in 23 Charts (link unavailable, although this Vox article reproduces some of the graphs).