What is the energy transition?
The future of energy is about more than just the move from fossil fuels to renewable power. It involves the decarbonization of all sectors of the economy.
The energy transition is about more than clean energy. It is about decarbonization of all businesses, in all sectors, with the aim of reducing or removing altogether the harmful greenhouse gas (GHG) emissions made by businesses and individuals, which are recognized to be a key contributory factor to climate change.
Decarbonization may start with the energy sector, but it goes beyond simply the end of fossil fuels and a move to renewable power, or so-called ‘green’ gas, encompassing those hard-to-decarbonize sectors such as cement, steel, aviation and shipping.
The need to decarbonize is supported by scientific evidence and assessment gathered by the Intergovernmental Panel on Climate Change (IPCC). The IPCC documents the impact that climate change is having in significant and measurable ways — rising sea levels threatening low-lying island communities, for example, or the increasing frequency of extreme weather conditions.
Despite attempts by a minority to deny the science, climate change is real and can no longer be ignored.
The UN Framework Convention on Climate Change entered into force in 1994 with the aim of stabilising GHG concentrations “at a level that would prevent dangerous anthropogenic (human induced) interference with the climate system.”
However, it is only since the signature of the Paris Agreement in 2015 at Cop21 that climate change and the imperative to decarbonize have moved into the mainstream of public and political consciousness. The Paris Agreement aims to limit global warming to well below 2°C, preferably to 1.5°C, compared with pre-industrial levels. A global collective effort to decarbonize is required.
Spurred on by their legally binding obligations under the Paris Agreement, many governments around the world are tracking emissions and have committed to ambitious carbon reduction targets.
As a matter of corporate governance, corporates are increasingly voluntarily (or as a result of investor pressure) measuring and reporting on their GHG emissions. However, increasingly lawmakers are requiring businesses to account for GHG emissions attributable to them, with a view to decarbonizing both emissions for which they are directly responsible and also their supply chains, and in some cases, onward sales of products too.
What is net zero?
‘Net zero’ is not the same as carbon neutral or emission-free. While emission-free power, heating, transport, food production or industrial processing might be the ideal, it is generally acknowledged that this scenario lies some way in the future. Until then, governments will be seeking to rely on achieving an overall balance between emissions produced and emissions removed from the atmosphere, so that they level out at ‘net zero.’
Pursuit of decarbonization involves not only a move towards producing electricity from renewable or other low-carbon sources — and the replacement of fossil fuels such as coal, oil and natural gas (methane) with electricity or low-carbon hydrogen — but also the capture and storage of remaining carbon emissions, alongside direct air capture technology to extract existing carbon from the atmosphere.
Decarbonization of heating and transport are also high up the political agenda, with both sectors looking at electrification and also the potential to replace petroleum products or gas with hydrogen — either in the form of hydrogen fuel cell technology or as a direct replacement for natural gas in both commercial and domestic use.
Good for the planet, good for the economy?
Decarbonization will require significant investment, not only to replace carbon-emitting assets and related infrastructure, but also because not all the technologies required for the energy transition are fully commercialized or cost competitive at present. As such, the energy transition provides an opportunity for governments and corporates to take the lead in new and emerging industries by investing in research and development, investing in new asset classes and creating the skilled workforce required for a decarbonized future.
Many governments are conscious of the need provide job opportunities for a new generation and, in the context of their obligations under the Paris Agreement and the threat caused by climate change generally, are working with industry to offer financial support for the development of new technologies, funding for pilot projects and the regulatory framework to incentivize decarbonization efforts in all sectors.
What is the role of renewables in the energy transition?
A cornerstone of the energy transition is the decarbonization of the electricity generation mix, away from fossil-fuel generation such as coal and gas. Instead, renewable sources of energy, or ‘green energy,’ will play a vital role in future energy systems.
Policies to support the commercialization of renewable sources of electricity have been successful in reducing technology costs, particularly for technologies such as solar photovoltaic (PV) and wind energy. The scale of deployment will need to increase, however, to meet decarbonization targets. The IEA World Energy Outlook 2020 forecasts that by 2030, hydro, wind, solar PV, bioenergy, geothermal, concentrating solar and marine power between them will provide nearly 40pc of electricity supply.
From 2020 to 2030, the IEA forecast that solar PV is likely to grow by an average of 13pc per year, meeting almost one-third of electricity demand growth over the period. According to a report by Mercom capital, the leaders in solar PV development include Adani Green Energy, GCL New Energy, SB Energy, Enel Green Power, Brookfield Renewable, First Solar, AES Corporation, Invenergy, Lightsource bp and Engie, accounting for 33 GW of operational projects globally as of August 2020.
Wind, onshore and offshore, will play a significant part in the energy transition. The Global Wind Energy Council (GWEC) in its 2021 Global Wind Report estimates 469 GW of new onshore and offshore wind capacity will be added in the next five years, based on present policies and pipelines. Wind power development is a truly global market, with Vestas, GE Renewable Energy and Goldwind leading the market in wind turbine technology, according to GWEC.
The scale of offshore wind development has accelerated and the size of projects increased as technology costs have reduced. For example, the Dogger Bank wind farm in the UK, under development by SSE Renewables and Equinor, will be 3.6 GW when all phases are commissioned. There is significant scope for innovation, however, particularly in the development of floating offshore wind technology. The market is still nascent, with significant opportunities for partnering and consolidation. Active developers of floating offshore wind include Equinor, EPD Renewables and Engie.
Some renewable generation technologies are described as variable or intermittent — they generate electricity depending on weather or climatic conditions, and need to be accommodated within a flexible energy system that can respond rapidly to variable levels of output. This is particularly hard in developing markets with fragile grid systems such as in sub-Saharan Africa. Ways in which flexibility may be delivered are considered further below.
Other renewable electricity generation technologies are dispatchable, such as energy from waste, pumped hydropower or biomass generation, contributing to system stability. Bioenergy with carbon capture and storage (BECCS) may even deliver negative emissions, providing more headroom in the emissions budget for those sectors where emission reductions are hard to achieve. Proposals for BECCS are being developed by a number of companies, such as Drax in the UK.
The increase in renewable generation has shifted electricity generation away from a centralized, linear model where large power plants are connected to the high-voltage electricity transmission system, to a more decentralized model. Onshore, renewables may be co-located with demand, onsite and behind the meter, or connected to the low-voltage electricity distribution system. Because these tend to be less ‘visible’ to the system operator, this can create challenges for grid management in developed networks.
However, distributed generation also presents an opportunity to electrify remote communities and isolated areas of industrial activity in regions such as sub-Saharan Africa, enabling the establishment of mini-grids, combining renewable sources of generation such as solar power with diesel generation and battery storage to provide a continuous power supply structured to meet the load profile of the end-user(s).
There has been a rapid expansion of mini-grid and off-grid developers over the past few years, and these projects and initiatives are becoming increasingly targeted to meet the end-user consumer need. Scaling up of mini-grid and off-grid projects and improvements in financeability are being spearheaded by developers such as CrossBoundary Energy Access, which is taking an open source approach to increasing investment in mini-grids in Africa.
The offshore sector is bucking the distributed generation trend. To accommodate ambitious targets for offshore wind development in the UK and the EU, the development of offshore electricity grids is likely to be required (see further below). Renewables may also be used to generate heat or produce fuels, such as ethanol, biodiesel and methane. Biofuels are produced when organic matter is processed by anaerobic digestion, pyrolysis or gasification. These are considered further in the Gas and LNG section below.
As corporates seek to green their operations, as a result of commitments such as RE100, many are seeking to procure renewable electricity directly from renewable generators. Corporate renewable power-purchase agreements (corporate PPAs) are also beneficial for renewable generators that, in the absence of subsidies, need a contracted revenue stream for their projects and to manage wholesale power market price volatility to secure debt finance (and in developing economies a corporate PPA may be a preferable offtake solution to an incumbent state-owned utility).
Large corporates reported to have signed corporate PPAs include technology giants such as Microsoft and Google. Another is Amazon, which is reported to be investing in 3.4 GW of renewable electricity including a ten-year corporate power-purchase agreement with Orsted to offtake 250 MW from Orsted’s planned 900 MW Borkum Riffgrund 3 offshore windfarm in Germany.
Corporates have a variety of other options to meet their individual climate and sustainability policies, including adopting energy efficiency measures, imposing sustainability measures on supply chains and service providers, utilizing green electricity supply tariffs and purchasing renewable energy certificates of origin.
Why is electrification important in the energy transition?
Electrification using low-carbon and renewable sources of electricity will be important, not just to decarbonize electricity consumption but also in decarbonizing the heating, cooling and transport sectors. The shift away from fossil fuels and towards electricity in these sectors, together with the imperative of improving access to electricity in emerging economies, means electricity demand increases by roughly 50pc in just 20 years in all scenarios of the IEA World Energy Outlook.
EVs will play an important role in reducing road transport emissions. Global sales are forecast to top 12.2mn in 2025, indicating annual growth of nearly 52pc (compounded), according to a report by IHS Markit. This will bring with it a need for EV charging infrastructure, together with electricity grid reinforcements to accommodate rising demand at low voltages.
Leaders in EV services and charging infrastructure include BP Pulse (formerly Chargemaster), Innogy, Tata Power and Star Charge. Electrification of railways, to facilitate the move away from diesel engines, will also play a role in emissions reduction in the sector.
Heat pumps and direct electric heating will be important to decarbonize the heating sector. In particular, air and ground-source heat pumps are expected to play an important role. Although a fragmented market, manufacturers include Carrier Corporation and Daikin.
In addition, local or district networks, using combined heat and power (CHP), improve efficiency, saving carbon emissions. Indirectly, electricity used in the production of green hydrogen will also play a role in decarbonizing heat, by blending into existing gas supply and even replacing natural gas entirely (see further below).
From an energy transition perspective, it is vital that renewables and low carbon sources of electricity deliver this increased demand for electricity. In addition to renewable electricity generation technologies (see above), low-carbon generation technologies such as nuclear power and gas-fired power stations with carbon capture, usage and storage are likely to play a role in the future energy mix in a number of countries.
However, with renewable generation typically damping electricity wholesale price signals, increasingly market interventions are likely to be required to support high capital investments in newbuild electricity generation.
The integration of intermittent renewables and the accommodation of EV charging will become increasingly important, and with this a requirement for flexible energy systems. This will necessitate flexible peaking capacity, energy storage and demand-side response to manage spikes in demand at times of low renewable generation.
With increased demand for electricity, grid network upgrades will be needed, although some capital expenditure may be avoided by deploying storage or smarter grid management.
A variety of energy storage technologies is likely to be required — from batteries to flow-batteries, pumped hydro and compressed-air storage. In relation to standalone battery energy storage, 2020 saw the installation of the world’s two largest battery storage systems in California: the 230 MW/230 MWh Gateway project by LS Power and the 300 MW/1,200 MWh Moss Landing project by Vistra.
Cost reductions in longer-duration storage in particular will be needed to enable seasonal storage. In this regard, green hydrogen, produced by electrolysis using renewable or nuclear power, will have a role to play (see further below).
Interconnectors will also play an important role in managing supply and demand, allowing low-cost power to flow to high price regions. And, in regions with significant planned offshore wind generation capacity, such as in the UK and EU, the approach to interconnection will necessarily evolve to ensure a more efficient use of infrastructure, respecting the interests of local communities and other maritime stakeholders.
Here, we are likely to see the emergence of multi-purpose interconnectors and meshed offshore grids to bring the power generated onshore.
Initially we should expect to see more multi-purpose projects where offshore energy generation is connected to offshore interconnectors. An example of this is the Danish Kriegers Flak windfarm, which will be integrated into the Kriegers Flak Combined Grid Solution interconnector linking Germany and Denmark.
Looking further ahead, we may see meshed grids coupled with energy hubs to store the electricity generated or convert it into a more flexible energy carrier such as hydrogen. An example of this is the North Sea Wind Power Hub, an international consortium consisting of TenneT, Energinet, Gasunie and the Port of Rotterdam, which is evaluating this approach in the North Sea. In developing economies, individual trading markets will incrementally become increasingly connected with regional pools established and expanded.
Digitization, smart grids and smart appliances will play a vital role in the energy transition. Interconnected, Internet of Things (IoT) devices, in combination with AI, self-regulating systems and self-optimizing systems will enable production and consumption peaks to be smoothed. Smart meters will play an important role in the emergence of smart grids.
A smart meter consists of hardware that includes real-time or near real-time IoT, enabling two-way communication between the meter and the central system, permitting data to be gathered for remote reporting. With improvements in technology, smart devices are expected to enable EV-charging infrastructure to have a bidirectional grid connection (vehicle-to-grid), meaning EVs act as battery storage, discharging electricity to balance the grid during peak times.
New business models are emerging to deliver electricity balancing services and system flexibility. For example, commercial and industrial electricity users will increasingly use a combination of demand-side response and onsite generation to manage their energy costs but also to access additional revenues from the electricity services market.
Prosumers will also play a role via aggregators that manage domestic generation and storage assets to provide demand-side response and additional capacity when required.
Gas and LNG
What is the role of gas and LNG in the energy transition?
Businesses with an interest in hydrocarbons are approaching the energy transition in many ways. Some are divesting their oil and gas assets entirely (with Orsted leading the way on this front) whereas others are diversifying their businesses, acquiring stakes in renewable projects while retaining an interest in hydrocarbons.
However, the strategy for developing and marketing natural gas is changing. Some companies are promoting natural gas or LNG as a replacement for more heavily polluting primary energy sources, while others are planning to process gas (methane) into a cleaner product (hydrogen) to be used as a replacement for natural gas. Some are also exploring the use of biofuels and biogas (fuels produced directly from organic materials such as plants or animal waste) to replace fossil fuels.
The first approach is to continue to sell the same end product but attempt to market either the gas or LNG as a ‘transition fuel.’ It can be used to replace coal in those hard-to-decarbonize sectors, gradually reducing the carbon footprint while alternative options are explored. There has been much talk within the LNG industry of converting the global fleet to run on LNG rather than heavy marine fuel, for example, until lower carbon alternatives can be found.
However, it is no longer sufficient to simply deliver LNG in the way it has always been delivered. Sellers will need a strong buyer interest and in the context of the energy transition, many buyers looking to reduce their emissions will be scrutinizing the entire LNG supply chain — from extraction to regasification — and encompassing liquefaction, transportation and storage along the way.
‘Green LNG’ is the most recent development keeping LNG relevant in the energy transition landscape, but for a cargo to be badged ‘carbon neutral’ the entire value chain needs attention — from electrification of platforms, to capturing and storing emissions associated with processing, ensuring transport emissions are offset, and finally reporting on all of these efforts to buyers. Singapore’s Pavilion Energy is the first off the blocks with this approach, hoping to set a market standard for others.
A number of other players are following suit, for example, Shell and Russia’s Gazprom have announced the transport of ’carbon-neutral’ LNG cargoes, and Dutch energy and commodity trading company Vitol launched a green LNG product for its LNG customers looking to further reduce carbon emissions, which is based on offsetting.
Meanwhile, BP is working with Pavilion Energy in the longer term to co-develop and implement a GHG quantification and reporting methodology. The methodology will cover emissions from wellhead-to-discharge terminal and be principled on mutual transparency and adherence to relevant international standards.
It would be impossible to mention the energy transition without discussing the role of hydrogen, which can be used in place of natural gas in many contexts, producing only water as the byproduct when it burns. There are many so-called ‘colors’ of hydrogen, but in the context of hydrogen produced from natural gas, the hydrogen is referred to as ‘blue’ providing the carbon produced when the hydrogen is created is captured and stored (if not, it is known as ‘grey’).
‘Blue’ hydrogen is produced by steam methane reforming (i.e. mixing natural gas with very hot steam in the presence of a catalyst (nickel) to create hydrogen and carbon monoxide) with the resulting carbon being captured and stored.
Even blue hydrogen comes in different shades — there is also ‘turquoise’ hydrogen, which is created when natural gas is broken down with the help of methane pyrolysis into hydrogen and solid carbon. Either way, the end product is emission-free, although as with traditional gas and LNG there are emissions associated with production which need to be addressed before it can be described as a completely clean energy source.
The cost of hydrogen production also cannot be ignored and many energy companies believe that, without government funding or subsidies of some kind alongside both carbon and methane taxes, it will be difficult to persuade consumers to make the switch to a product that can cost up to four times as much as natural gas.
Biofuels and biogas
The third category, biofuels and biogas, has been in general use for some time. Although the majority of these fuels can reduce carbon emissions in comparison to fossil fuels by around 30pc (21 out of 26 types according to a study carried out by the EU in 2008), not all biofuels are created equal.
Some are ‘greener’ than others, and many well-known biofuels have been condemned by environmentalists for the damage they do elsewhere in pursuit of green energy — for example, the well-documented deforestation in the Amazon, or damage to human health and ecosystems.
These negative impacts have been high-profile stories across global news reports, which perhaps explains why biofuels appear to have waned in popularity as a contender for a role within the energy transition, although having said that, both the UK and EU have regulatory requirements for a certain proportion of renewable fuels to be used in the transport sector which will continue to stimulate demand as the mandated proportion increases.
Where will the funding required for the energy transition come from?
Significant investment is required to deliver the energy transition. Both public and private sector funding will play a key role. Public sector finance, for example in the form of support schemes, grants or tax breaks, plays an important role in assisting pre-commercial technologies and business models to move into commercial development. Public sector finance also plays a role in crowding in private sector funding, by de-risking aspects of an investment proposition.
An example of public finance being used in this way is the financing packaged proposed for the EU Green Deal in the EU Green Deal Investment Plan. It comprises two principal financing streams totalling €1tn. Over half of this cash, €528bn, will come directly from the EU budget and the EU Emissions Trading System. The remainder will be sourced through the InvestEU programme, which combines €279bn from the public and private sectors to 2030 and €114bn from national co-financing. It will provide an EU budget guarantee to allow the EIB Group and others to invest in higher-risk projects, enabling private investment.
Investment from via debt and equity funds will also play an important role. In this regard, the growth in sustainable finance and investment will play an important role in the energy transition. This refers to the integration of environmental, social and governance (ESG) criteria by investors and financial institutions into business or investment decisions.
There are two main drivers causing financial institutions and asset managers to focus on the sustainability of their portfolios. On the one hand there is a growing pool of capital seeking to invest in sustainable assets, driven by international initiatives to tackle climate change and investor mandates to promote sustainable development and the UN Sustainable Development Goals.
On the other hand is the recognition of the critical role that climate change risk management plays in a resilient global financial system, with voluntary measures such as the recommendations of the Task-Force on Climate Related Financial Disclosures (TCFD) beginning to be adopted by some regulators.
According to Bloomberg New Energy Finance, while the sustainable lending market represents a relatively small part of the broader capital markets, 2020 saw the highest volume of sustainable debt issued globally in any one year, totalling $732.1bn — an increase of 29pc from 2019.
The bond market, in particular, has seen significant increases in the issuance of green bonds. Green bonds are bond issues whereby the proceeds are ring-fenced and exclusively applied to finance or refinance in part or in full new and/or existing projects that will promote progress on environmentally sustainable activities.
Green bonds were historically issued by multilateral lenders, however, corporates and sovereigns have increasingly issued green bonds to increase market appeal to a broader investor class, and particularly if the proceeds will be used in any case for environmentally friendly projects.
Issuances to finance the energy transition are accelerating. For example, Italy’s Enel has issued green bonds since 2017 using the Green Bond Principles to fund green projects including, reportedly, projects for the development of renewable generation plants, the construction and management of transmission and distribution networks, smart metering systems, the development of sustainable mobility projects and demand response initiatives.
A new class of bonds known as transition bonds is also emerging, which are designed to allow companies that could not offer traditional green bonds to issue bonds that are linked to permit their companies to gradually transition to a greener business model.
Transition bonds also help to prevent ‘greenwashing’ of the traditional green bonds market as it allows industries and companies which have difficult environmental management records to begin managing sustainability in their supply chains without necessarily using the green tag.
Multi-laterals and development finance institutions also have a significant role to play in the energy transition, particularly in relation to climate finance. This refers to the financing of activities that reduce greenhouse gas emissions or help society adapt to the impact of climate change. This is often couched in terms of a flow of funds from developed nations to less developed nations, but climate finance mechanisms can be deployed in developed nations as well.
Article 9 of the Paris Agreement recognizes that developed country parties should deploy financial resources to assist developing country parties with respect to both mitigation and adaptation by mobilizing climate finance from a wide variety of sources. It goes on to encourage developing countries to step up their own efforts by recognizing that all countries have a part to play.
The scale of the investment required has been highlighted in the IEA Global Energy Review 2021, which states that annual clean energy investment in developing economies must increase seven times over by the end of this decade if the world intends to reach net-zero emissions by 2050.
Most climate finance efforts to date have been focused on mitigation finance but there is an increasing recognition of the need to mobilize more adaptation finance and reducing emissions from deforestation and forest degradation (REDD) finance to help achieve the target set in the Paris Agreement.