Managing energy crises in an age of climate disruption

Jörg Haas, Lili Fuhr December 13, 2021 09:10

A recent report by Goldman Sachs reached a surprising conclusion: Over the past eight years, financial markets have been increasing the cost of capital for big, long-term, high-carbon investments in sectors such as offshore oil and liquefied natural gas. But when it comes to renewable projects, the “hurdle rate” – the minimum rate of return required by investors – has been declining. The difference is significant, translating into an implied carbon price of about $80 per ton of carbon dioxide for new oil developments and $40 per ton of CO2 for LNG projects.

Capital markets seem finally to be internalizing the message that high-carbon investments should carry a significant risk premium. This insight has not emerged spontaneously. It is the result of many years of in-depth research, targeted analyses by groups like Carbon Tracker and the Institute for Energy Economics and Financial Analysis, pressure from investor alliances, hard-hitting NGO campaigns, and divestment decisions by foundations, churches, universities, and pension funds.

The shift in capital-market sentiment has been reinforced by political action. At last month’s United Nations Climate Change Conference (COP26) in Glasgow, nearly 40 countries and institutions pledged to end public finance for oil, gas, and coal projects overseas. In addition, Denmark and Costa Rica spearheaded a group of 12 countries and regions that launched the Beyond Oil and Gas Alliance.

These efforts, though still partial in their coverage and insufficient, are to be welcomed as a sign that financial flows are now starting to align with the goals of the 2015 Paris climate agreement, as mandated by article 2.1(c) of that treaty. But the implicit carbon price demanded by capital markets so far covers only the supply side: the oil, gas, and coal fields, refineries, and transport infrastructure that feed fossil fuels into the global economy.

Unfortunately, similar progress on the demand side for coal, oil, and gas has been lacking. Despite much talk of green recoveries from the COVID-19 shock, huge government stimulus programs have largely failed to discriminate between green and dirty economic activity, and have thus stabilized the global economy on the old growth path.

Moreover, these interventions have created significant consumer demand as the economy bounces back. Movement profiles point to renewed car use and air travel, while energy-intensive industries like cement, steel, plastics, and chemicals are again fueling demand for electricity, gas, and coal. Significantly, China’s economic stimulus has focused far too much on the highly carbon-intensive building sector, instead of undertaking the long overdue reorientation of the country’s growth model in line with its climate goals.

The current surge in fossil-fuel energy prices reflects a multitude of highly idiosyncratic factors. But today’s situation may well presage a future in which a misalignment of supply- and demand-side climate policies generates significant price swings.

Hydrocarbon lobbyists have been quick to exploit the recent uptick in fossil-fuel energy prices to advocate for renewed government financing and subsidies, as well as favorable regulatory treatment for their clients’ investments. In essence, they are calling for the public sector to step in to help fossil-fuel producers at a time when private capital is quite rightly shying away from climate risk and slowly withdrawing from the sector.

Efforts to ease the energy crunch can and must be aligned with solving the climate crisis. Each well-insulated house, wind park, and solar panel reduces the strain on gas supplies. Making cities attractive for cycling and walking, and upgrading public transport, is not only good for public health and safety; it is also an investment in weaning ourselves off the oil that is straining our purses and killing our planet.

Similarly, reducing demand for single-use plastic packaging will further decrease demand for the fossil-fuel feedstocks of petrochemicals. And innovations like flying taxis, supersonic air travel, and space travel that benefit only the super-rich and create new, wasteful energy demand could easily be restricted or even banned before they are widely adopted.

Instead of loosening supply-side carbon policies, as some short-sighted voices advocate, we must – even in periods of high energy prices – keep our eye on the main goal. That means focusing on the inevitable, well-managed decline of coal, oil, and gas and their substitution by sustainable clean energy. In the short term, the best remedies for high energy prices are demand-reducing measures, like the lower highway speed limits that some Western governments instituted following the 1970s oil-price shock.

In short, a just transition away from fossil fuels requires us to “cut with both arms of the scissors.” As the UN Environment Programme emphasized in two pre-COP26 reports, that means simultaneously closing the huge gaps in climate action on both the demand and the supply side.

Despite the much-needed progress toward pricing high-carbon investments appropriately, these gaps are still far too big. Only by closing them quickly and in parallel can we stave off catastrophic climate disruption, and avert the economic disaster that could result from massive energy-price swings and extensive stranded fossil-fuel assets.

Copyright: Project Syndicate
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Jörg Haas, Lili Fuhr

Jörg Haas is Head of International Politics at the Heinrich Böll Foundation. Lili Fuhr is Head of the International Environmental Policy Division of the Heinrich Böll Foundation.