Towards low carbon energy systems
Other sectors Maritime Oil and gas Power and renewables

Fossil fuels have dominated the world’s primary energy supply for the last century, but a transition to a more integrated and low carbon energy system is now gathering momentum.

The transition may seem slow because the replacement energy providers — mainly wind and solar PV — start from a very low share. Indeed, by 2030, fossil sources will still comprise more than 70% of the energy mix, and continued investment in new sources will be critical, as will the quest to lower the carbon footprint of fossil fuel production and consumption.

However, the pace of renewable energy development is accelerating, both technologically and in terms of affordability, such that the next decade will witness some key tipping points in the energy landscape1.

The present shift in the energy mix is both market and policy driven, with climate-related concerns, amplified by youth activism, expected to have a significant regulatory impact. Local pollution and environmental problems are also playing a part in driving this transition2, in addition to a geopolitical trend of reducing dependency on energy imports.

The shift towards low carbon energy systems is taking place in all industry sectors and across all world regions. Many of the drivers and technologies are well known, but there are nascent technologies, with more uncertain futures, that could emerge and scale over the coming decade. These could significantly reinforce or delay the transition away from fossil fuels, depending on their rate of development.

A decade of change

Peak energy: In the period between now and 2030 almost all (90%) net energy additions are expected to come from renewable energy sources, mainly wind and solar PV. These additions will start to affect the mix and compete with existing energy carriers. Coal demand peaked in 2014, and we expect oil demand to plateau and peak in the coming decade with a marked decline from 2028. Overall energy use will continue to grow in the next decade as natural gas becomes the largest energy source. However, owing to the cumulative effect of energy efficiencies (mainly related to accelerating electrification), the world will reach a major energy watershed – peak primary energy supply – by 2030.

Energy efficiency: One measure of efficiency is the energy intensity of the global economy, expressed as primary energy per unit of GDP. Energy intensity has reduced by 1.6% annually over the last two decades and is expected to accelerate towards an annual reduction of 2.5% by 2030. This is principally driven by the growing renewable share in electricity generation, eliminating enormous heat losses, and electrification of the energy system generally. As a result, GDP growth is starting to decouple from energy use — a split that will become increasingly evident by 2030.

Electric vehicles (EVs): The most visible aspect of the energy transition by 2030s will be the ubiquity of EVs. Three times more efficient than their combustion counterparts, EVs will have a major impact on overall energy efficiencies. By the mid-2030s, EVs will reach lower cost of vehicle ownership compared with internal combustion vehicles in many national markets. 50% of new vehicle sales will be EVs in the EU and China by the late 2020s and, globally, EVs will surpass the 50% mark for new passenger vehicles by 2032. Battery costs will continue to plummet as emerging chemistries further improve their energy densities and charge rates, supporting electrification of the transport sector.

Opportunities and risks

The energy industry is global, affecting both people and planet, and its transformation will affect all those using or producing energy – i.e. almost everybody. However, the emerging shift towards a low carbon energy system will be even more challenging for large, existing energy players. Thus, it is important to understand the transition risks and potential effects on asset evaluation, where some assets could become stranded.

At the same time, energy expenditures as a fraction of world GDP are starting to decline as efficiencies increase3. World expenditures on fossil energy as a fraction of GDP are expected to shrink from today’s 2.5% to 1.5% of GDP in 2030, while expenditures in renewables and grid will keep pace with GDP growth and will double in absolute terms in the coming decade.

With a stagnating market outlook for oil demand from the early 2020s and gas in the early 2030s, we expect to see an integration of energy markets and technologies unfold.

The strategic response from oil majors to these challenges is multifaceted, but the main themes are: an increased focus on natural gas, along with options to ‘green’ the gas mix; a focus on switching to renewables, where scale and returns do not match those historically achieved in the oil and gas industry; and an intense focus on production costs, where digitalization is key.

Smaller operators have greater flexibility to switch to low carbon sources – for example, Danish Oil and Natural Gas, DONG, has sold all its fossil assets to become one of the major players in wind energy (especially offshore), changing its name to Ørsted. Full-scale transformation eludes big oil, but the major steps taken by several companies, notably Total, Equinor and Shell entering the electricity market should not be discounted, with the latter aiming to become the world’s largest electricity provider by the 2030s4.

Not surprisingly these companies, and other oil majors, are pivoting towards natural gas, such that they may more accurately be referred to as ‘gas and oil’ companies. Uniformly, they are also focused on cost reductions while increasing the efficiency and lowering the carbon footprint of their operations. The cost, productivity and low-carbon drive involves many technologies, and there is intense competition to become the leading digital upstream business5.

Electrification is a main contributor towards building a low carbon energy system. However, a higher penetration of variable renewables also brings another factor into play: weaker prices for wind and, especially, solar PV, when these sources compete between and amongst themselves6. Thus, adding flexibility in the form of battery storage, seasonal storage of gas, demand response and dispatchable power through gas-fired power plants increases the integration of renewable energy sources.

The combination of emerging technologies and an accelerating energy transition will put the risks associated with depreciation of existing assets into focus, where stakeholders will also need to fully evaluate the risks associated with future technology investments. Investors, insurers, energy providers and users, as well as society at large, will expect this energy transition to be conducted in a safe and sustainable way. This will, in turn, call for new market structures, regulations and assurance regimes.

Transition drivers

Policy: A growing spectrum of government policies and targets, implemented through incentives, taxes and specific regulations. Nationally Determined Contributions (NDC) and the Paris Agreement are likely to be strengthened from 2020. Other policies linked to local pollution, energy security and independence will increasingly focus on the role of renewables in satisfying these aims.

Investment community: Intensifying focus on the implications of oil demand peaking, and the risk of stranded assets, coupled with growing demands for climate related financial disclosure. The investment community will increasingly require companies to stress test their business models based on different low-emission energy futures7.

Technology and costs: Rapid developments such as advancing digitization and connectivity are enabling reduced costs and contributing to the speed of this transition. Renewable energy has seen dramatic cost reduction the last 10 years, and further significant reductions of solar or wind generated electricity cost are expected. Wind is increasingly going offshore, initially with fixed installations like today, but eventually floating wind farms will become cost-competitive, in addition to not contending with other land use.

The extractive fossil fuels industry itself is currently transforming to respond to the technological and policy changes. Coal-fired generation investments have plummeted 75% since 20158 and many companies in oil and gas are transitioning towards the less-polluting gas value chain. Increasing gas demand leads to gas transport on keel more than doubling toward 20309, leading to stabilization in gas prices globally.

Decarbonization: With oil and gas still dominant in 2030, there will be increased focus on decarbonization in areas where emissions reduction is difficult to achieve by fuel switching, and thus there will be growing demands to further develop carbon capture and storage (CCS).

Transition barriers

Lock-in and inertia of the existing energy infrastructure, where existing fossil fuel subsidies and a need to protect both energy and job security, are significant barriers to change.

A pivot from opex to capex: Renewables require high up-front investments, but those are offset by lower operational costs compared with fossil fuels. The extra risks associated with any investments in an environment undergoing rapid technical and policy change can make it challenging to access capital, especially in developing economies.

Power market: A higher mix of renewables tends to lower electricity prices in certain periods, but variable resources may then struggle to secure profits from further investments without changing the structure of the power markets. This is amplified by internal competition between these sources, such as low-cost wind competing with even cheaper solar PV.

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