3 June 2020

In my last blog Post-Covid: Crucial Decade for Climate Change, I suggested that in the post-Covid period, Climate Change would reassert itself as the most important macro-issue. And, if the world is to have any chance of attaining the objectives of the Paris Climate Accord, dramatic reductions in the level of carbon emissions will be required in the coming decade. Therefore, the issue should be at the heart of all investment decisions; however, regretably, it is not yet. Previously, I began by making broad obervations about our failure to prevent ongoing increases in Green House Gas emissions (GHG). My ultimate intention is to develop specific analytical tools aimed at giving climate considerations top priority in investors’ macro-strategy process.

The Chart above provides a sectoral breakdown of CO2 emissions. By far and away, the energy sector is the largest contributor to GHGs. And, its share continues to grow. In large part, therefore, our ability to halt further damaging increases in world-wide temperature levels will depend on this sector’s ability to dramatically change course. However, we will discover that the demand for power will continue to grow in coming decades. The objective, therefore, is to ensure this is achieved in an environmentally sustainable manner, which contributes to lower income (and energy) inequality both globally and within indivdual nations. Not much to ask!

Energy Transition Remains in the Slow Lane

The World Economic Forum’s Energy Transition Index provides an annual scorecard on how successfully energy systems — both globally and within individual nations — are responding to the climate challenge. The ETI provides a snapshot of each national system’s ability to provide widespread energy access, and to contribute to economic growth in an environmentally sustainable manner. In addition, an assessment is made about each nation’s ability to make necessary improvements in the future. Overall, the Chart above illustrates that improvements have been modest in the past five years. More worrisome, the WEF’s assessment is that the world’s energy transition lost momentum during the past year. Furthermore, despite a rising transition readiness score, the world’s ability to make future adjustments is particulary low.

Country performance differs widely (Chart above). European nations are consistently at the top of the table. The USA and Australia fare less well compared to countries at similar levels of income. India and China are further down the list. Most importantly, however, the Chart illustrates that developing countries have the most fragile energy systems. As poor countries are the most vulnerable to climate change, global income inequality will widen inevitably further unless the performance of these emerging nations is strengthened.

Fortunately, the Chart above illustrates that many developing nations have made sustained, consistent improvements in their energy systems in recent years: most noteworthy are China and India (the average world-wide score improvement is 2). The performance of other key countries – the USA, Germany, Brazil, and Russia – has been subpar. Nigeria, Turkey, and Guatemala have actually deteriorated.

There are key lessons to be learned. Fortunately, the gap between the best and worst performers is narrowing, partly driven by improvements in developing countries. However, part of the narrowing has resulted from lacklustre OECD country performance — this must change. In addition, countries can learn from each other. Developing countries can adopt the best practices of more prosperous nations. Technology transfers would strengthen the systems of the world’s poorest nations. Meanwhile, perhaps the USA can pick up some tips from Europe.

How to Put Energy into the Transition?

The continued rise in demand for energy has played a central role in the world’s inability to curb the relentless rise in CO2 emissions. Indeed, global consumption of primary energy has grown nearly 2% annually in the past decade, as outsized 3% gains in non-OECD nations swamped the most reductions in OECD countries. Demand in China and India soared 4% and 6% per year respectively, while Vietnam rose over 10%. Consequently, CO2 emissions increased 1% per year, with the OECD’s 1% decline again offset by 2.5% increases elsewhere.

Almost inevitably, the demand for power will continue to rise, as global population and income grows. In addition, increasing access to electricity, especially in Afica, will boost demand further (Chart above). Meeting rising demand in an environmentally sustainable manner will require dramatic improvements in both energy efficiency (e.g. the amount of energy needed to produce GDP) and CO2 intensity (the amount of CO2 produced per unit of energy consumed).

The Chart above illustrates energy effiency varies widely across countries. Russia and Canada are the worst performers amongst the most heavily-emitting nations. China and Korea are not far behind. On the other hand, European countries, especially the UK, Germany, and France are most efficient. The large disparity suggests that ample room for improvement exists. For example, compared to Canada, the UK needs only one-third the amount of energy to produce GDP.

Fortunately, the Chart also illustrates sharp efficiency improvements in recent decades. In particular, China’s deployment of energy-saving technology has been impressive. The USA and Canada are 20% and 13% more thrifty than in 2005, but these improvements lag European counterparts: the UK (33%), Germany (28%), Sweden (25%), and France (22%). However, oil-rich countries, e.g. Russia and Saudi Arabia, enjoyed only modest improvements or went into reverse. Nevertheless, these impressive effiency gains have not gone far enough to prevent continued increases in global CO2 emissions. Moreover, the pace of improvement appears to be slowing: energy intensity has declined 0.8% annually since 2010 — half the pace of the 2000-18 interval.

Meanwhile, reductions in the carbon intensity of energy consumption (carbon emissions per unit of energy used) have been far less impressive. The Chart above indicates that other than the UK, meaningful reductions have not occured. And, Brazil, Mexico, India, Saudi Arabia, and Japan appear to have deteriorated. The metric’s key determinant is the mix of energy consumed. As the following Chart illustrates that the global mix of energy sources has not changed dramatically, it’s hardly surprising carbon intensity has not declined consistently.

To be sure, oil has lost share to less-polluting natural gas. However, despite China’s success in reducing its reliance on coal (now a still very high 58% of energy consumed compared to 74% in 2005), the proportion of coal consumed world-wide remains stubbornly high. (Also, bear in mind the share of coal used in the USA declined from 24% to 14% during the interval). For all the buzz about renewables, whose use has increased an impressive 16% annually during the past decade, this source still only accounts for only 4% of world-wide energy needs. Indeed, renewables have lagged oil, gas, and coal in satisfying the increase in global energy demand since 2005.

Learning from Each Other

The wide variation of national performance — either in CO2 emissions or the WEF index — allows countries to learn lessons from each other. First of all, while no country is doing enough, Europe is taking the lead. The Chart below illustrates the carbon intensity of European economies (the amount of carbon emitted per unit of GDP) is the lowest in the world. Indeed, all of the top-10 ten countries in the WEF ETI are European. Some of the achievements can not easily be replicated. For example, hydro-power accounts for 66% and 26% of power consumption in Norway and Sweden respectively. However, while Europe accounts for 15% of global energy consumption, the region’s share of world-wide usage of renewables is 30%. Not only is the area’s carbon intensity comparatively low, but performance also has showed significant improvement. During the past 15 years, the metric has declined 44%, 40%, and 34% in the UK, Sweden, and France respectively, compared to America’s 29% improvement.

Energy-producing nations tend to be complacent. Russia has the highest carbon intensity within the G20. Saudi Arabia’s performance on this metric has deteriorated. Even Canada, the worst G7 performer only improved its performance by 15%. Fortunatley, the United States — a major energy supplier — does better. However, the US would do well to emulate top European economies on energy efficiency and carbon intensity of energy use.

There is no getting around China’s crucial role. The Chart above illustrates that despite very impressive improvements, China’s carbon foot print remains enormous. And, the Chart above indicates the country has accounted for roughly 50% of the increase in global energy demand since 2005. China’s energy efficiency has vastly improved, and is now not too different than in the USA. However, its energy intensity of energy use is the world’s worst, reflecting its heavy reliance on coal. Even though China has cut coal usage from 74% of energy consumption to 58%, this remains well above the 27% global average.

Electricity: Bringing Power to the People

Electrification will be at the heart of any successful strategy to cut emissions and limit the damage of rising temperatures. From electric vehicles, to aviation and the rest of the transport sector, to HVAC in homes and commercial buildings, to industrial processes, all sectors will need to undergo huge change. Indeed, Mckinsey estimates electricity demand will roughly double during by 2050 (Chart above).

This transition will pose serious challenges for global utility companies. In particular, the reliance on coal in power generation is even greater than in the overall economy: coal accounts for 38% of electricity compared to 27% of overall global energy consumption. The Chart above illustrates Asia’s particular dependence on coal. Indeed, 67% of China’s electricity and a staggering 75% of India’s is generated by the black rock. And, the following Chart illustrates the world’s power industry’s inability to reduce its reliance on this highly-polluting energy source.

In the power generation sector, non-fossil fuels have an even greater role to play than in the overall economy. McKinsey projects radical change in the electricity energy mix. The share of coal and oil will virtually disappear by 2050. Even natural gas usage in the electricity sector will peak by 2030. Already, 35% of global electricity is generated by hydro, nuclear, and renewable power. McKinsey estimates that over 50% of electricity will be generated by renewable sources by 2040. Already nearly 20% of Europe’s electricity output is generated by these non-polluting supplies.

Despite its heavy reliance on coal, China’s contribution to the growth in the global electricity industry’s demand for renewable energy even tops Europe’s — a further indication of the scale of China’s demand for power.

Strategic Considerations

• Establishing an energy sector that can deliver economic growth and universal access to electricity in an environmentally sustainable manner will require radical changes in energy efficiency and the mix of energy consumed. Some progress has been made, especially regarding efficiency/conservation, but much more is needed.
• Renewables will need to account for 30-40% of global energy consumption by 2050 (now 4%). Even that might not be enough to meet the Paris climate goals. The share of oil and coal will decline dramatically.
• Mitigation may not be enough. Efforts to remove GHGs from the atmosphere must be intensified. Afforestation and Carbon Capture and Storage must play a key role in environmental strategy.
• We are in this together: we must learn from each other. Europe’s Green Deal and the UK commitment to net carbon neutrality by 2050 provide leadership. Other OECD nations, especially the USA, must redouble their efforts. Developing countries should learn best practices from advanced economies.
• China is making considerable progress on energy and carbon efficiency. Nevertheless, the nation’s appetite for energy remains enormous, and capping emissions will require ongoing efforts. The rebalancing of the economy towards consumer services will help curb energy demand.
• Poor countries are especially vulnerable to climate change. Unless the energy systems in these nations are strengthened, the impact of rising temperatures will contribute to wider income disparity in coming decades.