Pandemic risks slowing the energy transition
Beyond the forecast of a ‘new normal’ that accelerates the move to a lower-carbon future, there is also a scenario where change is retarded
Decarbonisation of the energy mix is receiving a boost from the recent collapse of the global economy—with investment in fossil fuel production being hit harder by Covid-19 than renewables, based on the IEA’s latest World Energy Investment report.
But, in a post-pandemic world, the global energy transition is likely to be slower than it would otherwise have been for three reasons: greater geopolitical rivalry; fewer financial resources; and lower oil and gas prices.
America’s unipolar moment following the collapse of the Soviet Union in 1991 was relatively brief. A new authoritarian bloc—in which China and Russia were most prominent, if not always allies—began to emerge as US authority was eroded by missteps in the Middle East, in particular post the Iraq War in 2003.
Since the middle of last decade, this trend has accelerated on the back of bolder moves by Russia and China’s strongmen. President Vladimir Putin annexed Crimea and began funneling assistance to Russian separatist militias in Ukraine from 2014. And Xi Jinping has de facto declared himself president-for-life of China and billed his country’s authoritarian system as superior to a democratic one.
US president Donald Trump has responded with a trade war directed primarily at China. In recent months numerous pundits and publications including Foreign Policy, The Wall Street Journal and the Financial Times have stated the international political order has fallen into a ‘New Cold War’.
This could negatively impact the energy transition—and hence efforts to combat the global climate crisis—because the three key drivers for national energy policies are economics, the environment and security of supply. In a more polarised world, major powers will place relatively more emphasis on economic growth and security of supply, because the failure to do so could mean a loss of relative political power and even military defeat—as Japan found out the hard way in 1945.
The New Cold War is especially worrisome given the lack of agreement on facilitating a rapid global energy transition in a significantly more benign geopolitical world for most of the period since the 1997 Kyoto Accord. The Republican administrations of George W Bush and Trump have received much of the blame for sandbagging international efforts to combat climate change, but at least the US has significantly brought down its greenhouse gas (GHG) emissions since 2005 with the help of cheaper shale gas out-competing coal in power generation. In contrast, the Chinese government has provided rhetorical support for international efforts to combat climate change, including the 2015 Paris Agreement, while the country’s GHG emissions have continued to rise.
310pc of GDP – Chinese non-financial debt
The only major power to strongly support international efforts while producing a roadmap for relatively rapid energy transition is the EU. Even then, Europe could stand accused of merely ‘offshoring’ its emissions through its de-industrialisation and its trading scheme that concentrates only on (large) end-users’ CO2 emissions and ignores the footprint across the full value chain.
Looking forward, Joe Biden winning the US presidential election in November may provide modest impetus for the energy transition globally, as he should keep America in the international climate order and will likely agree to more stringent GHG emission reductions for his country at COP 26 in the UK in November 2021.
But the election of Biden would not bring an end to the New Cold War, as the Chinese threat is a bipartisan issue in the US, with almost as many Democrats concerned about it as Republicans, based on a poll by thinktank the Pew Research Center released in April. As a result, US energy policies, particularly non-domestically, may still put a higher value on economic and security of supply concerns whether Biden or Trump is elected in November. This will in turn impact the policies of other major actors, with potentially deleterious consequences for a quicker energy transition.
In the aftermath of the Covid-19 pandemic there is likely to be significantly less government— and private—resources available to help finance the energy transition. And the upfront costs of innovations such as electric vehicles and new solar and wind generation tend to be high.
The sustainable rate of global economic growth is likely to be slower in the future for two reasons: the rise of trading blocs under the New Cold War; and a lack of fiscal and monetary firepower. During the original Cold War from 1947 to 1991 the global economy grew at an average of about 3pc/yr compared with 3.7pc/yr since 2001, when China joined the WTO and globalisation took off in earnest.
However, since the 2007-09 global financial crisis, growth has been supported by loose fiscal and monetary policies by the major powers much more than it has done historically. The consequence of continuing to use these tools even after the global economy had supposedly returned to normal creates a lack of policy firepower now we are again in crisis—with China particularly exposed.
Chinese non-financial debt has more than doubled to 310pc of GDP over the past decade. Even prior to the pandemic and a large increase in government spending, the IMF was forecasting China’s general government deficit to be 6.3pc of GDP in 2020. Despite these supports, Chinese economic growth fell to 6.1pc in 2019, about half its pre-financial crisis rate.
$3.7tn – Forecast US deficit in 2020
And all major economies are now having to move to even looser fiscal and monetary policy to try to mitigate the full financial impact of Covid-19 lockdowns. For example, the Congressional Budget Office (CBO) is forecasting the US federal deficit to be $3.7tn in fiscal year 2020 based on current spending plans, or 17.9pc of GDP, the largest deficit since 1945. In addition, assuming a deficit of $2.1tn in fiscal year 2021, federal debt will be 108pc of GDP by the end of that year, based on CBO calculations—the highest in US history.
These measures will contribute to a significant diminution of government resources in the future. It may require instead a move to some form of carbon tax to finance and support the energy transition. But these taxes have been much more popular among economists than politicians in the past and may be even less likely to be widely adopted under a New Cold War.
Most forecasts suggest oil and gas prices will be lower for longer post-coronavirus. Lower demand growth is an obvious corollary of retarded global economic growth. Gas—the industry’s bigger demand hope—may be particularly vulnerable, in the IEA’s view, as the driver of demand growth moves away from power generation to the industrial sector and hence becomes more dependent on macroeconomic health.
On the supply side, US production may be facing tough times at present as its relatively high opex costs hobble its ability to compete for demand that has shrunk at a rate unprecedented in peacetime. But, while the industry may have been less well-placed to absorb the Opec+ move to unconstrained supply just before the scale of the pandemic became clearer than it was after a similar move in 2014, the resources and technology remain there.
In short, US shale is an oil price cap for the foreseeable future. And yet more technological innovations and operational and corporate efficiencies are only going to push that price cap lower.
Nor is the picture any rosier for gas. A flood of new LNG production capacity in the second half of the 2010s, led by the US Gulf Coast, was threatening to overwhelm demand even before Covid-19. Now predictions of when the market will rebalance are being pushed further into the 2020s. And, again, even when prices might recover, there is proven supply jostling to service demand and more robust prices as and when they emerge.
And sustained lower oil and gas prices improve the competitiveness of internal combustion engines over electric vehicles and gas-fired power plants over wind and solar. It will thus be more expensive and, particularly for developing economies, more painful to transition to new low-carbon forms of energy, especially in a geopolitically charged and financially constrained world.