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Energy transition after COVID-19: what pathway are we on?

Energy transition is a widely used term but means different things to different people. Energy markets have always been in transition, shifting to cheaper or cleaner fuels as they become available and competitive. Invariably these transitions are journeys, taking time for new entrants to displace incumbents.

While the technology in the current energy transition is new, it will still be a process to shift from fossil fuels to cleaner alternatives. The disruption of COVID-19 complicated matters, challenging many of the assumptions around the long-term evolution of energy markets.

S&P Global Platts Analytics' Future Energy Outlooks Annual Guidebook, issued in February, lays out the pathway of the energy transition: here are five key energy transition themes that we highlighted in the publication.

  1. 1. COVID-19 has significantly altered the energy transition outlook, but has not transformed it

CO2 emissions outlooks to 2040

It is painfully obvious that COVID-19 has disrupted the short-term, cross-commodity outlook, particularly for fossil fuels, with a massive shock to the macroeconomic framework in addition to restrictions on mobility. Across all fuels, CO2 emissions from energy combustion declined by the greatest extent in human history, falling by 6.4% in 2020.

It has also become increasingly clear that the impacts of COVID-19 will linger into the medium to long term and be deflationary to demand on a net basis. Changes to the macroeconomic outlook will depress energy demand not only because of weaker GDP projections, but due to "economic regression", where the global middle class—the real engine of energy demand—will stagnate or shrink.

There will also be behavioral changes in response to COVID-19, with a greater prevalence of working from home, reductions to business travel (particularly aviation), and potentially the shortening of supply chains also reducing energy demand.

Finally, there have already been a spate of policies unveiled in the aftermath of COVID-19, ranging from "green stimulus" to net zero pledges. All three of these adjustments—macroeconomics, behaviors, and policies—will significantly deflate energy demand, and by extension CO2 emissions, from the pre-pandemic outlook.

However, while the huge decline in demand and emissions in the immediate aftermath of COVID-19 has the world temporarily on or ahead of a path that would limit global heating to 2 degrees celsius, the recovery in demand, even blunted by the lingering impacts of COVID-19, will bring about a return to CO2 emissions growth over the medium term. While there is perhaps an opportunity for COVID-19 to be a catalyst if behavior and policy changes become severe, Platts Analytics does not believe this is the path energy markets are currently on.

2. Peak oil demand isn't here… yet

Petrochemicals demand supports oil demand growth

Even before the coronavirus pandemic disrupted demand, oil consumption growth was showing signs of slowing. The lingering impacts of the pandemic have reduced growth largely in the transportation sector, across aviation, road, and marine transportation.

There are still backstops to demand, particularly if gasoline and diesel prices fall, which makes electric vehicles more expensive relative to internal combustion vehicles. But even accounting for these backstops, we project that oil demand for passenger vehicles will peak by 2030 and move into structural decline thereafter.

Outside of personal transportation, there are limited economic alternatives to oil at scale, particularly in aviation, marine bunkering, and heavy trucking. Petrochemical sector oil demand has already become one of the largest areas of growth for oil, and the increase in demand in 2020 is a testament to the diversity of products that emerge from this sector and the fact that the recovery from COVID-19 will require both durable and non-durable petrochemical products.

Underlying all these factors is that the cost of oil is, and will remain, low. Platts Analytics estimates that oil production cost breakevens are below $50/b (in real 2019 dollars) in most non-OPEC growth areas, with some breakevens in the low-$40s/b or high-$30s/b. Such low-cost supply on top of even less expensive OPEC barrels will keep oil economically competitive with alternatives, supporting demand overall.

  1. 3. Fleet turnover rates are more important than new technology adoption to the energy transition and meeting emissions goals

Global coal power fleet age

When it comes to the energy transition, much of the focus falls on the deployment of new technologies. New electric vehicle models, wind/solar capacity additions and new hydrogen electrolyzer plants certainly grab the headlines, but turnover rate of existing infrastructure will be a critical determinant of how quickly sectors can transition to low carbon pathways.

It is a much easier and less expensive proposition to replace an older, inefficient vehicle, power plant, or boiler at the end of its useful life than it is to do so with efficient infrastructure that may have decades of useful life left and perhaps some capital left to recover.

For example, the relative old age of the coal-fired generating fleets in Europe and North America was a major factor in coal's displacement by gas and renewables. Conversely, China has virtually no coal-fired capacity older than 40 years, with most of its fleet at less than 20 years of age.

Another example of this dynamic is in passenger vehicles. While EV penetration of new car sales continue to rise, around 95% of new cars hitting the road are still internal combustion engine models.

Passenger vehicle scrapping profile

In industrialized nations, new vehicles last on average 10-13 years, but a significant amount of them will continue to operate for another decade or more, perhaps sold as used vehicles in developing nations. Globally, the passenger vehicle fleet doesn't fully turn over for 30 years or more, illustrating the lag between the adoption of EVs from a sales perspective and a use perspective.

  1. 4. Natural gas' role as a "bridge fuel" is shorter and narrower

Natural gas has long held the promise of being a "bridge fuel", essentially spanning from coal, and a lesser extent oil, to renewables. As a generally less polluting fuel than coal, with supply that has turned out to be abundant (or overabundant in some instances), natural gas has broadly been used to displace coal in industrialized nations and slow the growth of coal in developing nations.

Renewables are clearly far from just a promise anymore, and the other side of the proverbial bridge is coming into focus. The downgrade in the long-term macroeconomic outlook from COVID-19 has reduced global energy demand growth considerably, while more aggressive emissions policy pushes over the past year have caused Platts Analytics to upgrade the outlook on renewables penetration, which will further limit the upside to natural gas.

Additionally, there are longstanding structural impediments to gas demand growth that we have cautioned about for several years, not least gas pricing, particularly LNG. The global gas market is in a precarious position if it wants to continue growing strongly, as prices need to be high enough to incentivize new liquefaction but low enough to keep demand growing.

  1. 5. Hydrogen will be transformative in markets that overcome economic barriers with policy

For many years, the view of hydrogen developing into a potential clean energy solution was characterized by its potential. Hydrogen has always had the potential to be used in a variety of sectors and applications without emitting CO2 at the point of consumption.

However, hydrogen had long been seen as being only that, just a potential fuel, with its hypothetical application and related reductions to oil, gas, and coal emissions still decades away.

Commitments to hydrogen have accelerated considerably over the past year, an achievement made all the more impressive for taking place during the COVID-19 pandemic.

There have been notable policy pushes such as the European Commission's hydrogen strategy; development of regional partnerships; and deployment of hydrogen production capacity and end-use technologies.

It should not be surprising that the catalyst of the acceleration of hydrogen's development has been more companies and governments making net zero pledges. Achieving net zero or even severe reductions in CO2 emissions without a non-intermittent energy source is next to impossible. The use of carbon-free hydrogen as an energy carrier offers pathways to decarbonization in sectors where electrification is ill-suited, such as industry, refining, chemicals, and heavy transportation.

The production of hydrogen with renewables could provide solutions to electricity intermittency and longer duration storage, and the production of hydrogen with fossil fuels and CCS offers ways to continue to use those fuels without emitting CO2.

The biggest barrier to hydrogen's ultimate development and potential use as a major driver of emissions reductions is cost, particularly in markets that do not offer financial incentives to reduce CO2 emissions. Policymakers in Europe (and a few other countries) have signalled their willingness and ability to subsidize the deployment of hydrogen, with the aim of driving down the cost globally so that it can be more widely deployed globally. Cost declines will be key to the ultimate deployment of hydrogen and other clean energy solutions.