Investments in sustainable industrial innovations should quickly become more attractive now that the transition towards a low carbon society is starting to look more certain and less risky.
2015 was a stressful but interesting year for the energy industry with the need for innovation and sustainability becoming more important than ever. From the conclusion of COP21 in Paris where 195 countries committed to a landmark agreement to combat climate change and unleash actions and investments towards a low carbon sustainable future, to many credible agencies including the IEA (International Energy Agency) adjusting their forecasts for hydrocarbon demand, indicating that the world is at or close to “peak oil demand”, one thing is certain: change is happening and policies are being put into place that will significantly impact the energy industry. We see the playing field between “old” and “new” energy starting to be leveled – even though the transition to a carbon free society may not go as fast as many in Paris thought was possible.
A lot of hard work needs to be done to start executing on the Paris Agreement. For starters, countries will need to “sell” the agreement nationally. Renewable energy providers will have to prove that they can quickly gain market share all over the world while current low oil and gas prices may make that more challenging in the short term. And oil and gas companies will need to figure out how to be recognized as a valuable partner in the discussion on how to combat climate change while ensuring people have access to the energy they need. They will have to change the way in they operate their core businesses while expanding and differentiating their energy offerings beyond just oil and gas.
The New Norm seems to be that every company needs to become a tech and IT company, and every operation will need to become sustainable and not dependent on subsidies. Without clear actions and innovations towards that New Norm, many industry leaders of today could lose their independence or even cease to exist completely.
It was encouraging to see that while still in Paris, 19 countries including the U.S., Canada, China, India, France and Germany, as well as many industry leaders, signed on to Bill Gates’ “Mission Innovation” initiative, which aims to double public investments in energy research over the next five years in order to accelerate the clean energy revolution.
But in order to ensure reliable and cheap clean energy, the world needs more than just research. Scale-up capabilities and logistics for build-out, as well as cheap financing are equally as important. In that regard the United States Congress has shown leadership by passing a major spending bill that includes extended tax credits of 30% for wind to 2019 and for solar to 2022. The result will allow for the creation of much needed “investor certainty” in renewables. This will, according to Bloomberg New Energy Finance, result in $73 billion in incremental wind and solar investments in the U.S. (almost double the growth that was expected without the tax credit extension), 44 gigawatts of new wind farms and 59 gigawatts of new solar projects (primarily utility grade). In the meantime the cost of renewables keeps coming down, beating the existing grid prices in increasingly more places in the world.
Additional actions that may level the playing field between “old” and “new” energy include: the interest of many countries post Paris to start applying a price on carbon; possible measures to reduce the $550 billion annual subsidies to the traditional oil and gas sector; the approval of the Low Carbon Fuel Standard (LCFS) in California in late November; the halting by Obama of new coal leases on federal land; and similar actions other countries are working on.
We may have to recognize that we are at the beginning of a major bifurcation in the energy industry towards a lower carbon society in which renewables will continue to gain market share despite low oil and gas prices. Case in point is that new capital investments in alternative energy soared to their highest level ever in 2015: $329 billion (according to Bloomberg New Energy Finance) with solar and wind taking the majority. Admittedly oil and gas prices will remain volatile. And current underspending in new capital hydrocarbon projects could easily lead to new unbalances between oil and gas demand and supply, causing price spikes in 2017 and beyond as hydrocarbons will still be needed for some time. But longer term the price volatility will trend downwards. The outlook for the next decades is lasting lower energy prices with oil probably trading not as low as $20 but more in the $40 to $65 range.
The acceleration towards the new energy industry of the future will likely gain further steam in the next few years as financial institutions fearing carbon exposure and stranded assets become more reluctant to participate in long term hydrocarbon projects. Please note that divestments from hydrocarbon companies are growing and are already believed to be more than $2.6 trillion.
Probably the most important question in following up on the Paris Agreement: is there more long-term value in being a buyer or a seller of new energy? Some countries are starting to shift their attention to the size of the prize of winning important positions in the new energy industry. The land grab for innovative technologies, jobs and industries for the future has started. For example, the Chinese government has a deliberate strategy to strengthen its positions in clean energy and rake in many new tech jobs under its “Manufacturing 2025” program. At the same time, more forward looking oil and gas companies are exploring which new products and services should be added to their core offerings in order to sustain their position as a Fortune 500 “energy” company in the future.
French oil giant Total for example already has a significant position in solar. Focusing attention on executing the Paris Agreement with efficiency improvements and other innovations that could expand the shelf-life of your current oil and gas interests could result in winning a short term battle, but within 10 years’ time you may wake up and realize you have lost the war and that others own important future industries.
When we look back in a few decades, the world of energy will be very different. Investments in sustainable industrial innovations should quickly become more attractive now that the transition towards a low carbon society is starting to look more certain and less risky. Don’t be surprised if the significant sidelined capital currently sitting moribund in the coffers of many sovereign wealth funds and other financial institutions will therefore start moving. Early movers may not only earn outsized returns but lock in future ownership of entire industries that matter. Energy will remain an important investment asset class – just differently with sustainability as the new norm. Are you going to be a buyer or a seller?
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