The energy landscape has changed dramatically since the Russian invasion of Ukraine in late February.
On top of the tragic human toll of this conflict, the geopolitical situation has raised many questions about global energy security and potential trade-offs with a net-zero-emissions future. Given that Russia is the world’s second-largest oil and gas producer, dependence on this supply – especially in Europe – has come under the microscope.
Russia provides roughly 20% of total European refinery crude throughputs. It exports refined products such as diesel and supplies 40% of Europe’s natural gas. This reliance on Russian energy is not conducive to quick fixes. It also has many people asking whether government commitments to net-zero greenhouse gas emissions by 2050 are incompatible with shorter-term energy security issues. Investors must grapple with this question as well, as the financial sector increasingly makes its own net-zero commitments.
Two broad investment scenarios are being raised.
One is that short-term energy security needs to dominate, and there will be a rush to replace Russian production with more stable, politically acceptable sources (such as Canadian energy). The other scenario is that the Russian conflict presents an opportune time to ramp up production of non-fossil fuel energy, both to meet society’s desire to shift away from Russian energy and to maintain society’s net-zero-by-2050 goal, in alignment with the Paris Agreement.
In my view, these are not either/or scenarios. Let me expand on these points for broader context.
Energy Security as a Priority
Investors will be inclined to capitalize on the immediate opportunity: a world in need of more energy.
Even before the Ukraine crisis, energy supplies were challenged, with rolling blackouts in China and natural gas shortages in Europe. Russia’s invasion of Ukraine and the world’s condemnation has greatly exacerbated the imbalance of energy supply and demand. Much of this stems from years of under-investment in traditional sources of production as prices (and therefore return on investment) were low. With the recent spike in oil prices to above $100 per barrel, supply cannot catch up fast enough. These dynamics suggest a continuing tightening of supply and demand, and potentially high investment returns.
Energy security is a basic human requirement. People need to heat their homes, cook their food, generate power and transport goods. In the short term, these needs may trump our concerns over climate change, which means investing in infrastructure that is largely based on fossil fuels. It cannot be ignored that 80% of global energy supply is currently met with oil, gas or coal. Renewables simply cannot be scaled up fast enough to meet current needs, even if governments accelerate the permitting process. Technological advances are also required to ensure that baseload energy needs are met. Renewables are therefore unable to solve our immediate supply/demand imbalance.
Speeding the Energy Transition
On the flip side, one could argue that halting financial flows to Russia by weaning ourselves off of Russian oil and gas is a major opportunity to accelerate the development of low-carbon energy. In some regions, there is talk about delaying nuclear power plant closures to facilitate a faster transition to net zero. Expansion of renewables is largely being driven by simple economics: renewable energy is now one of the cheaper forms of new energy infrastructure. (Solar in particular has seen an 85% cost decline in the last 10 years.) The European Union faces this transition dilemma more urgently than most regions, due to its heavy reliance on Russian oil and gas, and the EU’s commitment to slash greenhouse gas emissions by 55% by 2030.
There is no question that the deployment of renewables will accelerate. Governments around the world continue to pass supportive legislation and provide industry incentives. Expectations vary, but according to the International Energy Agency (IEA), new renewable capacity between 2021 and 2026 is expected to be 50% greater than that added between 2015-2020. This expansion in renewables represents a significant investment opportunity.
Competing or Parallel Paths?
Solutions to many complex issues are often presented as black or white. Climate change is no exception. Polarized views either support the need for a widespread and urgent net-zero transition, or the immediate priority of energy security at all costs. This seems like a false choice. In reality, investors will likely need to pursue both paths to generate adequate returns for their clients.
In the short to medium term, the world needs additional investment in traditional fossil fuel infrastructure to meet the growing demand for energy security. In parallel, we can improve technological solutions to reduce carbon emissions. Energy storage, green hydrogen, and sustainable aviation fuels are just a few examples of solutions. Renewable sources of power are clearly winners in the long-term trend towards a net-zero economy, and we need to scale them up as quickly as possible.
Energy security and the net-zero transition may appear incompatible at first blush. In fact, investors are realizing that these themes can complement each another. Companies that are best positioned for success are those with nimble near-term strategies to leverage very tight energy supply/demand dynamics, while at the same time aligning their long-term view and business strategies with a net-zero world.
Aspirational net-zero commitments are no longer enough. Commitments need to be backed up with credible strategies, clear priorities, concrete targets and timely action that will deliver both shareholder returns and a meaningful contribution to emissions reductions. Budgets and capital expenditures need to shift, so they are on a path to align with the goals of the Paris Agreement.
Energy security and the energy transition are not mutually exclusive. We can and should pursue both. By doing so, we will make the ultimate transition to net zero as smooth as possible for citizens, companies, investors and communities. Focusing narrowly on one path while ignoring the other could cause extreme market and human dislocations in the long term.
Jennifer Coulson is Vice President, ESG, Public Markets, at BCI.