Rising geopolitical tension, an energy crunch and the thrum of pandemic economic recovery are setting an uncertain path to net zero.
But how did we get here? And what are the forces in play during a decisive decade for climate action?
Alexis Crow, a senior fellow at the Atlantic Council with a background in geopolitics and economics, joins co-hosts Mustafa Alrawi and Kelsey Warner to lay out what to expect in the year ahead for fossil fuels, renewables and the push and pull of the “old” versus “new” economies.
A transcript of the interview, edited for brevity and clarity, is below.
Mustafa Alrawi: Alexis, thanks so much for joining us. You know, the wider picture at the start of 2022 is heightened geopolitical tension. If we’re specifically talking about energy and the energy markets, what should we expect now, going forward, in general?
Alexis Crow: Thanks so much for having me, Mustafa.
So certainly what I would say is, we continue to contend with an elevated commodity price environment. That’s certainly the case across the commodity landscape with regard to fuels, and gasoline, petroleum, as well as metals and food prices.
And certainly here, I would say that while geopolitical events continue to contribute to a little bit of this volatility, it’s really on the supply and demand side that we’ve seen such shocks to price. And so if we go back to 2020 and we consider the emergence from the base effects of 2020 to where we are now, we saw unprecedented movements in both supply and demand, particularly in oil markets.
On the supply side, some estimates are that global oil production fell by 6.6 million barrels per day in 2020, which would be the largest contraction in postwar history.
And even on the demand side, we face that unprecedented event in WTI markets in America of negative oil prices. Oil demand fell by some 9.3 per cent, in some estimates, in 2020. And you know, connected to that is this, when we consider oil and gas and the use of which commodity, for which purpose, and we consider just the sudden cessation in mobility that happened in 2020. Carbon emissions fell by the largest amount on record. And that cessation of mobility has been unique to this particular recession.
So come into 2021 and we continue to see supply and demand landscapes considerably upended. And there are other facets now, related to this, in addition to the economic shocks related to the pandemic.
The second [component] I would classify, Mustafa, would be climate-related events, where flooding – and immense flooding – actually washed out coal supply in China. We continue to see climate-related events upending food prices as well.
And then the third component here would be this move towards the energy transition, where governments around the world with the tabula rasa, coming out of the pandemic, have committed to build back better. And what we’re seeing is a resource grab. In some cases I would call it EV nationalism, with governments looking to corner supply of the market and stockpile domestic supplies of critical rare earth material. And what a lot of this has done is confused and jigged the demand landscape as well, where I think there’s been a little bit of rosy optimistic lenses as to the extent to which countries, companies, households can move away from carbon-emitting fossil fuels and into a cleaner, greener future. And that’s also complicating the price landscape.
Kelsey Warner: Alexis, thank you for that broader context and kind of telling us what’s what. You wrote recently for the Observer Research Foundation that the skyrocketing commodity price environment has led one observer to point out that we might be seeing the “revenge of the old economy”, which I think you just really well described.
I want to ask you, where is this new economy? You talk about EV nationalism, which I want to ask you more about later. But, where does the green transition come into play and is it under threat in this current environment that we’re now in?
AC: Thank you so much, Kelsey. So here, what I would say is, for the non-econ nerd listeners, I would say that – the old economy versus new economy – basically what we’re talking about is moving from goods-producing to services-producing economies and employment, labour markets.
And so, you know, that quotation about the revenge of the old economy is that we’re trying to move into this brighter, cleaner future of services provision, according to which economies will be less dependent upon both producing oil and natural gas, as well as consuming oil and natural gas. And then it’s come back to bite us because, again, we’ve been too halcyon in our viewpoints.
And here I would actually say, this is where the word that we emphasise here is transition. And it’s very much that it’s a transition, according to which there is certainly still scope for the use of oil and natural gas, in transport, and so supporting mobility, as well as in urbanisation, supporting power generation. And what we continue to witness with the, I would say quite robust, economic recovery that we’ve witnessed across geographies in 2021, has been a reversion back to the mean of using that oil and natural gas. And in some cases, coal, you know, we’re seeing like gas-to-oil switching, and we’re seeing an increase in coal use from territories such as Germany, Japan and the United States as well.
So the revenge is that we, some observers would say, we underestimate – underinvested in that underestimation of the use of oil and natural gas. So remember, all of that talk about dinosaur investments and stranded assets and big natural gasfields would be stranded assets. And so now we face this position where we recognise our dependence upon some of these fossil fuels.
I think certainly amidst the green transition that there will be an elevated cost of capital. So, if we think about how this is unfolding across jurisdictions, I think it’s certainly divided between the importers and exporters. And we’re watching countries such as the UAE, for example, adjust fiscal balances and adjust government policy to be able to direct more growth towards non-oil and non-gas producing sectors. That’s a topic of debate in the Colombia election as well at the moment.
MA: So you talk about investment, you mentioned that there is sort of a quite a complex and maybe challenging environment for that. But there have been a lot of estimates about how much investment will be required for the energy transition. But also, there’s this competing narrative that we need to also maintain investment in fossil fuel capacity, because it’s going to be bumpy as we try to get to these new energy sources. So how do you think that push and pull is going to pan out?
AC: Well, it’s interesting, Mustafa, because I would actually say, so, who are we talking about in terms of investment? Is this companies in capex? Is this private investment and institutional investors? Or is this even government?
And here, I would actually say that the pass-through of a heightened headline inflation into core inflation for many economies today, which is directly affecting households, has certainly forced some government to be able to say, OK, we actually have underinvested in our own domestic production and domestic stores of fossil fuels. And we need to step some of this investment up.
So the United States obviously comes to mind here, from a government landscape.
I would say that, thinking about the corporate landscape, obviously, we’ve witnessed the extent to which in earnings season, the start of the earnings season now, some of the majors have posted their highest profits since 2014. And here, I would actually say that what’s going to be interesting to see is how some of those profits are distributed.
We noted that some of the majors didn’t pass this on into significant or meaningful wage increases in 2021. And so the extent to which, you know, you’re paying off a debt pile going back to 2020, from those basic facts that we talked about, and the extent to which you’re channelling this into investing in producing green energy, and here a couple of the European majors come to mind, being significant players in the space and really dedicated and focused on that. We’ve actually published on this previously, that some of these companies can be the brightest spots for investing in the energy transition.
On the private side, I would say, as well, one of the key developments that we note with regard to specifically climate investment is the extent to which private capital is still needing a lot of the de-risking from a multilateral development bank, such as the IFC [International Finance Corporation], to be able to enter in some of the larger infrastructure projects with regard to renewable energy. And I think that’s going to be a critical component going forward to be able to bridge that gap, you know, which is in some, you know, some estimates $26 trillion across developing Asia. So I think that’s going to be critical to focus on.
KW: Alexis, I have another question in this context of recovery meaning reversion. I like that line and [with] the record-breaking profits [we’re seeing], where does that leave ESG commitments and ESG aspirations? Are these going to be durable in the year ahead? Or are they under threat because we’re returning to some bad habits?
AC: So first of all, I would classify, probably single out, the e-components of that, when we're talking about the energy landscape, which of course you know in terms of taxonomy is more easily codified, when you look at the TCFD [Task Force on Climate-Related Disclosures] requirements and disclosures, particularly what some of the European banks are now doing with regard to climate stress-testing.
And so here's where I would say that, as we start to make these commitments, particularly to net zero, and investors are looking at potentially divesting carbon assets, the cost of capital of producing oil and natural gas is going to go up and it's going to go up in different ways.
One is just in value terms. You actually had Al Naimi going back to his position in Saudi Arabia, talking about the cost of production in Saudi was actually increasing at a time when some were comparing it to a somewhat lower cost of production, obviously, than in the US unconventional plays. So just in terms of actual E&P, the cost of production is going to go up.
The social cost of capital is going to go up significantly, where shareholders are going to demand to what extent, if you’re extracting and producing, exporting resources, are you really focused on carbon capture, sequestration? Are you really focused on addressing some of the methane leakage, which is something that we’re witnessing in the Permian Basin, a significant contributor to greenhouse gas emissions? And so how efficient are you going to be in your production?
And obviously, then, in terms of reporting, that if, for example, you are one of the Seven Sisters, and you say that nat gas is going to be X amount of your portfolio by 2035, how are you going to actually approach the net zero target in tandem with that?
And so, again, we’re going to have to witness a lot of innovation, which in turn will spur, I think, significant investment opportunities. The ‘S’ [social] and the ‘G’ [governance] are two components that are not necessarily handled by this whole debate.
The ‘S’ we’re witnessing is, if there is a disorderly energy transition, there is a social cost, which is negative, associated with the removal, or the perceived rapid removal of our lifeline to oil as a use for transport and to nat gas for power generation. Some data shows that 315 million people in 2021 suffered from power outages. Now, in a year where many schools were online, where many households have been online working, that’s significant disruption to productivity and in turn to economic growth.
So there is a social cost for the price-takers and the price-makers. I’ve certainly witnessed this in some of the exporting countries, the fact that we didn’t get to have and enjoy the national income from E&P that other exporting countries did. And it’s this energy transition.
The ‘G’ part I will also call out because I think there is significant opportunity as we think about the new greener landscape in terms of job creation. And really, here, I would call out some energy companies and countries and exporting countries have been significant in putting women in positions of leadership with regard to engineering. And I think there will be a lot of investors focused on investing in skills and training offer this new energy transition.
KW: You’ve written about this a bit, and it’s something I’ve also thought about. A green future, if you think about it, maybe overly simplistically, should untether us from relying on others for energy. Wind, waves, sun – all local. But why is that wrong? You spoke of EV nationalism earlier. So, can you talk a little bit about where geopolitics come into play in a renewable grid?
AC: Sure. So, it’s certainly in terms of some of the raw materials, some of the goods, the capital, the know-how and the expertise. These are not tied to any one domestic jurisdiction. And we’ve watched that, witnessed that play out, with regard to even the US moving to an energy transition, and just the cost of capital of investing in this.
So firstly, I would say, in the resource side of things, we’re witnessing this with regard to European shortfalls and aluminium supply, for example. It’s so much investor attraction and attention going into lithium assets across the globe, really putting a spotlight on jurisdictions across Latin America, across sub-Saharan Africa.
Increasingly, we’re seeing rhodium come into demand because it’s a key component in wiping nitrous oxide from exhaust gases, so a clear part of that greener, cleaner future. So we’re certainly witnessing this in terms of the raw material landscape. We’re certainly seeing that is a cross-border activity that no one country is necessarily exhibiting the progress to do that on their own.
And then just the human capital, the know-how, as well as the financial capital, that has to come across borders. So I think there has been this allure that if we move towards a more renewable future, as you say, these are local, these are domestic, that we will not be reliant on other powers. And I think that’s certainly evidencing itself to be fiction.