Detour, derailment or driver? How geopolitical shocks change the path to net-zero

The industry’s move towards net-zero has been complicated by a succession of destabilising world events. But will they detour, derail or accelerate the energy transition?

The question of how to lower carbon emissions without damaging quality of life has been complicated by a succession of destabilising world events. Opinions differ over whether the turmoil surrounding Russia’s invasion of Ukraine has accelerated or set back the energy transition in the short term, but in the longer term the transition remains inevitable, with emerging markets among the leaders.

A divergence of views

Divisions have widened over the right approach to environmental, social and governance (ESG) investing within what is a deeply uncertain geopolitical and macroeconomic landscape. Brent crude prices were tracking up even before the Russian invasion, a result of major economies lifting their COVID-19 restrictions, but the conflict saw them spike above US$125 before seesawing wildly in the months afterwards as Western European countries sought to reduce or end their imports of Russian oil and gas.1 Spot prices for natural gas also rose quickly.2

For some, this has shown the urgency of moving away from hydrocarbons altogether, not only to prevent global temperatures from rising to catastrophic levels but also to untangle democracies from their economic reliance on rogue regimes and the multitude of risks they present. These voices, which urge an even faster divestment from hydrocarbon energy, see the geopolitical disquiet as a driver of change along with the rapid advancement of low-carbon technologies.3

For others, the war has demonstrated the opposite: that decarbonisation should be slowed or even abandoned, because financial institutions have been too quick to divest from oil and gas, creating a supply shock that is inflicting a cost-of-living crisis, with political unrest and debt default following in the case of Sri Lanka.4 They worry that divestment is pushing up fuel and fertiliser prices for some of the world’s poorest people,5 and also that by turning oil and gas facilities into stranded assets, divestment could have vast and unpredictable impacts on pension funds, notably in the US and UK.6

While in the short-term such concerns are understandable, in the longer term the derailment theory overlooks the strong incentives that geopolitical shocks create in favour of decarbonisation. First, such events demonstrate not only the world’s reliance on hydrocarbons, but also why this dependency is unwelcome and a potential cause of conflict. Secondly, as energy prices rise, they make greener technologies and practices more economically viable. For these reasons, while such shocks may delay or detour the journey to net-zero, they will not derail it. Indeed, they may ultimately prove an accelerant to the transition.

A bridge too far?

It is generally acknowledged that oil and gas will be with us for decades to come, but that the world needs to scale back its use of these hydrocarbons urgently.7

"The demand for oil and gas is such that you cannot just switch off the pumps, without a massive social consequence" says Ben Daly, Head of Transition Finance at Standard Chartered. "That's not just for cars and airplanes. There's a critical role of oil and gas in heat, electricity, chemical production and so on." He adds that the oil-and-gas industry is a repository of technical expertise that will prove vital to scaling up the production and distribution of renewable energy and decarbonisation technology, and therefore must be part of the solutions.

When it comes to financing the transition, the war in Ukraine has again complicated the picture. Courtesy of Russia’s actions in Ukraine, capital is not only needed for transitioning from fossil fuels to renewables – it must also now support geographical transitions.

“Cutting out Russian gas is much more complicated than cutting out Russian oil,” says Emily Ashford, Executive Director, Energy Analyst, Standard Chartered. “There is much more impact on industry. Ending this reliance requires every piece of slack in the energy market to come into play.”

Germany, for example, currently lacks a permanent LNG terminal that would allow it to import gas by sea and sever its reliance on pipelines from Russia. It has moved to charter floating LNG terminals8 to permit seaborne imports while it works to build onshore infrastructure.9 The contractual side is also challenging. “LNG will require Europe to outcompete Asia for cargoes, many of which are subject to long-term contracts,” Ashford notes. “But it also depends how much demand for Russian gas heads to Asia.”

Some European countries are even tracking back towards coal-fired plants, the most carbon-intensive form of power generation, driving up coal prices in the process.10 This has prompted fears that such backsliding could encourage emerging and frontier markets to conclude that they, too, need not shift away from coal, perhaps also fostering a more pro-hydrocarbon mindset among some finance houses.

EMs as climate leaders

However, it is important to avoid the misconception that wealthy nations are doing better on their energy transitions than emerging markets. In many cases, the opposite is true.

In Sub-Saharan Africa, Zambia derives 85% of its electricity from hydropower11 which, while not without its environmental impacts, is a renewable energy source. The figure is even higher in the Democratic Republic of Congo.12 In Asia, China has installed 330 gigawatts of wind power capacity and 320 gigawatts of solar13 - multiples of the installed solar and wind capacity of the United States.14

With oil, gas and even coal prices rising, such investments in green energy are reaping clear economic dividends for the countries in question, for instance by acting as a brake on inflation. As for countries and companies that are producers of hydrocarbon energy, the surge in prices offers an opportunity to re-invest in a greener future.

Daly points out that with many oil and gas companies pocketing windfall profits, they have now been presented with an opportunity to deploy those gains to establish themselves as transition-friendly enterprises. They could, for instance, become lead off takers in voluntary carbon markets, thereby supporting investment in projects to decarbonise and otherwise mitigate the impacts of climate change.

Such initiatives would also serve to make these companies more credit-worthy. While much of the media focus is on the super-majors, there is a much wider universe of smaller energy companies, notably on the exploration and production side, that require access to credit.

More attention needs to be focused on those smaller players when it comes to linking finance to sustainability as that can make a big difference. For instance, the avoidance of practices such as gas flaring – the burning of excess gas from oil wells – can be linked to finance for these smaller energy companies. With the right amount of investment, that gas can often be conserved for industrial use rather than flared.15

In the short term, the consequences of geopolitical turmoil are not straightforward. They create both headwinds and tailwinds for the energy transition. In the longer term, however, the direction of travel is clear: helping to fund the transition away from fossil fuels is going to become an ever more important function for financial institutions, while the appeal of solar, wind and other sources of power that are not only renewable, but also domestic - and thus immune to external supply shocks like the Ukraine war - is only going to grow stronger.

This article is based on themes discussed during a panel at Standard Chartered’s recent Global Credit Conference: Riding the wave. View the recording.

1 https://markets.ft.com/data/commodities/tearsheet/summary?c=Brent+Crude+Oil

2 https://www.eia.gov/dnav/ng/hist/rngwhhdm.htm

3 https://www.ft.com/content/1bb216ee-0647-4d3c-aa17-c3629ab84b80

4 https://www.bbc.co.uk/news/business-61505842

5 https://www.politico.eu/article/starvation-risk-gas-energy-un-food-economist-torero/

6 https://www.theguardian.com/environment/2022/may/26/people-in-us-and-uk-face-huge-financial-hit-if-fossil-fuels-lose-value-study-shows

7 https://unfccc.int/news/governments-fossil-fuel-production-plans-dangerously-out-of-sync-with-paris-limits

8 https://www.bloomberg.com/news/articles/2022-05-05/germany-charters-floating-lng-terminals-to-help-cut-russian-gas

9 https://www.euractiv.com/section/energy/news/german-government-agrees-on-law-to-speed-up-lng-terminal-construction/

10 https://www.economist.com/the-economist-explains/2022/05/09/why-the-war-in-ukraine-is-driving-up-europes-use-of-coal-and-its-price

11 https://www.usaid.gov/powerafrica/zambia

12 https://www.trade.gov/country-commercial-guides/democratic-republic-congo-energy

13 https://english.news.cn/20220321/7a98c5f7b54b438484f78a03cc4999ba/c.html

14 https://www.energy.gov/eere/solar/solar-energy-united-states#:~:text=Solar%20power%20is%20more%20affordable,18%20million%20average
%20American%20homes.

15 https://www.worldbank.org/en/programs/gasflaringreduction/gas-flaring-explained#:~:text=Gas%20flaring%20is%20the%20burning,appropriate%20regulation
%20and%20political%20will.

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