Back to the future: the Horizons year in review
We look back at the highlights of our Horizons thought leadership series
COP26 may not have ended with a bang, but the series of announcements made at the global climate conference weren’t exactly a whimper either. Despite last-minute, headline-grabbing amendments, Glasgow was about far more than a ‘phasing down’ of coal. As COP26 president Alok Sharma said, ‘1.5 is still alive, but its pulse is weak’. With nearly 200 countries signing the Glasgow Climate Pact, however, the way has been paved for future progress.
A major boon of COP26 was that it broke new ground in a number or key areas including methane emissions pledges and subsidies for fossil fuels as well as underpinning carbon market development. Glasgow also galvanised many countries, industries, companies and the financial community into action. We touched on a number of these issues in the inaugural year of our Horizons thought-leadership series, so this seems like an auspicious time to review our articles over the year and put them in recent context.
Horizons 2021 issues:
January ‒ Total eclipse: How falling costs will secure solar's dominance in power
February ‒ Fast and furious: Europe's race to slash emissions by 2030
March ‒ Tectonic shift: China's world-changing push for energy independence
April ‒ Reversal of fortune: oil and gas prices in a 2-degree world
May ‒ Swimming upstream: a survivor's guide
June ‒ Location, location, location: the key to carbon disposal
July ‒ Champagne supercycle: Taking the fizz out of the commodities price boom
August ‒ CO₂mmit and CO₂llaborate: Squaring the carbon circle for oil and gas
September ‒ One giant leap: President Biden's vision for repowering America
October ‒ The blue-green planet: How hydrogen can transform the global energy trade
November ‒ Plastic surgery: Reshaping the profile of the plastics industry
Renewables are where much of the energy-transition capital will be invested. Over the next 20 years, we expect renewables’ share of world power capacity to rise to 30% from 10% today.
Some 2.6 TW of this will be cheap solar; we forecast solar costs to fall 15% to 25% over the next 10 years. Silicon-based modules will dominate, but become more efficient, with higher power ratings. Tracker technology will evolve, with new configurations and lower prices enabling greater energy capture. The lifetime operation and maintenance of solar assets will be automated.
By 2030, we expect solar to be the lowest-cost source of new generation across the United States. Its very success poses new risks to its value proposition, however. Players looking to capitalise on solar growth will need to counter the risk of value destruction.
Update: The global pandemic has been nothing if not unpredictable. Norms have been broken, including the once ironclad tenet of declining solar costs. Various factors lifted the cost of new solar projects in the United States in H1 2021 (rising commodity prices, the tight polysilicon supply-demand balance, elevated high global shipping costs and covid-related logistics bottlenecks, while trade measures squeezed the global supply chain, leading to module shortages and even higher costs in H2. New solar projects coming online in 2022 will thus be at least 5% more expensive than in 2021. And if the existing solar tariff is extended, costs will not return to 2021 levels until 2024.
It is not all is bad news, however. US President Joe Biden’s climate agenda includes extending solar investment tax credits for another 10 years and allowing the technology to take advantage of the federal production tax credit and direct payment. If passed by Congress, the tax incentives will more than offset the near-term project cost increase. And solar will remain or become the most-competitive new-generation resource in many US states in the 2020s.
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If Europe is to cut its greenhouse gas (GHG) emissions to 55% below 1990 levels by 2030, dramatic changes need to be made. The European Union (EU) needs more renewable generation, a shift to electric vehicles, a faster phase-out of coal and new ways to encourage energy efficiency and accelerate the electrification of buildings.
Reforming the carbon market will be critical, especially in sectors such as cement and steel. Though the EU Emissions Trading System (ETS) covers sectors that generate half of the bloc’s emissions – power, industry and aviation – they will only deliver a third of the cuts needed. Policymakers must provide the energy industry with more certainty on the future cost of carbon and the sectors that will be affected. What’s more, reform must come soon to spur investment in technologies such as carbon capture and storage (CCS) and low-carbon hydrogen.
Update: The European Commission presented its Fit for 55 package in July, including plans to create a second ETS for buildings and road transport. The much-awaited carbon border adjustment mechanism proposal was diluted to cover just a handful of industries. Wind and solar remain crucial, but further policy and regulatory changes are needed to unlock growth.
The cost of carbon in Europe continues to rally and will give investors confidence to accelerate the deployment of newer carbon abatement options, such as hydrogen and carbon capture and storage (CCS). However, record gas prices are hampering coal-to-gas switching. The energy transition is not to blame, but short-term consumer protection measures will not help to get Europe race ready.
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China is increasingly dependent on the rest of the world for its energy (other than coal) and metals. In a bid to cast off the shackles of external reliance and dominate the resources and technologies the world needs to decarbonise, its goal of carbon neutrality by 2060 heralds the total transformation of its economy and how it produces, transports and consumes energy.
China is already well ahead of the game in virtually all clean-energy supply chains and technologies. Electrification is hitting its stride, underpinned by colossal investment in renewable generation. It dominates the supply and processing of most raw materials needed for batteries and other zero-carbon technologies. With governments globally selling green deals on the promise of job creation and prosperity, this is a major headache for much of the developed world.
Update: Recent high energy prices and widespread power shortages have highlighted the importance of coal in China, resulting in policy efforts to increase production. These events should not be seen as a diversion from China’s long-term strategy, however, but as a consequence of its rapid energy demand growth and competing energy goals. This balancing act will continue, but China remains committed to its 2060 net-zero target and to leading the energy transition.
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If the world cranks up its efforts to limit global warming to 2 °C, the consequences for the oil and gas industry will be severe. Under our accelerated energy transition 2 °C scenario (AET-2) to 2050, the energy market would be progressively electrified and the most polluting hydrocarbons squeezed out. Prices would come under pressure amid falling demand and the traditional relationship between oil and gas prices would be turned upside down, with gas prices trading at a premium to oil on an energy basis.
This is just a scenario, but the risks associated with robust climate-change policy and rapidly changing technology are great and the implications of such a scenario are profound.
Update: Much has happened since this insight was published although the AET-2 scenario remains viable and a possible outcome to the push for emissions reductions. More governments have put forward net zero targets while COP26 has pledged to limit global temperature rise to 1.5C, an even more challenging CO2 reduction target. At the same time, demand for fossil fuel has rebounded strongly, sustaining oil prices and pushing gas and coal prices to record highs, a clear reminder that more fossil fuel supply is needed even as efforts are underway to reduce demand and emissions. The road to achieve the Paris Agreement goals remains bumpy.
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The upstream industry finds itself having to supply oil and gas to a world in which future demand – and price – are highly uncertain. The range of potential outcomes is dizzying. A gradual energy transition, for instance, could require the industry to invest in new production capacity for another decade or two. Our AET-2 scenario, in contrast, sees oil demand and prices slide while gas fares comparatively well. This makes strategic planning infinitely more complicated as the upstream sector positions itself for the challenges ahead.
Update: The pandemic recovery has driven oil and gas prices above pre-downturn levels, so cash flows could remain at record levels in the coming years. However, COP26 has reinforced the momentum behind global net-zero aspirations, so the industry shouldn’t rest on its laurels.
The Global Methane Pledge is a catalyst for regulations, penalties and fines. For governments, this captures value, mitigates tax leakage and helps net zero goals. Most operators are on the right trajectory; for the rest, it’s a wake-up call.
The gathering momentum behind Scope 1 and 2 decarbonisation is needed to prolong the viable life of the industry and keep it investible. It also crystalises gas’s role as a transition fuel. Strong near-term oil cash flows exacerbate the strategic challenge.
COP26 has also brought the upstream sector closer to being considered part of the climate solution. In defining the framework for voluntary carbon markets, carbon pricing will become more visible and transparent, offering a window into CCS revenue streams and alternative business models.
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Even if we manage to meet the goals of the Paris Agreement and limit global warming to 1.5 °C of pre-industrial levels, fossil fuels will still account for close to 37% of the world’s primary energy demand in 2050. We estimate that we would have to cut emissions by 1.8 billion tonnes of CO2e a year over the next three decades to have a chance of hitting the 1.5 °C target.
This is a challenge that a transition to renewables alone cannot solve. Achieving a low-carbon future also requires carbon removal, especially through CCS. We believe a real, scalable solution lies in basin-wide CCS.
We have identified the location of 1,500 potential depleted oil and gas reservoirs that are technically capable of storage. Our asset-level emissions benchmarking tool has enabled us to map industrial point-source emitters to potential storage sites and we have validated our approach through case studies. Matching pre-screened storage sites with nearby industrial clusters could be the foundations of a commercially viable carbon disposal industry.
Update: The second half of the year has seen increased momentum and interest in the idea of CCS hub development. While many were already in the planning and execution stages in Europe, North America is climbing on board. Several firms are actively pursuing opportunities to identify storage sites that could become CCS hubs, while others are looking to provide CO2 gathering, transport and disposal as a service.
New investors and financials are entering the CCS space, while a few financial companies have recently set up brand new CCS-focused desks to identify investment opportunities in CCS hubs in the Lower 48. The one question is how to make money from CCS aside from credits. A pathway to true revenue generation through CCS will supercharge CCS development.
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Another supercycle is coming. But while previous cycles lavished windfalls on the entire natural resource sector, the forces shaping this nascent boom are unlike any other. For the first time, hydrocarbons will be bystanders, while those metals critical to the energy transition will take centre stage with a sustained period of extraordinary demand growth.
Three potential developments could challenge how this supercycle unfolds, however:
- the rise of ‘consumption consciousness’, undermining the long-term use of primary metal
- systemic supply uncertainty, forcing commodities into obsolescence
- the narrowing control of metals’ supply chains, excluding many from the party.
Crucially, unlike previous cycles, this supercharged growth has been flagged well in advance. With such forewarning, the mining sector has the opportunity to act pre-emptively to achieve a more sustainable long-run market dynamic. Not acting will leave the industry at risk of perpetuating the boom-bust cycles that have plagued it since time immemorial.
Update: Despite the spectre of rising interest rates and slowing demand, claims persist that a natural resources supercycle is underway. Mined commodity prices reflect an assumption of persistently strong demand, increasingly supported by energy transition uses, something that is by no means assured, at least in the medium term. Should the world opt for faster decarbonisation, the supercycle will inevitably occur, bringing with it material shortages and lofty prices.
COP26’s re-affirmation of the accelerated adoption of renewable energy and electric vehicles reinjected the fizz into the champagne supercycle, at least for energy transition-focused metals. Consequently, transformational demand and concomitant sustained high prices seem assured, ultimately spurring primary and secondary supply growth.
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The oil and gas sector is on notice. Stakeholders are demanding greater accountability for carbon emissions along the value chain. Net zero Scope 1 and 2 emissions by 2050 are now the industry standard. Scope 3 emission reductions are coming – with significant implications for corporate strategies and capital allocation.
The pressure is rising from stakeholders in large part because there is growing pressure on them to decarbonise their own portfolios. The momentum is inexorable, driven by the underlying facts of climate change.
Carbon-related investment standards will mature and converge – perhaps soon. The pool of investors that will agnostically invest in the oil and gas sector, indifferent to the energy transition, will continue to shrink. Governments are setting increasingly ambitious national emission reduction targets and stricter, mandatory corporate climate reporting will follow. Now is the time to reinvest cash flows from higher oil prices in building a sustainable business for future decades.
Update: Since the Insight was published, stakeholder pressure to decarbonise has accelerated. COP26 catalysed initiatives such as the Glasgow Financial Alliance for Net Zero and the formation of an International Sustainability Standards Board was formally announced. The investor-led Net Zero Standard for Oil and Gas illustrates expectations for oil and gas companies and it is clear that the message is getting through. The US Majors are now guiding that low carbon will account for c. 10% of investment (from no guidance) over the next 4-5 years, while Euro Majors have significantly increased their own low-carbon investment plans. New net zero commitments by NOCs illustrate that this is resonating beyond public IOCs.
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US President Joe Biden has a challenging, transformative vision of net-zero emissions in the US power sector by 2035 and the broader economy by 2050. Technological limitations, policy design, market structures and the political and constitutional foundations of the United States create roadblocks that will impede the pace of progress towards this goal. Even so, efforts to meet them will bring about major change in the US market that will help lower global carbon emissions.
Update: In a first step towards reaching net zero, President Biden signed the Infrastructure and Investment Jobs Act into law on 15 November 2021 after months of Congressional negotiations. The Act takes support for emerging technologies to the next level, transforming carbon capture, utilisation and storage (CCUS) support from a niche tax-equity incentive to a bolder infrastructure plan with US$7 billion in funding. It also affirms a plan for a hydrogen hub strategy, while nuclear power is back in vogue, with US$6 billion to fund a civil nuclear credit programme.
These technologies have a way to go before they can make a material difference to US emissions. Further support has been proposed as part of the Build Back Better Act, which is still being debated in Congress.
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Electrification is at the heart of the changing energy mix, with innovation driving down the cost of renewable power, denting longer-term demand for hydrocarbons. Electrification can only take the world so far, however. Many industrial sectors, as well as heavy-duty trucking, shipping, aviation and chemicals, will need alternatives. Low-carbon, green hydrogen has potential to capture a sizeable market share, with the world’s major energy importers already rolling out their hydrogen roadmaps.
In turning the energy-trade world order on its head, net zero simultaneously offers energy exporters a once-in-a-lifetime opportunity to secure future revenues by developing low-carbon hydrogen supply. This will include blue hydrogen from those with access to low-cost natural gas resources and carbon capture potential – Russia, Canada, the US and Saudi Arabia – and green hydrogen from those with vast renewable resources – including Australia and the Middle East. The race is on.
Update: The form of future physical trade in hydrogen and the corresponding midstream infrastructure linking remote markets is uncertain. Pipe or ship? Compression or liquefaction? Pure hydrogen or via carriers such as ammonia? Players are evaluating the infrastructure investments they want to ensure high utilisation over the next 20 to 30 years, but confidence is proving elusive.
The rhetoric around the low-carbon hydrogen trade has gained momentum of late. Alongside an increase in project announcements, Article 6 resolution at COP26 provided a framework for emissions accounting, paving the way for global carbon market development, while the US government approved a clean hydrogen production tax credit of up to US$3 per kilogramme, which we expect to boost electrolyser installations in the US.
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Plastic has a key role to play in delivering a more sustainable future – be it as a key material in delivering the energy transition or in displacing other materials that have an even more challenging environmental footprint. Greater efficiency won’t be enough to tackle environmental challenges that will only intensify under the industry’s current business model, however.
In our base case, these efficiency gains are swamped by the impact of rising demand, leaving the world awash in plastic waste and struggling to pursue net zero targets. But the industry can pursue a better future if takes tough decisions to bend the curve of environmental damage. In our ‘peak plastic’ scenario, we show that a challenging regimen of diversifying feedstocks, minimising the production footprint and cleaning up the waste chain can deliver a healthier plastics value chain.
The industry, therefore, needs to make transformative change across the entire chain. Failure to act could cost it the support of stakeholders and markets, maybe even the social licence to operate.
Update: Dow recently announced the creation of the world’s first zero-emission ethylene facility, while at the other end of the value chain, Coca-Cola has rolled out a trial-scale, all plant-derived polyethylene terephthalate (PET) bottle. Such innovations are examples of those necessary to drive a more sustainable industry, but there is still a long way to go and challenges persist.
We hope you enjoyed our 2021 Horizons thought leadership series. We’ll be back next year exploring the themes shaping the energy and natural resources landscape.
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