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COP27 AND THE GLOBAL ENERGY SECTOR – A HAZY OUTLOOK

09 November 2022 | Insight

Post-Ukraine upheaval in energy markets makes this year's UN climate summit unpredictable for the industry

Start with the one thing everyone can agree on: the energy sector will play a critical role in reaching Paris Agreement climate accord targets. Ahead of the United Nations' COP27 summit this month, we analysed the impact of climate change on the sector from a physical and regulatory perspective and explore what will likely loom on the horizon following the conference.

According to an International Energy Agency report published in May 2021 (available here) (the IEA Report), the energy sector is the source of a substantial proportion of global greenhouse gas emissions. With the sector set to play a crucial role in the transition to net zero emissions, COP26 brought climate change to the forefront of many political and societal agendas.

However, recent events, including Russia's invasion of Ukraine and the global surge in inflation, have dominated political debate and drawn attention from climate action, even as many states saw record-breaking temperatures in the summer. Notably, the Ukraine invasion led certain countries to prioritise security of energy supply by investing in oil and gas (such as Italy); granting new oil and gas licences (as seen in the UK); increasing the use of thermal coal for power generation; and possibly delaying the phase-out of nuclear power (both notable responses in Germany). It has been observed that such actions may undermine long-term climate commitments but it remains to be seen whether this is a temporary pivot or a substantive shift with profound consequences. It should be noted, however, that significantly rising oil and gas prices have further highlighted renewable generators' ability to provide the cheapest available electricity, while reducing Western nations' reliance on fossil fuel exporters such as Russia.

Nonetheless, commentators have observed that this current reprioritisation, in the context of ongoing tensions between developed and developing countries, may stall significant progress at this year's COP27, being held in Egypt from 7 to 18 November. As such, many expect that COP28, which will be held in Dubai in 2023, is likely to be significantly more energy focused than COP27.

how has climate change impacted THE ENERGY SECTOR?

While geopolitics has dominated news coverage, 2022 brought a stark increase in extreme weather events across the globe. Record heat and drought occurred across Europe, the US and China, with forest fires raging and rivers running dry, while other countries such as Pakistan and Nigeria experienced severe flooding. The climate emergency has never seemed more tangible.

These physical effects of climate change also impact on the energy sector directly. Renewable power generation is weather dependent, so climate change can significantly affect levels of power output. Power generation infrastructure can also be affected, as seen in August when China and Norway experienced challenges with hydropower generation due to extreme changes in river water levels following droughts.

These impacts are set to become more profound given that the infrastructure for low-carbon electricity is usually more vulnerable to extreme weather events than pipelines or underground storage facilities, as the infrastructure could be damaged by wildfires (as seen this year in California) or by flooding. Pipelines, on the other hand, are not immune to climate change impacts; gas pipelines in the Arctic are being destabilised by thawing permafrost causing the ground to shift.

how has climate change impacted investment in the energy sector?

Although climate change has become an increasingly important consideration over the past decade, it is just one of a range of factors driving investments in the global energy sector. Economic uncertainty, rising fuel costs, decreasing costs of renewable technology and security of supply concerns all affect the nature and size of investments.

Nonetheless, more ambitious climate targets have been set at national and international level in recent years. Over 70 countries, including the largest emitters – such as China, the US and the EU – have now all set net-zero targets. In some countries, this has led to a corresponding rise in climate change-related policies, which often aim to both encourage certain investments, often in clean energy, and discourage fossil fuel production.

For example, after creating a legally binding target to reduce net greenhouse gas emissions by 55% by 2030, the EU published the 'Fit for 55' package, a suite of policies to adapt its regulatory and legislative landscape to this more ambitious target and help Europe become the "first climate-neutral continent in the world". The package included measures to discourage fossil fuel use (such as expanding the scope of the EU Emissions Trading Scheme (EU ETS)) and to drive renewable power production and energy efficiency initiatives.

The effects of climate change, as well as the sources of emissions, vary between jurisdictions, leading to a range of policy responses. For example, while some developed countries are working to phase out fossil fuels, others have adopted a more cautious approach (a communiqué released following a meeting of African ministers in Cairo in September resisted an abrupt move away from fossil fuels for fear of threatening Africa's economic development).

Some climate policies have proven less contentious. From a small number of national emissions trading schemes (ETS), such as the UK ETS, which was originally launched in 2002, to the EU launching the first international equivalent in 2005, there are now over 20 such schemes globally (including in China, Switzerland and Mexico) and more have been announced (notably in India). These schemes have differing scopes and mechanics and, as a result, the prices for allowances vary greatly. Carbon Emission Allowances under China's ETS have reached highs of 61 CNY/t (approximately €9/t), while the price of EU Allowances under the EU ETS has hit highs of €99.22/mtCO2e.

KEY PRIORITIES FOR THE ENERGY SECTOR

Many energy companies have published climate commitments, with the majority of European multi-national energy companies having announced aims to be net zero by 2050. Current strategies to meet those net zero goals include:

  • Cutting carbon in operations and production;
  • reducing emissions from fuels and other energy products;
  • developing new low carbon energy, businesses, products and services (including solar and wind); and
  • developing carbon capture and storage technology.

Although working towards ambitious climate goals, some companies have announced their intention to use their oil and gas production to fund other branches of their business, at least for transitional periods. Russia's invasion of Ukraine and the related oil price rise has also led to a renewed focus on oil and gas production to ensure security of supply.

Within this context, a number of energy firms have faced greenwashing claims, leading to an increased focus on the substance of public communications and practical measures to mitigate disclosure risk.

Companies operating in specific parts of the energy sector will have different priorities compared to firms focused on oil and gas production. For example, renewable energy firms may be focusing on raising investment to increase generation capacity and, secondly, to develop energy storage solutions to mitigate the intermittency limitations of most renewable sources.

how do post-Ukraine priorities align with cop26 pledges?

Net zero emissions by 2050 targets:

The priorities set out above largely align with the commitments made at COP26. Although last year's summit did not deliver on high expectations, some progress was made, including recognition that the target should be to limit warming to 1.5°C above pre-industrial levels, rather than merely "well below 2°C". The IEA Report concludes that to hit the 1.5°C target, the world will need to reach net zero emissions by 2050. It is therefore positive that several companies are aiming to reach net zero emissions by 2050, as this target aligns with the Paris Agreement.

Phasedown of coal use:

A key element of the Glasgow Climate Pact (the main agreement reached at COP26 – for further information, see here), was a commitment to phasedown unabated coal power. The sector accounts for a quarter of global greenhouse gas emissions and coal is the single largest contributor to human-created climate change. However, coal power generation has been increasing again in Europe and China, to meet power demand from the European shift from Russian gas, and in China in response to reductions in hydropower output.

Methane emissions:

Another key agreement reached at COP26 was the Global Methane Pledge: over 100 countries committed to reduce global methane emissions by 30% by 2030. As methane is 25 times as potent as carbon dioxide, this agreement is an important step in reaching net zero emissions by 2050. A significant proportion of methane emissions come from the oil and gas industry. A focus by the sector on reducing emissions from operations and production, as well as reducing emissions from fuels, aligns with this pledge.

what is on the horizon for the energy sector?

Companies in the energy sector will continue to work towards their climate commitments, but progress will be impacted by shifting government priorities. For example, Russia's invasion of Ukraine has led several countries to prioritise security of supply. The UK Energy Security Strategy aims to align with the UK's Net Zero Strategy – including by accelerating the deployment of wind, solar and hydrogen generation – but has been criticised for its focus on domestic oil and gas. It is expected that over 100 new oil and gas licences will be issued in the next licensing round.

Companies also face investment challenges. Several governments targeted the industry in response to rising inflation, including through caps on energy bills (seen in the UK, Norway and France) and 'windfall' taxes (notably in the UK, Spain and Italy).

The Glasgow Climate Pact included a commitment for all parties to revisit and strengthen their climate commitments and in 2022 submit revised state action plans – known as nationally determined contributions (NDCs) under the Paris Agreement framework. Although energy companies would not be directly affected by this, they will likely be impacted by resulting legislation to implement ambitious state climate goals.

Looking ahead, it remains unclear what impact COP27 will have on the energy sector, as countries have been unable to agree on broad priorities. Developing nations insist that climate finance should take precedence, while developed countries have argued discussions should focus on emissions cuts. Recent measures by developed nations to protect energy security that seemingly undermine their climate ambitions have only exacerbated underlying tensions.

The global energy sector is in the invidious position of knowing that geopolitics and state regulation will increasingly and dramatically shape the industry's destiny throughout the current decade while the outcome of those forces has never been so hard to usefully forecast. The industry will be watching closely for any clues emerging this month from Sharm El-Sheikh.