POTHOLES IN THE ENERGY TRANSITION
The disruptions in global energy markets and the war in Ukraine have reinforced the commitment to renewable energy and the desire to achieve net zero carbon emissions. However, even in the face of the growing strength of the global consensus on an energy transition, the obstacles it faces are becoming increasingly clear.
In addition to the uncertain pace of technology development and deployment, four challenges stand out:
- The recovery of energy security as a primary requirement of countries.
- The lack of consensus on the speed at which the transition can and should be made, in part because of the economic disruption it may cause.
- A deepening divide between advanced and developing countries over transition priorities.
- Obstacles to the expansion of mining and the creation of supply chains for the minerals needed to achieve the goal of zero net emissions.
The need for energy security as a priority had taken a back seat in recent years. The confluence of an energy shock, the economic hardship that followed, soaring energy prices (unthinkable 18 months ago) and geopolitical conflicts have forced many governments to re-evaluate their strategies. This recognizes that the energy transition must be based on energy security – i.e. adequate supply at reasonable prices – in order to gain the support of the population and avoid economic disruption, with the dangerous political consequences that this can have.
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The current global energy crisis did not begin with the invasion of Ukraine in February 2022, but in the late summer of 2021. The rebound in the economy following the end of global confinements by COVID-19 triggered global energy consumption. Oil, natural gas and coal markets contracted in the last months of 2021, causing prices to rise, as demand ran up against what became clear: insufficient supply. In November 2021, three months before the invasion, the U.S. government announced the first release of crude oil from its strategic reserve. If anything has become clear, it is that “preemptive underinvestment” has limited the development of new and adequate oil and gas resources. This underinvestment is explained by several reasons: government policies and regulations; investors’ environmental, social and governance (ESG) considerations; poor returns caused by two price collapses in seven years; and uncertainty around future demand. The underinvestment was “pre-emptive” in the mistaken belief that by now there would be ample and sufficient alternatives to oil and gas. The current situation has been described as “the first crisis of the energy transition”, a mismatch between supply and demand. If it turns out to be only the first, in the future such crises will generate uncertainty, cause serious economic problems and undermine popular support for the energy transition.
Energy transitions throughout history
The first energy transition was from wood to coal in the 18th century. Although coal was already being used in Britain in the 13th century because the cost of wood had risen, it was not until January 1709 – when Abraham Darby, an English metallurgist, demonstrated that coal was a “more efficient means of producing iron” – that it began to be used specifically as an industrial fuel. Darby was aware that many considered him foolish.
Still, transitions have almost never been rapid. Although the 19th century is known as “the century of coal,” at that time “wood, charcoal and coal waste” were still used, in the words of energy expert Vaclav Smil. It was not until 1900 that coal covered half of the world’s energy demand.
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Oil was discovered in the United States in 1859. More than 50 years later, on the eve of World War I, Winston Churchill, then First Lord of the Admiralty, led the Royal Navy’s conversion from coal to oil, for technological reasons: speed, flexibility, ease of refueling and elimination of coal shoveling personnel. However, it was only until the 1960s, a century after its discovery, that oil replaced coal as the world’s main energy source.
To date, energy transitions have been protracted over time (see “Under the Magnifying Glass” in this issue of F&D); in fact, rather than transitions, they have been additions at heart. In the six decades since oil replaced coal as the world’s main energy source, global coal consumption has nearly tripled.
The current energy transition, driven by climate change, is intended to be rapid and completed in just over 25 years. It is also intended to be transformational. Coal is going to disappear, and the European Union forecasts that 20%-25% of its total energy by 2050 will come from hydrogen. Although an increasing number of activities and energy targets focus on hydrogen, it provides less than 2% of today’s energy supply.
The speed of the transition
If energy security is the first difficulty facing the transition, timing is the second. How fast must – and can – it move? There is a lot of pressure to bring forward a significant part of the 2050 carbon reduction targets to 2030. However, it sometimes seems that the magnitude of this attempt is being underestimated.
In my book entitled The New Map (2021), I analyzed previous energy transitions, and it is clear that the current one is unparalleled. All the previous ones were caused by economic and technological advantages, and not by political ones, as is mostly the case now. All the previous ones took a century or more to complete, and none of them was a transition like the one now being forged. The goal of this transition is not just to find new sources of energy, but to completely change the energy fundamentals of what is now a USD 100 trillion global economy, and to do it in just over 25 years. It is a very ambitious project and something on such a scale has never been attempted before.
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Some warn that, as it is such an important and far-reaching transition, the macroeconomic effects call for further analysis. According to economist Jean Pisani-Ferry, co-founder of Bruegel, Europe’s leading economic think tank, accelerating the achievement of net carbon emission reduction targets too fast could generate larger-than-expected economic disruptions-what he calls “an adverse supply shock, very similar to the shocks of the 1970s.” In 2021, just before the current energy crisis began, Pisani-Ferry wrote prophetically that such a transition is “unlikely to be benign, so policymakers should prepare to make tough choices.” In 2022, he added: “Climate action is now one of the main topics in macroeconomics, but the macroeconomics of climate action is far from the level of rigor and precision needed to inform public debate and adequately direct policymakers. For obvious reasons, advocacy efforts have taken precedence over analysis. However, at this point in the conversations, self-indulgent scenarios are counterproductive. The policy debate requires methodical, peer-reviewed assessments of the potential costs and benefits of alternative intervention plans.”
The North-South divide
The third challenge is the emergence of a new North-South divide: a widening of the differences between developed and developing countries in terms of how to advance the transition. In the 1970s, the gap was due to the clash between developed and developing countries over the distribution of wealth and, in particular, commodity and raw material prices. That divide faded with globalization and technological advances, reflected in the change of nomenclature in favor of “emerging market countries.”
The new North-South divide reflects disagreements over climate and transition policies, their effects on development, and who is responsible for emissions, cumulative and new, and who should pay for them. The global commodity shocks triggered by the war in Ukraine, as well as the subsequent interest rate hikes and currency devaluations, have only deepened the pressures on developing countries.
In developing countries, what is perceived as the sole goal of emissions reduction must be weighed against other urgent priorities, such as health, poverty and economic growth. Billions of people continue to cook with wood and waste, generating indoor pollution and damaging health. Many of these countries believe that, in order to raise living standards, it is essential to increase the use of hydrocarbons. As India’s former Petroleum Minister Dharmendra Pradhan said, there are several possible paths to energy transition. Despite its stated commitment to renewable energy, India is also building a $60 billion natural gas distribution system. Developing countries want to introduce and expand the use of natural gas to reduce indoor pollution, promote economic development and job creation and, in many cases, eliminate emissions and pollution from burning coal and biomass.
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There is a tendency in advanced economies to ignore this gap, but the reality became palpable in September 2022, when the European Parliament, in an unusual expression of extraterritoriality, voted to reject a proposed pipeline from Uganda through Tanzania to the Indian Ocean. The Parliament had denounced that the planned pipeline would have negative consequences on the climate, the environment and “human rights”. This body is based in France and Belgium, countries whose per capita income is almost 20 times that of Uganda. Predictably, the rejection provoked a strong reaction in Uganda, where the pipeline was considered essential for economic development. The deputy speaker of the country’s parliament denounced the European resolution as reflecting “the highest level of neo-colonialism and imperialism vis-à-vis the sovereignty of Uganda and Tanzania.” The energy minister added that “Africa has been green, but its people are cutting down trees because they are poor”. Uganda’s national student union took to the streets to demonstrate against the European Parliament; one of the student leaders stated that “Europeans are not morally superior”. Without going into details, it is hard to deny the stark difference in perspectives.
The divide is especially evident in financing. Western banks and multilateral financial institutions have cut off financing for pipelines, but also for ports and other infrastructure related to hydrocarbon development. One African energy minister summed up the effects of denying access to finance as akin to “taking away the ladder and asking us to jump or fly.” Finding the balance between the prospects of the developing world, where 80% of the world’s population lives, and those of Western Europe and North America is becoming increasingly urgent.
Disruption of financing
The fourth challenge will be to secure new supply chains for climate neutrality. The passage in the United States of the Inflation Reduction Act, with its huge incentives and subsidies for renewable energy sources; Europe’s REPowerEU plan; and other similar initiatives will accelerate demand for the minerals on which these renewables are based, for which wind turbines, electric vehicles and solar panels, among other things, are needed. A wide range of organizations – the IMF, the World Bank, the International Energy Agency (IEA), the U.S. government, the European Union, Japan – have published studies on the urgency of creating these supply chains. According to IEA projections, the world economy will shift from a “fuel-based to a mineral-based energy system,” which will “overstretch demand for essential minerals.” In The New Map, I refer to this situation as the shift from “Big Oil” to “Big Shovel.”
S&P Global, the financial and analytical firm of which I am a vice president, has delved into these studies to quantify this “overstretched demand” for minerals. S&P Global’s study titled “The Future of Copper: Will the Looming Supply Gap Short-Circuit the Energy Transition?” (2022) focuses on copper because the energy transition pushes toward electrification, and this is “the metal of electrification.” It took the types of 2050 targets announced by the US government and the EU, and looked at the implications of realizing them in different areas; for example, the different components of an offshore wind farm or electric vehicles. For an electric car, for example, 2.5 times more copper is required than for a conventional internal combustion engine vehicle. The analysis concludes that, in order to meet the 2050 targets, copper demand would have to double by the mid-2030s.
The bottleneck is in supply. At the current rate of supply growth – which encompasses new mines, expansion of existing mines and increased efficiency, and recycling as well as substitution – the amount of copper available will fall significantly short of supply needs. The IEA, for example, estimates that it takes 16 years from the discovery of a deposit to the first production from a mine. Some mining companies talk of more than 20 years. Around the world, permitting and environmental issues impose significant constraints. In addition, copper production is much more concentrated than that of oil, for example. In 2021, three countries produced around 40% of the world’s oil: the United States, Saudi Arabia and Russia. In the case of copper, two countries produced 38%: Chile and Peru.
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Copper is essential
Copper prices have fallen by 20% since the peak recorded this year, a consequence of the well-known role of “Dr. Copper”, the name by which this metal is known, whose price is an indicator of economic slowdowns and recessions. Precisely, the IMF – like many other experts – foresees a sharp slowdown in world growth in 2022, to be followed in 2023, and a possible recession. However, after the recession, the incoming flow of demand due to the energy transition will cause copper prices to rise again. As in the past, the increase in demand and prices is likely to generate new tensions between resource-holding countries and mining companies, which in turn will affect the rate of investment. Moreover, as the race to climate neutrality intensifies, the fight for minerals will be caught up in what is known as the “great energy competition” between China and the United States.
With its copper study, S&P Global wants to contribute to a deeper analysis of the physical challenges of the energy transition. The wind sector has what a 12th century English proponent of windmills called the “free benefit of wind.” And solar energy has free benefit from the sun. However, the physical inputs used in harnessing wind and solar energy are not without cost. The effort to advance a significant number of the 2050 targets to 2030 is likely to run up against considerable physical constraints.
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These four challenges-energy security, macroeconomic effects, the north-south gap and minerals-will greatly affect the development of the energy transition. They will not be easy to deal with separately and, moreover, they will interact with each other, multiplying their impacts. Even so, recognizing them will allow a better understanding of the issues and requirements involved in achieving the energy transition.
Source: https://www.imf.org/es/Publications/fandd/issues/2022/12/bumps-in-the-energy-transition-yergin
