How can we deal with the unforeseen implications of global decarbonisation?
It has become increasingly clear over recent years that the world has not only a moral imperative to decarbonise, but also an urgent practical incentive. If we continue on the current trajectory based on a worldwide fossil fuel-dependent energy system, we will breach the global temperature limit identified as necessary for our ecological sustainability within the next decade or so.
The science of climate change is therefore undeniably urgent and requires action by all economic participants from market issuers, asset managers, asset consultants and asset owners to regulators and media. The Paris Climate Accord and COP26 reinforced this message through the identifying and setting of a global climate change limit to 1.5 degrees Celsius in an attempt to avoid significant climate disruptions that could see an exacerbation of hunger, conflict and drought globally.
However, while we have seen immense progress in worldwide decarbonisation efforts in recent years, it is essential that this is done in an orderly fashion. The recent move upwards in oil and gas prices and general energy crunch in Europe (even before the Russia/Ukraine crisis) is a clear indicator of the repercussions that a disorderly approach to the transition away from fossil fuels could bring if it isn’t balanced with enough production from renewable sources to meet global demand.
Currently, individual economic actors – such as pension funds and other asset owners, banks and other lending institutions – are decarbonising in various ways, with each individual actor behaving rationally and for the right reasons. However, as a collective, the impact has potentially severe unintended consequences. Indeed, already the resulting material reduction in capital investment in fossil fuel provision (by some estimates a halving of investment in recent years) has meant less fossil fuel supply at a time when it will be many years before renewables, at the current production rate, can take up the slack. This has had dire consequences for energy prices, even before the Russian invasion of Ukraine.
A secondary effect is that this cut in the production of fossil fuels is also raising the cost of steel and other commodity resources that are needed to construct renewable energy infrastructure such as wind and solar farms.
Escalating sanctions and reduction of oil trade with Russia by Europe and the US in an attempt to curtail the current conflict is a further aggravating factor in the situation. The conflict has created a powerful imperative to accelerate European and US investment in all forms of energy production from fossil fuels to nuclear to renewables in order to reduce current dependencies on Russian oil and gas. As long as the West retains any form of material dependency on Russian fossil fuels the less their ability to constrain Russian aggression and the associated threat to global peace and stability.
A managed transition whereby investment in fossil fuels is managed appropriately whilst renewable capacity is ramped up, would be a desirable and important outcome. However, governments are not at this stage stepping in to manage it properly. The increased pace of the transition into renewables necessary to ease the rising price of fossil fuels is much more difficult to achieve sensibly without government direction. Perhaps the urgency of the Russian threat will expedite European and US government intervention in this regard, but to truly manage the transition and rising fossil fuel prices, there would need to be a synchronised global effort.
In the meantime, for investors there is likely a continued opportunity to achieve capital gains in fossil fuel companies as commodity prices rise, which means economic owners are now less inclined to disinvest. This in itself is hindering the transition to renewable energy as the primary source of global energy and the sector’s establishment as a viable source of higher returns. For now, it is also critical for investors to continue to engage fossil fuel and related companies to influence change and help with an orderly energy transition.
Ultimately, if we are to address rising fossil fuel prices, we need to see significantly accelerated investment in all renewables, as well as more investment in both energy storage (batteries at scale) and base load energy provision – for example, nuclear energy. The challenge is still the pace of change and how quickly an orderly transition can be implemented. But despite the horrors of war, if a holistic, ordered approach can be achieved, then we may just be entering a new era, one in which, at last, we could see the successful entrenchment of clean energy as the world’s leading source of fuel. DM
Author: Hywel George, Director of Investments, Old Mutual Investment Group
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