A slow and flawed transition
The developed world’s energy transition efforts are making the problem worse by moving energy-intensive manufacturing to the developing world
The energy transition that the world will have to undergo over the coming decades is truly unprecedented in scope and scale. It will be the biggest reallocation of capital that investors will see in their lifetimes.
Global warming is the biggest single threat to our way of life, and unfortunately most people still do not adequately appreciate the difficulty in making an energy transition away from fossil fuels. Even today, while the world is getting more energy-efficient, absolute emission levels continue to rise. While the developed world has reduced its primary energy consumption, and is projected to continue doing so, it has managed this by shifting most of the energy-intensive manufacturing to the developing world, where energy consumption is accelerating. Coal is still relied upon by many developing countries, with nearly 60 per cent of India and China’s primary energy consumption based on this dirty fuel. Thus, as the mix of energy consumption shifts towards the developing world, we are actually making the emissions problem worse.
Energy transitions, first of all, are not similar to transitions that you see in technology. In tech land, within 15-20 years, you can see very substantial penetration and cost curve crossover. For example, within 15 years, 90 per cent of consumers in the West had switched to smartphones. Within 20 years, 60 per cent of advertising had moved to digital and 50 per cent of the developing world had internet access. Within this same 20-year period, despite all the cost reduction and policy support, wind and solar combined accounted for less than 5 per cent of primary energy consumption.
Even today, the world relies on fossil fuels for 83 per cent of its primary energy consumption (source:j P Morgan Private Bank); it was 90 per cent in 1990. This shows how slow the transition is. Under many credible future scenarios built by the International Energy Agency, our fossil fuel reliance will remain over 60 per cent, even in 2050, unless we drastically accelerate behavioural change.
Further, while we are seeing some progress in decarbonising the grid, and moving electricity production away from fossil fuels, the real issue is decarbonisation of industrial production, transport and residential/commercial heating, where progress has been slow.
To effectively tackle global warming and reduce carbon emissions, we have to move electricity production entirely to renewables and then electrify other parts of the economy like industrial production, transport and residential heating, all large direct consumers of fossil fuels. This is the principal challenge.
While the media and investors focus on solar and wind investment and their levelised costs falling below thermal generation, not enough investor attention is focused on the challenge of how to electrify large parts of the economy. Without mass electrification, there is no path to net zero.
Today, if we look at the three big blocks of energy consumption — China, US and Europe — some facts become clear. China’s energy consumption is almost equal to that of the US and Europe combined. In the US and Europe, energy consumption between industrial use, transport and residential/commercial property is quite similar. In China, industrial energy use is more than double the combined energy use of the transport and property sectors. Electricity as a percentage of energy consumed is 18-20 per cent in all three blocks, implying 80 per cent of the energy consumed is non-electricity. The challenge ahead is clear. We need green electricity and the share of electricity in energy use has to drastically rise.
Renewables as a percentage of electricity generation was 20-25 per cent in the Us/china but 45 per cent in Europe, showing the progress made and the distance still to cover. The percentage share of renewables will rise, the costs are in place and public policy is supportive. The issue with renewables becoming the majority of the grid is more to do with intermittency and the need for dramatic strengthening of the grid. However, not enough is being done to enable transmission investments.
The electrification of energy use is at the heart of decarbonisation. Over the last 20 years, despite the building momentum against global warming, electricity as a percentage of energy use has risen only 2-3 per cent in most major economies. No major economy has an electricity share of more than 20 per cent in total energy use.
Electricity as a percentage of industrial energy consumption is stuck at 15-16 per cent if we look at combined data for the Us/europe and China. Cement, steel, plastics, chemicals and fertilisers are the main industrial users of energy. The main challenges in electrifying production seem to be that most of these processes use waste heat recovery of energy, which would be lost if one were to electrify the process. Many of these products are non-metallic, which also makes electrification more difficult. If we want to see an increased share of electrification, new investments will be needed to change the process and add specialised equipment. China is the major user of energy for industrial purposes. Given that China is focused on low-cost manufacturing, will it take on the cost burden of enabling electrification?
The next big area is transportation. Looking at the combined data for the Us/europe and China, electricity today accounts for only about 2 per cent of the transport energy consumed. The obvious road ahead is battery-powered electric vehicles (EVS). While EVS today are about 9 per cent of new vehicle sales, they are only about 1.5 per cent of the total stock of vehicles on the road. Even in 2040, while EVS may account for 70 per cent of new sales, they will still be only 40 per cent of the vehicles on the road. The transition will take its own time given the scrappage rates and the age of fleet. The issue here is the US, which has the highest global transport energy consumption, the most miles driven and the lowest use of public transport. In the US, EV share of new vehicles is only 4.5 per cent and low-mileage SUVS and light trucks remain the most popular vehicles. The US has the lowest gasoline prices of any major economy and does not seem to have the political will to put in place the tax structure needed to shift preference to EVS.
For residential and commercial heating, the issue is replacing on-site combustion of natural gas with electric heat pumps. Not simple, because the costs and energy efficiency of on-site burning of natural gas are difficult to improve upon. While many European countries and large US cities have banned burning of fossil fuels in new buildings, given that only about 1 per cent of the housing stock gets added yearly, this will not move the needle. You need to move to a newer technology of electric heat pumps in buildings, as simply electrifying heating using the traditional resistance heating is a non-starter due to the amount of power consumed and grid capacity required.
As the above data shows, while we have seen many pledges and statements of intent from countries, the path to net zero is not trivial. I am not even going into the area of carbon capture and sequestration, a critical assumption in most net zero pledges, but a technology not proven to work as of now.
The world will have to accelerate action to get anywhere near its targets. Massive investments will have to be made. Every investor will have to focus on where in the value chain they wish to participate.