The Fundamentals of Energy Transition

Supply and demand

The transition to low and zero emission sources will disrupt conventional commodities supply and demand, touching every market participant. As more renewables hit the market, supply profiles for electricity change. Coal and natural gas are now competing against cheaper, cleaner alternatives. From a trading perspective, producers will look to hedge against market changes while investors can find opportunity in the disruption.

Supply and demand will also be subject to accessibility and cost of renewable energy components such as hydrogen and enablers such as metals. Many of these raw materials are acquired in locations that are often remote from point of use—as just one example, the largest supplier and consumer of cobalt (the DRC and China, respectively) are more than 10,000 kilometers apart.

Transportation availability (rails, ports), combined with rising sea levels, weather and supply chain issues and geopolitical challenges, will be critical in managing the evolving, all-important supply/demand equation. Detailed forecasts and timely, accurate tracking are now essential tools for businesses as well as for commodities traders.

Pricing

The ability to view detailed fundamentals and access real-time market pricing becomes even more important as price volatility increases and fundamentals shift with the move from traditional energy sources to renewables. For traditional sources, potential declines in demand can affect contract prices and trading volumes. For renewables, components that are scarce or difficult to obtain will only increase in cost as demand rises.

Financing

Rising shareholder focus on ESG and sustainability is putting pressure on financial institutions to allocate more to sustainable and renewable solutions. With individuals protesting fossil fuel financing and asset managers needing to comply with regulations and provide transparency to investors on ESG practices, businesses and private sector entities are moving to more sustainable investment practices. At COP 26, more than 450 financial firms spanning 45 countries committed to provide $130 trillion for investments that enable net zero emissions by 2030.

The shift to renewables

With growing awareness of the critical need to rethink global energy production, renewable energy sources – from biomass, hydropower and geothermal to wind and solar, amongst others – are steadily rising to alter the fuel mix and replace fossil fuels.

The rapid expansion in developing and using renewable energy sources has precipitated a fundamental shift in international supply-demand dynamics, with profound commercial, reputational, national and geopolitical consequences for all stakeholders. 

• For the world’s 1,600 listed fossil fuel producers, median prices fell 25% in 2020 (vs 7% for renewable energy peers).
• Large crude oil consumers, such as Finland, have dramatically cut their reliance on oil.
• Sales of plug-in electric vehicles surged 160% in the world’s three largest markets during the first half of 2021.

As electricity becomes the core of the energy system, metals sit at the heart of the green revolution. They are essential both for transmission (power lines) and clean power storage (batteries).  With sales of electric vehicles soaring and demand for sustainable solutions rising across the board, batteries will be critical to smoothing out the variability of renewable energy supplies. Yet raw materials are rarely where the demand is, and data is the key to understanding availability, demand, pricing and trade flows—along with trade financing and supply chain challenges.

In addition to fuel cell technologies, hydrogen also has the potential to significantly move the needle in the shift to a carbon-free economy. According to PwC, by 2050 total demand for green hydrogen could displace roughly 10 billion barrels of oil in the heating, transportation, power generation, chemicals and primary steel manufacturing sectors. 

The impact of a changing climate

As droughts, floods, fires, and natural disasters continue to unfold with increasing frequency across the globe, the reality of climate change is becoming ever more tangible and highlighting the urgency for transition.

The complex, interconnected ripple effects of the climate crisis are many and varied. For example, research shows that a potential “hot-house world scenario” could occur, in which physical damage from climate-related disasters could lead to increasing debt-to-GDP ratios and rising unemployment in many countries, starting with equatorial and southern European regions. Developing nations are likely to suffer more as the climate crisis progresses and will need support and funding from their wealthier counterparts.

Growth in emerging technologies

Technologies such as carbon capture, utilisation, and storage (CCUS), and green hydrogen from non-fossil sources offer us the necessary tools for achieving global transition goals.

Additionally, new technologies that enable and optimise clean energy production are continually being developed, driving exponential change within the energy sector.

According to the International Electrotechnical Commission (IEC), many of the technologies needed to significantly reduce emissions in line with agreed 2030 targets are already available. On the other hand, many of those needed to meet 2050’s ambitious net zero emissions target are still in the early stages of development. As these emerging technologies are refined and perfected, they will add increasing impetus to the pace of transition.

Key policy initiatives

Policy frameworks continue to drive energy transition across the globe, but remain a mix of mandatory, voluntary or specific to a single country. They vary with regards to scope, requirements for implementation and consequences.

The World Bank’s RISE (Regulatory Indicators for Sustainable Energy) scorecard measures policy progress relating to renewable energy, energy efficiency, electricity access, and access to clean cooking, and in 2019 reported that nearly 70 percent of the countries monitored had enacted plans to improve energy efficiency, with OECD countries developing the most sophisticated policies.

That said, the World Bank also notes that several developing countries, including Mexico, China, Turkey, India, Vietnam, Brazil, and South Africa are implementing “robust policies to support energy access, renewables and energy efficiency”.

Financing and investing in the transition

According to the United Nations, “insufficient financing remains one of the greatest bottlenecks that prevents the world from achieving the Sustainable Development Goals.” Providing capital and funding the energy transition will cost trillions of pounds a year: therefore, there is an urgent need for banks to step up and provide the financing needed to develop the necessary technologies.

Publicly-held firms have significant incentives to act – not only does climate change pose investment risk, but the energy transition can create investment opportunity. The consequences of inaction are significant, from reputational risk to negatively impacting the bottom line or opening the doors to competitors. Beyond being good business sense, sustainable finance and investing is also in the best interests of shareholders and potential investors, consumers, employees, suppliers, and distributors.