Energy Transition Picks Up Steam

Precisely when the world passes peak oil demand is still very much a contested debate, but the one thing that is clear is that many of the macro trends are negative for the oil industry.

Most recently, Chinese President announced plans to achieve net-zero carbon emissions by 2060. While light on specifics, the pledge would carry enormous significance if Beijing follows through, and it is merely the latest in a series of high-profile developments that have added momentum to a shift away from fossil fuels.

If successful, China’s 2060 plan could avoid 0.4 to 0.7 degrees Celsius of additional warming.

Clean energy shift accelerates
By mid-century, China aims to phase out coal plants, and dramatically scale up solar, wind, battery storage, nuclear power and electric vehicles. A rough estimate from MIT said that if successful, China’s 2060 plan could avoid 0.4 to 0.7 degrees Celsius of additional warming. “Humankind can no longer afford to ignore the repeated warnings of Nature and go down the beaten path of extracting resources without investing in conservation,” President Xi said at the UN General Assembly on September 22.

The Chinese government will soon release its next five-year plan, which may fill out more of the details. There is no shortage of soft pledges and aspirational targets for decarbonization, but if Beijing is serious, the implications could be enormous. The largest greenhouse gas emitter – and one of the largest consumers of crude oil, natural gas, coal and many other commodities – intends to embrace a (relatively) rapid shift to renewables. Time will tell, but in the interim, China may move up its date for when it plans on reaching “peak emissions.” Its current target is 2030; the European Union has been pressing Beijing to move it up to 2025.

Meanwhile, signs of progress on energy transition continue to proliferate. California just announced plans to phase out the internal combustion engine (ICE), with plans to ban new gasoline and diesel vehicle sales by 2035. That policy is subject to political, regulatory and legal risk, but if successful, California will join the UK, France, Germany and more than a dozen other countries in laying out similar bans. Recent regulations put forward in the European Union would tighten emissions limits, which could translate to 60 percent of new vehicles coming in the form of EVs by 2030, up from 4 percent today. “Europe and China have woken up to the fact that [the combustion engine] is dead,” Arndt Ellinghorst, automotive analyst at Bernstein Research, told the Wall Street Journal. “Now, it looks like the U.S. is waking up.”

Government policies aimed at phasing out ICE vehicles undergird the shift towards electric vehicles on the corporate side, a trend that continues to gather momentum. GM, Volkswagen, Ford and many other automakers are spending billions to roll out new EV models. Cost trends are also favorable as the cost of producing batteries continues to fall. Analysts now believe that the average cost of battery packs to hit $100/kWh – a level viewed as cost parity with an average ICE vehicle – is drawing near. Battery costs could reach that critical threshold sooner than previously projected targets of around 2025.

The oil majors, to varying degrees, have begun a shift towards renewables.

Oil executives are no longer in denial. The oil majors, to varying degrees, have begun a shift towards renewables. BP recently said that the world has passed peak oil demand, and the British oil giant has plans to cut oil and gas production by 40 percent over the next decade while shifting capital into solar and wind. One of the largest private oil trading firms in the world, Trafigura Group, just announced a new $2 billion venture in renewable energy.

Poland pledged to wind down coal mining by 2049. While that move does not exactly position Poland at the leading edge of climate ambition, because Poland has consistently fought to protect coal mining and coal-fired power plants, the shift is notable.

“I’m optimistic, there is a momentum, and this way may well be a turning year for energy and climate change [although[ governments are sitting in the driving seat,” Fatih Birol, Executive Director of the International Energy Agency, said at a conference on September 28. “This is a very grim year, but I’m more optimistic than ever for the clean transition.”

A world in transition
Progress on renewable energy and initial moves by oil companies to transform themselves notwithstanding, the world still remains far off from hitting crucial climate targets. The IEA’s Fatih Birol cautioned that roughly half of the emissions reductions over the next few decades will need to come from technologies that are not yet commercially viable. Moreover, stated carbon pledges from oil companies only cover a tenth of global production.

A much larger portion of global oil production comes from national oil companies (owned by governments), who find themselves in an even deeper quandary. With shrinking revenues and mounting debt, NOCs are stuck trying to drill their way out of the latest downturn. Whether it is Pemex, Petrobras, Rosneft or Saudi Aramco, the way forward is unclear. NOCs prop up their governments, so much more is at stake than shareholder dividends. A clean energy transition is both necessary and incredibly risky at the same time.

Meanwhile, some believe the calls for the imminent demise of oil are overblown. JPMorgan said in June that the collapse of supply will lead to a price spike in the years ahead. If oil demand does not peak, the savage cuts to upstream spending will create a gap between supply and demand.

For now, though, capital markets are increasingly rewarding companies that are less exposed to the volatile oil market, while penalizing oil companies that are stubbornly sticking with growth plans. Energy makes up a small and shrinking

A new report from Moody’s Investors Services warns that the accelerating transition could threaten access to capital to oil and gas companies. “Among the long-term risks facing oil and gas companies today, access to capital and divestment trends will become increasingly important to their credit quality as energy transition reduces long-term demand,” Moody’s wrote.

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