A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google “Deloitte Monday Briefing”.
The energy crisis is likely to have a significant impact on carbon emissions for years to come.
In the near term, and in certain areas, the crisis is likely to lead to higher carbon emissions. Shortages of natural gas are forcing some countries to use more polluting coal and oil to generate electricity. Germany has brought two mothballed coal-fired power stations back into operation and increased its use of heavily polluting lignite, or brown coal. Helping households and businesses with fuel bills has reduced the capacity of governments to invest in renewable capacity, energy storage, heat pumps and upgrading energy grids. Higher energy prices have contributed to the rise in interest rates which increases financing costs for renewable projects.
But higher energy prices and shortages of gas have other effects, especially in the long term, which could accelerate the move away from hydrocarbons.
European gas prices are running at roughly ten times the levels that prevailed before 2021 and the oil price is about a third higher. Financial markets assume that higher energy prices are here to stay. This has huge incentive effects. A doubling in the price of energy halves the payback period for energy-saving projects and vastly strengthens the case for renewable sources of energy.
The response of western economies to the 1973 oil shock, which saw the oil price triple, demonstrated what can be achieved. Between 1975 and 1985, the fuel efficiency of US cars doubled thanks to improvements in engine design and vehicle weight.
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Some countries have introduced energy-saving mandates – in Germany retail stores are required to keep doors closed, public buildings and monuments cannot be illuminated at night, and temperatures in office buildings must be limited to 19 degrees.
Painful though high hydrocarbons prices are, they encourage the drive for efficiency and for alternatives. The International Energy Agency (IEA) estimates that a carbon price of $200 to $250 per tonne would be needed to achieve net zero by 2050. According to the Climate Change Committee, the average UK home emits around four tonnes of CO2 from heating and electricity. The average UK domestic energy bill is currently capped at £2,500, more than twice the average of recent years. This is equivalent to a carbon price of around $670 per tonne, well above the IEA’s $200-$250 threshold, suggesting that meeting the 2050 climate goal is attainable.
Security of energy supply has long been a concern for governments. Even in pre-coal, pre-industrial England sourcing sufficient firewood was seen as an existential task. A pamphlet of 1611 on the contemporary energy crisis was entitled “No Wood, No Kingdom”. In the second world war German and Japanese strategy was heavily influenced by the need to secure new sources of oil and coal.
In recent years, low energy prices, and the growth of renewables and of US energy supply have eased western worries about energy security. Now, with Russia’s invasion of Ukraine, energy security is at centre stage again, providing a new impetus to the drive for renewables.
The EU aims to generate 45% of its energy from renewables by 2030, up from a pre-crisis target of 40%, and has announced the first of a new string of renewable power projects. President Biden’s recently passed Inflation Reduction Act included $391bn in funding for energy projects including energy efficiency and renewable power. In the UK, the new government has announced plans to end what has effectively been a moratorium on onshore wind development. The drive for greater energy independence does not, however, only involve carbon-free energy sources. A number of countries, including the UK, Germany and Denmark, have announced that they plan to start new drilling for oil and gas to secure domestic supplies of hydrocarbons.
Low-carbon energy sources have risen from 8% to 18% of the global energy supply since 1973 though many richer countries have moved more quickly. Renewable sources accounted for 5% of UK electricity generation in 2007, a figure that, by 2021, had risen to 40%. Even after accounting for nuclear generation dropping by approximately half since the late 1990s, low-carbon sources produce over half of the UK’s energy output. Together with the near-complete phasing out of coal – which still generated almost 40% of electricity in 2012 – UK electricity is almost two-thirds less carbon intensive than in 1996.
While low to middle-income countries consume more energy as they become more prosperous this does not necessarily hold for richer countries. The UK, Germany, Denmark and Switzerland have managed to grow GDP per head in the last 25 years with stagnant or even declining per capita energy use. In the UK, for instance, between 1995 and 2019, per head GDP rose 42% while per capita energy declined by 8%.
Meanwhile economies of scale coupled with advances in design and technology have collapsed the cost of energy from new renewables. The price per unit of energy from onshore solar panels fell by 90% between 2009 and 2019; the price of energy from onshore wind fell two-thirds. Both sources of energy are now far cheaper than gas or coal.
Governments have to keep the lights on come what may. In the current crisis that means some countries are using more polluting sources of energy. But there’s another story here too. Three powerful forces – a greater focus on energy security, the prospect of a prolonged period of elevated hydrocarbon prices and the declining cost of renewables – could speed the energy transition. The risks and uncertainties in getting to net zero are enormous. But the energy shock could just help us to get there.
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