The Oil Downturn: A Catalytic Moment for Renewable Energy? [GGP]
Although the massive output cuts of 9.7 million barrels per day agreed by OPEC+ partners in mid-April are starting to take hold, uncertainty persists as oil prices have experienced a decline from the highs of around USD60 per barrel, at the start of the year, to less than USD20 at times, and even to negative territory concerning the US benchmark.
This article explores whether the current oil market downturn could provide a catalytic push to the large-scale deployment of renewable energies on the distinct, but mutually reinforcing, state and industry levels.
According to the International Energy Agency’s (IEA) Global Energy Review, protracted restrictions on mobility and socio-economic activity will critically impinge on global energy demand, reducing carbon emissions by a record of nearly 8 percent, down to a decade-low. Simultaneously, low-carbon technologies (wind, solar, hydropower and nuclear) are poised to thrive at 40 percent of the global power mix, partly due to a projected 5 percent decline in overall generation.
All major economies undergoing lockdowns (U.S., EU, China, India) witnessed their renewables-based generation rising throughout the first quarter of 2020, since subdued demand scaled down coal and gas-fired generation.
Renewables’ immunity lies in them being the cheapest electricity form. Accordingly, they are given priority dispatch in electricity grids, to the benefit of consumers. Lower electricity demand is pitting generators against each other to produce the costliest power. Wind and solar farms are preferred because they do not have to buy fuel.
Notwithstanding that use of renewable electricity supports decarbonization, an excess of variable energy sources, like wind and solar, can also put the flexibility of the grid at risk. The use of home or car batteries, electrolyzers, as well as of the capacity of the gas grid as a means of storage of superfluous renewables in the form of hydrogen or hydrogen-derived gases can help avoid major destabilization. Therefore, the integration of renewables necessitates a cross-sectoral market and system approach, involving both electricity and gas transmission infrastructure. But how successful can world powers’ decarbonization agendas actually prove, with “lower-for-longer” as the normal in the new oil order and economic distress set to worsen in case of potential upcoming pandemic waves?
Assessing the global climate action momentum
Before proceeding to a succinct country-by-country analysis, it should be stressed that the oil collapse has coincided with a period of growing installed renewable capacity, driven by already-built new projects and enhanced clean energy financing over 2019, as well as of continuous cost-competitiveness in onshore wind, solar photovoltaics and battery storage. In 2020, renewable installations are set for a 13 percent decline, but will rebound to, and perhaps exceed, pre-pandemic growth in 2021.
In the US, a gradually shrinking shale industry, marred by consecutive production shutdowns and financial challenges for independent drillers with thinner balance sheets, could thwart Donald Trump administration’s denial of any steps needed to address climate change. According to the Energy Information Administration, COVID-19 will lower US energy-related CO2 emissions by 7.5 percent. Of course, the complete phase-out of fossil fuels, as the climate activist movement suggests, seems rather impossible, as shale oil, and its gas subsector, will be largely consolidated by international oil companies (IOCs) willing to invest in short-cycle supply – i.e. supply that can be quickly brought on and off-line responding to global prices. Still, the revival of the long-stalled Green New Deal could now stand a better chance as part of a “Post-COVID-19 Green Recovery”.
In contrast to their NATO ally on the other side of the Atlantic, which is making advances through an amalgamation of various private sector initiatives and through a large institutional shareholder base of corporate ownership focused on sustainability, the EU Member-States are actively discussing and coordinating in a governmental institutionalized manner a 2030 greenhouse gas (GHG) reduction of 50-55 percent, with the aim of reaching carbon neutrality by 2050. This framework of the European Green Deal, presented by Ursula von der Leyen’s Commission late last year, holds implications for fossil fuel consumption, notably for the future of unabated gas and its associated infrastructure.
The EU has also been developing its green finance taxonomy, a common classification scheme for sustainable investments, that should enter into force by 2022. The schedule of the taxonomy and sustainable finance will be influenced by Member-States’ will to scrutinize what type of activities shall qualify as “low-carbon”, “transition” or “enabling”, with some already pushing for nuclear and gas to be recognized as green.
Despite occasional calls, especially by the coal-dependent Visegrad Group, to scrap the EU Green Deal and to focus on eliminating COVID-19 instead, the EU wants to place climate action at the heart of its recovery plan. According to a recent publication by the European Parliament, coronavirus “has so far not diverted Member-States from […] clean energy transition by 2050”, while economic stimulus measures to counter its effects “are likely to include greater investment in renewable energy projects and technologies.” Throughout March and April 2020, the peak months of the lockdown, European renewable generation soared at the expense of coal and natural gas (down by 17 percent and 35 percent and by 5 percent and 24 percent for each month, respectively). The Institute for Energy Economics and Financial Analysis reported that renewables delivered nearly half of all electricity generation between March 10 and April 10, an increase of 8 percent compared to the same time in 2019.
Regardless of it being historically more oil-intensive than Western Europe and depending on the outcome of the 2020 presidential election, the US could follow suit, setting up an analogous strategy to salvage a viable energy transition governed by sustainable regulatory principles.
Falling renewable costs could moreover incentivize further progress with China’s national and multilateral clean energy initiatives. According to its Energy Revolution Strategy, released as an official policy response to President Xi Jinping's stated goal, the non-fossil fuel share in China’s energy mix should account for 15 percent in 2020 and 20 percent in 2030. Green energy cooperation, as a vital necessity for survival and sustainability, is also foreseen on the international and regional levels by the Belt and Road Initiative and the Association of Southeast Nations (ASEAN)-EU action plan.
However, “lower-for-longer” prices will hinder China’s attempts to move beyond the Oil Age, as it continues its economic development to help maintain the legitimacy of the Chinese Communist Party, and to prune emissions through the development of its electric vehicle (EV) industry. On the positive side, they will likely encourage a broader coal-to-gas switch, having considerably reduced the spread between long-term oil-indexed and spot Liquid Natural Gas (LNG) contracts.
India might equally benefit from the alignment of the main regional gas benchmarks, allowing for LNG to make inroads against coal. But the lockdown ordered by Prime Minister Narendra Modi on March 24 has undermined its national clean energy plan. India’s Nationally Determined Contribution (NDC) under the Paris Agreement involves 40 percent of non-fossil fuel power generation capacity installed by 2030 and a 33-35 percent reduction of the GDP’s emission intensity from the 2005 level. The government thus pledged to 175 gigawatts of renewable capacity by 2022 and 450 gigawatts by 2030. The halt in construction and tendering out of renewable capacity, because of the lockdown and the subsequent recession, will defer these goals.
Finally, the Middle East and North Africa (MENA), long diagnosed with the Dutch Disease and characterized for the most fossil fuel-centric mix internationally, will not see renewables winning from the current oil crisis. Similarly, with all other economic sectors, renewable investments are highly contingent on direct and indirect government support, owing to the modest private sector penetration in the region. Nevertheless, “lower-for-longer” prices could incentivize MENA to diversify away from the “resource curse” and to remove controversial energy subsidies that still constitute a crucial social safety net. If reforms do not evaporate the moment prices recover, MENA will manage to prove its low-cost producer status, as oil demand peaks, and will shield its economies from oil market volatility with countercyclical fiscal policies.
Therefore, low prices are unlikely to spur individual state climate action. That is because the integration of low-carbon sources and the electrification of the transition, via, for instance, the widespread adoption of EVs, necessitate spending that the coronavirus-impacted world economies will struggle to afford.
That is even more the case with the resource-driven MENA states, whose budgets depend upon OPEC’s output regulation decisions. Countries with steadily negative opinions about the oil industry and its carbon footprint, like the EU Member-States, are better positioned to keep the momentum of climate policy strong. Others, like China and India, are willing to exploit low prices with uncertain effects for their national climate strategies, although this will also prompt a systematic coal-to-gas switch. For example, China has recently announced a suspension of financing “clean coal” projects through green bonds, by excluding projects intended for clean utilization of fossil fuels. The discussion surrounding a Green New Deal, particularly following the negative West Texas Intermediate (WTI) prices, remains questionable and may be either abandoned or resumed in a modified form depending on the outcome of the U.S. election.
Aside from individual state action on climate change, the pre-COVID era has been marked by institutional-driven and corporate initiatives that are to fully come into effect within the following few years.
While the complete phase-out of fossil fuels may not be feasible or imminent it is and will continue to be under pressure from the financial system, asset owners, global consortiums, such as The Global Climate Action portal and “We Mean Business” coalition, and financial regulators, such as the Bank of England (“BOE”) – all of which in one manner or another are taking steps to address climate change through decarbonization of the world economy. Be it restricting the financing of fossil fuel investments by firms such as Goldman Sachs, J. P. Morgan and The European Investment Bank, utilizing the power of proxy voting by organizations such Climate Action 100+ to advocate policies to address climate change or subjecting climate risk to increased regulatory scrutiny by the European Central Bank and the European Banking Authority, which recently issued guidelines on loan origination and monitoring taking into account Environmental Social and Governance (“ESG”) considerations.
Beginning 2021, the BOE will be introducing a climate change stress test into its financial stability report. In connection with the stress tests, the BOE is also examining the case for a brown-penalizing factor that introduces additional capital charges on polluting and potentially risky activities, while acknowledging impediments to implementing such a measure, including: the lack of a universally accepted definition of brown and the possibility of activities transitioning from brown to green over time.
In addition, several transportation companies are setting goals to reduce their GHG emissions, in part through a pledge with the global initiative Science Based Targets, which advocates science-based target setting by companies as a way of increasing companies’ competitive advantage in the transition to the low-carbon economy. The overall goal of signatories to the initiative, is to limit global warming to below 2°C above pre-industrial levels.
Reducing GHG emissions is not limited to the fossil fuel and transportation industries, but high-tech companies have made similar pledges. For example, Microsoft, in early 2020 announced plans to become carbon negative by 2030, remove all the carbon it has emitted since its inception in 1975-while other companies have set carbon reduction targets but not carbon “negative” targets. This was preceded by Amazon and Global Optimism announcing in 2019 “The Climate Pledge,” which is a commitment to meet the Paris Agreement 10 years early, by calling on its signatories to be net zero carbon across their businesses by 2040 – a decade ahead of the Accord’s goal of 2050. In addition, The Global Investor Statement on Climate Change, urges governments to phase out thermal coal power, put a meaningful price on carbon pollution, end subsidies for fossil fuels, and update and strengthen NDCs to meet the goals of the Paris Agreement.
The above initiatives, in part, support global supra national diplomacy to address climate change. Indeed, the theme of the 2020 World Economic Forum (WEF) was “Stakeholders for a Cohesive and Sustainable World”, wherein a global risks report published by WEF for the first time, noted that all of the top long-term risks by likelihood are environmental, and climate change is rated the biggest global threat.
But what will the future be like for coordinated supra national climate action in the post-COVID era?
We argue that the coronavirus economic crunch is likely to jeopardize multilateralism, an essential element to meet the climate challenge on the international scene, and will instead foster isolationist and/or unilateral policies. Despite that, the oil downturn could present an opportunity for world governments to increase fossil fuel taxation. At the present price lows, taxes will not hurt consumers and will boost budget revenues in favor of climate funding.
The Industry Outlook Amid Peak Oil Demand
While energy markets have historically been driven by the fundamental precepts of supply and demand, the fossil fuel industry has been inextricably linked to climate change – a threat to the global commons which requires coordinated collective global private and public sector action to address. As such, unlike other industries which have declined through, for example, technological obsolescence, the fossil fuel industry is under pressure globally to change from the corporate-societal-investor-regulatory ecosystem demanding and imposing change. The potentially seismic change to the fossil fuel industry emerging through public and private sector initiatives to provide for a “Post-COVID-19 Green Recovery” may presage further usage of renewable energy at the expense of fossil fuels to sustain future economic growth.
The decline in emissions and fossil fuel use raised ambitions that the need to respond to COVID-19 could accelerate the development of corporate climate action models, although it is easily possible to claim the opposite. The unprecedented economic contraction gave humanity a glimpse of its overreliance on fossil fuels and of the political and economic rigor needed to meet Paris targets.
These realizations encourage IOCs to adapt their investment choices to the pace of the energy transition. From an economics standpoint, oil price volatility accentuates the intrinsic risk factor of fossil fuel investments. Albeit more modest, low-carbon project returns are more predictable and bankable. Furthermore, renewables have room for growth, should the policy choices made after the crisis be in their favor. Financial institutions’ level of commitment towards fossil fuel exploration funding constitutes an example of such a policy choice. The US-EU company approaches again differ.
European energy firms clearly abide by the Green Deal roadmap. During their quarterly earnings calls, BP and Shell highlighted commitments to emission cuts and low-carbon investments. Spanish utility Iberdola and Ørsted (formerly Danish Oil & Natural Gas), already profit from orientating their capital spending on renewables, while, in the latter’s case, divesting upstream oil and gas and LNG assets.
Pressured by society and investors, US firms, including ExxonMobil, Chevron, ConocoPhillips and Occidental Petroleum, participate in global climate diplomacy through the voluntary Oil and Gas Climate Initiative and the Climate Leadership Council. However, they lack the domestic policy incentives (e.g. climate-focused government stimulus plans), via which their European counterparts prop up their businesses. While they lack such incentives, they remain under pressure from an organized base of asset owners and managers seeking their acquiescence for greater responsibility and accountability to address climate change.
COVID-19 eradicated nearly a third of global oil demand, with Big Oil striving to self-determine as climate change acquires political visibility and oil demand nears its peak, according to Vitol and BP CEOs’ recent predictions.
From the onset of the twenty-first century, “peak oil” encapsulates the concept of poor innovation in oil production and a dearth of new extraction sites, both threatening the mere existence of the industry. The second tremendous price crash since 2014 reformulates this theory, shifting its perspective from “peak supply” to “peak demand”. Hence, the industry economics gain in importance.
“Peak oil” could actuate broader fossil fuel divestments, despite the fact that such divestments have so far been limited mostly to coal, rather than oil and gas. Meanwhile, it could give greater prominence to Majors’ natural gas portfolios, as a less polluting transition fuel that could alleviate solar and wind’s intermittency problem.
The downward trend in global spot gas prices was initiated before the coronavirus demand destruction, mainly because of successive unseasonably mild northern hemisphere winters. The present oil rout could also relieve buyers of oil-indexed contracts, albeit with a six to nine months lag, while producers could gauge the viability of new capacity at lower oil-linked prices later in 2020.
Consequently, the LNG market’s flexibility and liquidity could improve, facilitating coal-to-gas switches in Asia and Europe, also considering the value of the storage capacity of the gas grid for the system integration of renewables. Nonetheless, small inter-regional price differentials might dissuade Majors from new project investments, as the returns from switching gas between markets decline.
But what about their strictly renewable portfolios? The oil and gas sectors account for a negligible 2 percent of global renewables investment. Their cash flow generation, and carbon mitigation strategies require an oil price range of USD 50-60 per barrel. In this range, solar and wind assets, with average returns on capital invested of 5-10 percent (12-13 percent for offshore projects), cannot compete with fossil fuel project returns (20 percent for a joint oil project).
However, if oil remains within the USD20-30 range, its returns are pretty much equal to returns from low-risk solar and wind projects. In a low oil price environment, cheaper renewable costs imply that projects can avoid subsidization and can yield stable cash flows under long-term supply contracts, being on par with greenfield oil projects.
The above analysis is harder to apply to national oil companies (NOCs), which traditionally abide by their corresponding governments’ priorities and are rather likely to concentrate on deeper regional integration through the oil and gas value chain.
The extent of low and zero-carbon investments rests on the climate policies and regulations implemented by NOCs’ respective governments, as well as by those countries hosting IOCs, for the latter to preserve their social license to operate.
Nevertheless, low oil prices will likely increase the pace and quantity of the industry’s clean energy investment options. The big question pertains to companies’ medium-term expectations. If they deem that prices will rebound to the sixties’ range within the next decade, then saving money for future drilling makes economic sense. Instead, if they foresee demand peaking by 2030, they will definitely have to continue diversifying their portfolios – and investing in renewables will look proportionally more attractive.
Conclusions – The Shifting Energy Geopolitics
Our analysis has shown that “lower for longer” oil prices are improbable to engender individual governmental climate action policies, for different reasons per country/region, with the exception of the EU, where the Green Deal initiatives are coming to fruition as funds are allocated to them. Additionally, the economic distress associated with the restrictions intended to fight COVID-19 will likely obstruct multilateralism in global climate diplomacy, putting institutional-driven and corporate initiatives at risk. But potential exists for concerted solutions, like a consumer-friendly fossil fuel taxation that will boost international climate finance.
As for the industry, the possibility of peak demand sensed during this oil price fallout may make the IOCs revisit their medium-term clean energy alternatives. New gas project investment decisions, considering gas’ role as a bridge to renewables, seem doubtful, as reduced inter-regional price differentials entail limited returns from a coal-to-gas switch. Prospects are brighter for renewable projects that, with oil trading in the USD20-30 range, can generate appreciable cash flows. However, the extent of such investments revolves around climate policies and regulations of NOCs’ respective governments and IOCs’ host countries, which explains why the state and industry levels are distinct but mutually reinforcing.
Whether or not oil’s collapse will offer renewable energy its catalytical moment depends on the degree of its recovery to pre-pandemic highs. But it is a fact that the positive worldwide emissions and fossil fuel abstention figures have at least opened the debate on a possible long-lasting impact of the coronavirus on climate. This debate will raise the issue of how interstate power relationships are going to unfold in a clean energy world.
Historically, far-reaching energy market shifts are typically accompanied by geopolitical shifts. For example, the transition from coal to oil made relations with the Middle East and the Gulf geopolitically indispensable for any importing nation’s energy security. For some perspective, the transition by Great Britain’s Royal Navy from coal to oil, was made in 1911; oil is still widely consumed today and the MENA maintains its geopolitical importance, although different states, such as China, are more involved in the region. The shale revolution of the past decade, that expanded the US’s geopolitical clout thanks to its nascent net oil exporter status, offers another yet example of such a shift.
But the zeitgeist is now rapidly changing. The growth of decentralized technologies means that future energy systems will stand out for high-level competition and the absence of energy superpowers emerging from them. The gain-loss game about geopolitical advantages from the energy transition might even turn major hydrocarbon producers, such as Russia and Saudi Arabia, into holders of stranded assets – a point somewhat acknowledged by Saudi Arabia through its IPO of Saudi Aramco-monetizing its fossil fuel assets in advance of further decarbonization. As low oil prices suddenly render renewables as appealing as upstream projects, the evolving energy geopolitics deserve greater attention.
Mariana Liakopoulou is Research Fellow in Energy Security, NATO Association of Canada (NAOC). William Jannace is an Adjunct Professor and Lecturer at Fordham Law School, Baruch University and U.S. Army War College.
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