With the dust settled, it’s a good time to look at what the pledges and commitments made at COP26 mean for energy and natural resources. Here’s a summary of our views on the implications for the global economy, carbon markets and individual sectors in energy and natural resources.
Global economy: coordination, policy detail and firm spending commitments still lacking
Despite some progress, COP26 left key issues unresolved. Countries vulnerable to warming effects have higher adaptation costs. Meanwhile, the costs to mitigate climate change will be higher for carbon-intensive economies. But the renewed commitment to US$100 billion per year of support to low-income economies isn’t enough to address this and ensure a fair transition. At the same time, there is a lack of globally coordinated and aligned policies and projects for carbon reduction. Instead, we have a set of pledges, with countries setting their own policies to achieve them. Coordination, policy detail and firm commitments to public spending remain glaring omissions in the global climate pact.
Global carbon markets: inclusion in Article 6 makes global carbon markets a reality
After six years of missed opportunities, international carbon markets were finally included in Article 6 of the Paris Rulebook. Thanks to the more robust and transparent framework, we estimate the value of the market could surge from US$1 billion in 2021 to nearly US$200 billion in 2050. The elimination of double counting makes decarbonisation real (although the carry-over of 300 Mt of legacy Kyoto credits could undermine market transparency). In the near term, price volatility will continue. But by 2030 demand for high-quality credits could drive prices up more than tenfold, allowing the financing of real emission reduction.
Fossil fuels: subsidies are on the table
After 25 iterations, Glasgow saw fossil fuel subsidies mentioned explicitly in a COP cover decision for the first time. The debate over what constitutes a subsidy remains contentious, however, with the text referring to the ‘phase-out of inefficient fuel subsidies’ (our italics). We take that to mean regulated or capped pricing, which skews the competitiveness of energy supply, devalues the commodity, and fails to incentivise energy efficiency. The issue creates a difficult balancing act for many fossil-fuel dependent economies — the word ‘inefficient’ allows them plenty of room to manoeuvre.
The COP26 messaging was clear: coal’s days are numbered.
Coal: a stay of execution
The climbdown on a global agreement to phase out coal made headlines, but the COP26 messaging was clear enough: coal’s days are numbered. As a result, finance and insurance costs for coal will climb even higher. Alternatives to coal-based power and industrial applications that are both scalable and affordable will take time to roll out. But a global carbon market will eventually accelerate the competitiveness of low-carbon solutions in both the power and steel sectors. The consequences for coal are clear.
Gas: headroom for resilience
COP26 was positive for the gas industry, despite the lack of a clear statement on its role in the energy transition. To hit 1.5 °C, gas use will inevitably need to reduce over time. However, the global methane pact facilitates direct Scope 1 and 2 emissions reductions. That would give gas a role as a transition fuel. Meanwhile, the ‘phasing down’ of coal could encourage increased gas use in developing Asian markets. At the same time, global carbon markets could incentivise the scale up of carbon capture and storage (CCS), as well as blue hydrogen.
Oil markets: few surprises
Our base case energy transition outlook for oil needs no significant adjustments following COP26. We expect continued oil demand growth in the medium term, with production increasing enough to meet demand. In the long term, CCS and low-carbon hydrogen adoption will support synthetic eFuels supply into sectors which are harder to decarbonise.
Upstream oil and gas: all roads lead to Scope 1 and 2 decarbonisation
Under a 1.5 °C scenario upstream oil and gas must decarbonise, starting with Scope 1 and 2 emissions. But while most countries now have net zero goals, tensions remain between producers and consumers, and between developing and mature economies. These issues must be addressed so that policy ambitions can drive policy actions. The global methane pact will intensify scrutiny whether countries are signed up or not — that will embed the status of gas as a transition fuel. Meanwhile, the potential for CCS to form part of a climate solution is good news for upstream — it’s the only sector with the assets, infrastructure, and expertise to sequester gas at scale.
Petrochemicals: under the radar
Petrochemicals accounts for around 4% of energy-related emissions (and rising). Yet the sector was relatively unaffected by COP26. Article 6 developments should bring greater clarity to an industry pursuing offsets as a core element of its journey to net zero. Meanwhile, the phasing down of coal may limit appetite for further expansion of the (relatively small) Chinese coal-to-chemicals industry. For now, the hard-to-decarbonise petrochemicals value chain is an obstacle to change. But the industry needs to speed up net emissions reduction to avoid attention at future COPs.
Investors: COP26 turns up the heat on sustainability
Stakeholders responsible for assets worth over US$130 trillion joined the Glasgow Financial Alliance for net zero at COP26. Members and their portfolio companies must set science-based near-term and 2050 decarbonisation targets, both for the near term and for 2050. They must also release supporting plans and report progress annually. Another development was the formation of an International Sustainability Standards Board. This is aimed at developing globally consistent climate disclosure standards for corporates, to help investors compare their sustainability performance and related risks. More consistent disclosure will aid deeper scrutiny, which is likely to add to pressure on oil and gas companies.
Power and renewables: the electric 21st century
Increased net zero commitments and support for less-developed countries to decarbonise confirm it: the 21st century economy will be electric — and powered by low-cost renewables. However, as variable renewable generation proliferates, providing reliable supply will be a challenge. The phasing down of coal is therefore likely to force the power sector to depend on natural gas, at least over the next decade. That means reliable gas supply will be a key focus for utilities. Meanwhile, a global carbon market will reinforce how carbon pricing influences power prices and investment decisions.
The announcement of H2Zero was a step in the right direction for hydrogen.
Hydrogen: new pledges are a step in the right direction
The announcement of the ‘H2Zero’ initiative was a positive step for hydrogen at COP26. Twenty-eight companies from sectors including refining, fertilisers, and mining pledged to support the supply and demand of low-carbon hydrogen. That’s a step in the right direction, but only represents about 4% of the current overall hydrogen project pipeline. To achieve a 1.5 °C scenario, supply-side pledges will need to grow 20-fold. At the same time, demand-side pledges would need to increase from 1.6 million tonnes per year to 500 million tonnes.
Carbon capture and storage: set for rapid growth
Three key outcomes from Glasgow impact carbon capture and storage, if indirectly. Firstly, countries’ higher net zero ambitions will rely on both offsets from nature-based programmes and mechanical carbon removal; that will include both CCS and direct air capture (DAC). Secondly, the call to phase down coal should drive carbon abatement in the coal value chain. And thirdly, approval of Article 6 should be a spur for all forms of offsets. To achieve net zero by 2050, we still forecast up to 8 billion tonnes of total CCS and DAC. As of November 2021, the pipeline is at 500 million tonnes and growing rapidly.
Metals: positive outcomes but more focus needed
Any acceleration of the energy transition will drive greater demand for metals and battery raw materials. Several outcomes from COP26 are positive in this respect: these include the completion of the Paris rulebook, agreements promoting electric vehicles, Paris-aligned finance, and a shift away from inefficient fossil fuel subsidies. However, agreements like those on forest protections, while critical, work against the supply of elements such as cobalt and nickel which are crucial to the energy transition. As yet, decision makers apparently fail to fully understand this paradox.
Overall, we see COP26 as a qualified success. Of course, it could have gone further, but the pledges and commitments announced at the conference are a clear step in the right direction. Next stop, Sharm el-Sheikh, where COP27 needs to build on the progress made in Glasgow.