Energy storage and emissions abatement prices key to decarbonization

What is the price of the energy transition? It's a question that is often asked around climate issues and, more often than not, refers to cost. Another, more literal, framing is what will be the prices that drive energy contracts through and beyond the transition. This matters because those are the prices that will incentivize change, and how they are structured will have an impact on the outcome.

New price benchmarks are relatively rare. Out of the tens of thousands of commodity prices published every day, only a handful are regularly used in physical contracts, and fewer underpin liquid derivative contracts. The successful ones share some common features. Typically, they reflect markets that have multiple participants on both the buy and sell sides, experience less political interference and are able to support sufficient trade liquidity to provide observable prices on a consistent basis.

Crucially, successful energy benchmarks are built on commodities that are flexible. The energy markets of the last few decades have flourished on a foundation of oil benchmarks not because oil has been the leading primary energy source, but because oil can be stored, transported and used across a vast array of market segments.

If the world achieves a transition to a "2-degree" scenario in which greenhouse emissions are curtailed sufficiently by 2050 to limit global warming to that figure, most forecasts see a decline in the share of oil and gas in the global energy mix, but not a complete curtailment. Alongside the decline in fossil fuel use comes a substantial increase in the use of renewable energy for the generation of electricity.

What are the likely energy benchmarks in that outcome? There are two broad families.

The power industry is already looking at alternatives to natural gas as the medium of flexible generation, in various forms of storage

Renewables and storage

The first group is a consequence of renewables themselves. Power markets are driven by the marginal source of supply. In most of the world's largest economies, this has in recent years been natural gas, which has the flexibility to respond to daily, even hourly, changes in demand – meaning that power prices track gas prices fairly consistently. But as the share of renewables in the mix goes up, that relationship has periodically broken down – particularly when weather has led to curtailment of renewable generation.

A key feature of renewable power is that it is driven by the weather – and hence has a degree of chaos, a degree that will increase as the effects of global warming grow. When too much power is produced it can be managed by curtailing, or cutting back, generation. When too little, it needs to be replaced by something else – again, currently typically gas-fired generation.

But how can gas provide both the flexibility to meet changing demand and the intermittency of renewable power, while at the same time seeing an overall reduction in use to meet the required decline in carbon emissions?

Instead, the power industry is already looking at alternatives to natural gas as the medium of flexible generation, in various forms of storage. This has the advantage of reducing curtailment of renewables and therefore increasing their efficiency.

Batteries are one option, but scalability challenges make this unlikely; ditto for more traditional approaches like pumped hydroelectric storage.

The most likely candidate is hydrogen, generated using electrolysis during the peaks of renewable power. Hydrogen has similar flexibility to natural gas in terms of power generation and storage. However, like natural gas, it is difficult to transport long distances and will most likely be converted into ammonia for global trade.

Energy storage then, seems a likely candidate for one family of energy benchmarks in the future – produced by renewable power, and including both hydrogen and ammonia. Both of the latter markets have yet to truly arrive as active spot markets, although ammonia as a fertilizer, rather than an energy carrier, is itself an active market.

S&P Global Commodity Insights has started publishing prices for both of these markets as energy transition benchmarks of the future – and intends to actively support their evolution as they grow in relevance and importance.

Search for abatement benchmarks

The second family of benchmarks are a consequence of the other aspect of the energy transition – the reduction in usage of fossil fuels. These are enormously flexible sources of energy – compact, transportable and storable – but their environmental footprint means their use is likely to be reduced as the transition progresses.

On one level, that reduction will be the consequence of policy at the national and international levels. Governments already limit the use of fossil fuels through targets, caps and taxes. But the aim of those limits is not, in theory, an arbitrary reduction in use, but rather an efficient reduction in environmental impact.

Not all oil production is equal in terms of environmental impact. There are familiar debates around the impact of fracking and tar sands production techniques. When considering greenhouse gas emissions, however, there has historically been very little transparency on the full range of impact.

Recently, S&P Global has started to evaluate the carbon intensity of crude production across 104 fields. The results show a spectrum, from as low as 1.56 kg of carbon dioxide equivalent emissions per barrel of production for Norway's Johan Sverdrup field, all the way up to 1,460 kgCO2e/boe for Venezuela's Orinoco Belt.

A buyer of crude looking to meet limits on emissions will likely want to minimize use of the most carbon intensive crudes first, which in turn will affect the demand for such differentiated crudes. The resulting difference in price shows the cost of reducing, or abating, carbon emissions in crude markets. Such abatement prices are the second family of energy benchmarks.

This is a much broader family than the first. It covers not just crude oil but also its derived products, as well as natural gas and LNG. And it extends to other commodities, beyond energy. Petrochemicals, agriculture, metals, shipping, cement and other sectors all have processes that can be analyzed through the lens of carbon intensity. The cost of abatement will be different in all of these and hence each sector may have its own abatement benchmark.

Alternatively, many may make use of a more universal abatement price – carbon credits.

Voluntary carbon markets have been growing in size rapidly in recent years, and have seen active trade in credits that represent abatement projects from across the world. Some of these avoid emissions from traditional energy generation; others actively remove greenhouse gas emissions from the atmosphere. But the effect of them on global carbon levels is similar to moving from a high emissions intensity crude to a lower impact one.

Ultimately, therefore, an efficient market outcome would see a convergence across the abatement complex. There may be some discontinuities, due to policy divergence between sectors and countries, but the core set of benchmarks in this space should drive the most carbon efficient outcomes for fossil fuels within the energy transition.

This piece was first published in February 2022 under the special report Breaking Barriers to Accelerate Energy Transition