Author: Nicholas Butler

Economist, Professor at Kings College London

Energy and Climate Change in 2022

After the high rhetoric and ambitious pledges of the last twelve months, culminating in the COP26 meeting in Glasgow, 2022 promises to be a very different year with the emphasis on volatile prices, especially for oil and gas, and on the inconvenient details of the up front costs of delivering the transition to a low carbon global economy.
Energy and Climate Change in 2022

(©Envato)

High expectations were raised by the Glasgow meeting but the emerging reality of only limited change will provoke dismay among campaigners and could prove dangerous for Governments which have promised more than they can deliver and for companies who see transition as a gradual rather than an instantaneous process.

For Poland as for many countries the ability to influence what happens at the regional or global level is limited. But choices do remain to be made and an acute awareness of what is happening both within the climate change debate and the energy market is essential.

Over the last few months three distinct events have undermined the sense of achievement felt by the organisers of the COP26 meeting who had overseen a process which ended with 130 countries signed up to reduce emissions plus a series of side agreements by different groups of nations to cut coal use, eliminate methane emissions and protect forestry.

  • In the United States President Joe Biden’s ambitious plans including an objective of cutting emissions by 50 per cent by 2030 from a 2005 baseline have been set back by the administration’s inability to pass the necessary legislation. Although funding is in place for new infrastructure much of which is essential if there is to be a full scale transition of energy use, the failure to secure congressional agreement on the shorter term measures is a reminder that in the US as in many other nations there is still no cross party consensus on the climate agenda. That remains the case in Europe where the gap between West and East on the pace of change has widened over the last year.  Nor, at the global level is there a consensus on  the priority which climate policy should be given against the many other challenges facing national Governments. For some climate change is the dominant issue. The European Union is increasingly working towards a target date of 2045 (the new German standard) for the achievement of net zero. The West European view, however does not reflect the world further south or east.  India and China talk of reaching net zero by 2060 or 2070. For them and many others the dominant issue now and for a long time to come is still development – meaning economic growth and employment.
  • The second factor clouding the immediate prospects for tough action on climate change is the sharp increase in energy prices. Prices began to rise as the first wave of the Covid pandemic receded and economic activity picked up. That recovery began in Asia as early as the second quarter of 2020 but the dramatic effects of the surge in demand for energy only became evident as the market tightened through the summer of 2021. Oil prices at the end of 2021 are $ 20 higher than they were a year ago. Natural Gas prices in Europe have tripled over the same period. The market is overheated with speculation creating volatility completely divorced from the underlying reality of supply and demand but the resulting sense of insecurity has been compounded by fears that Russia – Europe’s main supplier of gas – has been manipulating the situation.
  • In China concern about security of supply in the face of growing import dependence has led to President Xi’s stated desire for greater self sufficiency in energy. In the short term the result has been renewed growth in the use of coal to sustain economic activity but that trend may not be permanent. China is the undisputed world leader in the development of low carbon energy sources and of new forms of energy consumption such as electric vehicles. Over time, a low carbon energy economy based on local supplies could be a major driving force for self sufficiency. China is capable of achieving net zero by 2060 and of becoming the industrial power base of the new low carbon global economy. In the short term, however, Chinese emissions will continue to rise and could well account for a third of the global total within the next five years.
  • Meanwhile in Europe the challenge of translating ambitious targets for emissions reduction into practical policies for delivery has been made more difficult by the increase in energy prices. Retail bills are set to rise sharply in the next six months as global prices feed through. As a result there is no appetite for imposing on consumers the costs of the next phase of the transition. The investments involved are critical to any future transition – from  the installation of domestic heat pumps, to the development of additional new nuclear capacity and the renewal of infrastructure needed if hydrogen is to become a major source of heat.
  • In normal times investment to cover many of these upfront costs could be led by public spending with the borrowing involved justified on the basis that in the long term the transition to a low carbon economy should bring lower costs and greater energy security. But the continuing waves of Covid have added a substantial unplanned burden to already stretched public finances. Public debt across the world  now amounts to almost $ 300 trillion dollars – approximately 350 per cent of GDP. The unsurprising result in recent months have been a distinct hardening of Government statements on spending and on fiscal policy. The idea that long term borrowing is cost free for Governments was further undermined in the closing weeks of 2021  as interest rates, having been close to zero, began to rise. The prospect of further massive public investment in the new green economy has receded. So have the prospects for large scale transfers to help countries and regions previously dependent on hydrocarbons. In Europe the Just Transition Fund envisaged as  a means of directly supporting the transaction away from coal has been reduced in scale from the € 40 bn proposed by the Commission to just € 17.5 bn. In countries such as the UK ambitious plans for a 78 per cent reduction in emissions by 2035 from a 1990 baseline have been announced but lack both substantive detail and any clarity on the financing mechanisms. For private investors including energy companies and their shareholders the business model of the energy transition remains unclear.

All these factors mean that while much change is underway the pace is below the  expectations of many campaigners. On current trends hydrocarbon consumption will continue to grow,  emissions will continue to rise for the next several years and atmospheric carbon concentrations will rise towards the level at which the risks of fundamental and irreversible climate change will be upon us. Current evidence suggests that a steady linear  increase of 1.5 or 2 degrees in global temperatures by the end of the century is less likely than an immediate growth in the number of extreme weather events. The heatwaves, wildfires and floods which hit Germany, the US and China in 2021 were confirmation that climate change is happening now.

The response to this context of reduced expectations will determine how energy and climate policies now develop. Glasgow with its successes and failures marked the end of the period in which energy and climate policy could be determined by leaders and experts. The next stage – the delivery process – will depend critically, country by country, on public acceptance of the changes which now need to be made.

  • First the actions of the new German Government in responding to the simultaneous challenges of the rising energy costs facing consumers and businesses and the energy security risks associated with the Nord Stream 2 project and reliance on Russia. Renewables will continue to grow and the longer term focus on developing green hydrogen will be maintained. In the short term, however, will Chancellor Olaf Scholz continue to focus on natural gas as the transition fuel or will the new Government reprieve some of the country’s remaining nuclear plants which are due to close by the end of 2022 and defer any attempt to accelerate the closure of coal fired power generation? German policy will also determine the extent to which other Members of the EU including countries such as Poland are required to set more rapid timetables for the transition.
  • Secondly the role of climate change in the US mid term elections in November. Will climate policies dominate the political debate and will the potential loss of congressional power undermine the ability of the President both to lead the energy transition in the United States and to to sustain the renewed US engagement in international action on climate change?
  • Thirdly, will climate change come to dominate international trade negotiations with divergent policies and timescales leading to increased fiscal and regulatory actions to limit trade in carbon intensive products. 2022 we should see the detailed proposals being made by the European Union in support of its Carbon Border Adjustment Mechanism – essential a tariff  to be levied on products from those countries judged to be underperforming in their pursuit of reducing emissions. The reaction from the countries likely to be targeted including China and India will shape what is likely to be a crucial debate on whether the climate agenda is best served by protectionism or by open trade.
  • Fourthly will climate activists, disappointed by the limited progress made in Glasgow turn to new devices such as legal challenges and financial reporting requirements to force companies to move away from hydrocarbons and to embrace a more rapid transition? The actions  of groups including the sustainability foundation  Urgenda which challenged Shell to accelerate its emissions reductions plans and the activist legal charity Client Earth are establishing precedents for use of different legal arguments to advance the agenda. Client Earth is supporting the case brought against the Polish Government in June 2021 challenging the absence of a clear strategy to reduce emissions. Worldwide a significant number of substantive law suits are due to come to court in 2021. Comparable action, using reporting requirements to expose climate risks are being pursued by the network of financial institutions launched in Glasgow. In Europe in particular attention will focus on whether new hydrocarbon projects such as the planned development of the Cambo oil field west of Shetland should proceed.  Every future coal development is likely to face a similar challenge. Will these professional and technical forms of climate activism achieve more than the street protests of extinction rebellion?

The uncertainties involved in each of these issues create a difficult environment for business. Glasgow confirmed a direction of change but did not produce a clear framework within which businesses can plan and invest. The absence of clear progress is likely to encourage campaigners to focus their attention on the activities of those corporates and financial institutions still reliant on oil and gas as producers or consumers. With companies such as Aramco and Rosneft beyond reach  businesses and institutions based in Europe and the US will offer the easiest targets, open to legal, financial and social challenge.

2022 will not be an easy year.

(©Envato)

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