Jostle the colossal fossil, a path to the energy sector transition; And: Global trade report – battling out of supply-chain disruptions

‘We are the first generation to feel the effect of climate change and the last generation who can do something about it.’ And, yes, the human exploitation of the planet is reaching a critical limit. With this week’s report on the decarbonization of the energy sector, we’re continuing our sector pathway mini-series that analyzes the investment requirements for several important sectors to meet the announced target of limiting global warming to 1.5°C. Global trade and the growing disruptions of supply chains is our second focus this week – with repercussions felt around the globe such as higher trade volumes and price increases; so we’re exploring how persistent supply-chain disruptions are likely to be. Plus a fresh episode of our Tomorrow podcast – this time about which Emerging Markets are most at risk of debt distress after Covid-19.

Jostle the colossal fossil: A path to the energy sector transition

Decarbonizing the Energy sector: How will oil and gas phase-out and what is an adequate phase-in of sustainable alternatives that is in line with the announced target of limiting global warming to 1.5°C? Where are the investment gaps and how much additional investment is needed? And lastly, why does the EU need to be more ambitious than other regions and how do I use pathways to measure the climate ambition of an oil and gas company? The highlights of our latest mini-series edition on how different industries are coping with the energy transformation:

The EU faces an implementation gap of six years in cutting greenhouse gas emissions from the energy sector by 2030. Decarbonizing the energy sector is crucial to achieve the net-zero target as nearly three-quarters of the EU’s total greenhouse gas emissions originate from the production and use of energy, notably from fossil fuels such as coal, oil and gas. In this context, the EU’s Fit for 55 legislation has set a 55% reduction target by 2030 for total emission (vs 1990 levels). For the energy sector, their proposal would result in a 45% emissions reduction by 2030 (vs 2015 levels). However, while the use of fossil fuels in the EU has been declining, and renewable energy is on the rise, the annual emissions reductions still won’t be enough to limit global warming to 1.5˚C. To comply with this goal, the EU needs EUR717bn of additional investments per year until 2030, including EUR118bn on the supply side (mainly for new power plants and grids) and EUR599bn on the demand side (mainly for the transport and residential sectors).

Coal, oil, gas: can they be phased out fast enough? In all the proposed 'Fit for 55' policy scenarios, electricity generation from coal must be phased out completely by 2030, but this looks highly unlikely. Although most EU member states and the UK have corresponding plans, Germany still lacks a full commitment (“ideally” by 2030) while the remaining Coal-5 countries (Poland, Bulgaria, the Czech Republic, Romania and Slovenia) have made commitments that come after the 2030 deadline. The share of oil in final energy demand is expected to decrease only slightly over the next ten years to 29% (from 37% in 2015) but will fall more dramatically in the following two decades. However, natural gas will remain an important fuel source to meet total energy demand for the time being, decreasing by only 13% in 2030 (from 2015 levels), until hydrogen, e-gas and biogas are ramped up.

In this context, companies can take control. The scope and timeframe with which fossil fuel companies plan to decarbonize is an important component in the energy sector transition. Together, these individual plans dictate a collective transition, which should be in line with a 1.5˚C future. Looking at the largest firms discloses the magnitude of the challenge: Most have to cut GHG intensities by half by 2035. For the EU as a whole, this implies that GHG intensity should be below the global average and reach negative net-intensities through carbon dioxide removal (CDR) by 2045.

Where do we go from here? Now more than ever, the decisions and actions of private and public corporations will play an increasingly important role in the energy sector's green transition. Overnight action is unrealistic, but fortunately there has never been a better time to ramp up investments in renewable energy: The cost of capital for renewable energy is now a whopping 15pp lower than that of fossil fuel competitors. A key area for investment is (green) hydrogen. The EU already has an ambitious goal to raise the share of hydrogen in Europe’s final energy demand to 30% by 2050, which provides European industry with a profitable opportunity in the form of a market worth EUR820bn in 2050. But investment in renewables must be simultaneously undertaken with de-investment from fossil fuels, which means governments need to reevaluate their sizable spending on fossil fuel subsidies.

You’ll find the full analysis here. Previous publications cover of our mini-series cover the utility transformation and the transport sector; more sectors are being covered early in the new year. 

Global trade report – Battling out of supply-chain disruptions

Global supply-chain imbalances have been exacerbated by the Covid-19 crisis, and have been driving trade volumes and prices over the past quarters; our trade report looks into how long supply-chain disruptions are likely to last, and what the implications for global trade will be. The main takeaways are:

Global supply-chain disruptions will remain high until H2 2022, on the back of renewed Covid-19 outbreaks globally, China’s continued zero-Covid policy and demand and logistic volatility during Chinese New Year. After exceptionally strong performance since H2 2020, global trade of goods contracted in Q3. We find that production shortfalls are behind 75% of the current contraction in the global volume of trade, with the rest explained by logistic bottlenecks. In this context, a soft recovery in Q4 2021 is likely (+0.8% q/q after -1.1% in Q3 for trade in goods) but there is a risk of a double-dip in Q1 2022 as volatility in trade flows should remain the norm until the spring. Looking ahead, three factors will drive the normalization of trade from H2 2022: 1) A cooling down of consumer spending on durable goods, given their longer replacement cycles and the shift towards sustainable consumption behaviors. 2) Less acute input shortages as inventories have returned to or even exceeded pre-crisis levels in most sectors and capex has increased (mainly in the US). 3) Reduced shipping congestions as capacity increases.

When it comes to inputs from China, Europe is on the weak side of the tug-of-war against the US. Europe is more at risk compared to the US when it comes to the heavy reliance on intermediate inputs from abroad, due to a lack of capex in production and shipping capacities. We simulate the impact of a shock represented by the Chinese slowdown (i.e. a 10% drop in Chinese exports) on EU sector outputs and find that the sectors that would be hit the hardest are the ones related to metals (basic metals and fabricated metal products) and automotive (motor vehicles, trailers and semi-trailers, transport equipment). Without production capacity increases and investments in port infrastructure, the normalization of supply bottlenecks in Europe could be delayed beyond 2022 as demand remains above potential.

Yet, reshoring and nearshoring will remain more talk than walk. Despite supply-chain disruptions, we find no clear trend of reshoring or nearshoring of industrial activities so far. The only exception is the UK, which is likely to have faced disruptions due to Brexit. However, protectionism reached a record high in 2021 and should remain elevated, mainly in the form of non-tariff trade barriers (e.g. subsidies, industrial policies).

Overall, we expect global trade in volume to grow by +5.4% in 2022 and +4.0% in 2023, after +8.3% in 2021. But watch out for increased global imbalances: The US will register record-high trade deficits (around USD1.3trn in 2022-2023), mirrored by a record-high trade surplus in China (USD760bn on average). Meanwhile the Eurozone will also see a higher-than-average surplus of around USD330bn. In terms of export gains, Asia-Pacific should continue to be the main winner in the next few years (over USD3trn in 2021-2023). By sector, energy, electronics and machinery & equipment should continue to outperform in 2022, but the main export winner globally in 2023 should be automotive, thanks to the backlog of work and lower capex in 2021.

Our full report can be found here. 

A fresh episode of our podcast ‘Tomorrow’ on which Emerging Markets are most at risk of debt distress after Covid-19; In this episode, Senior Economist Selin Ozyurt explains which countries are most at risk, and why current debt-relief initiatives will only kick the can down the road.