Geopolitical and economic stall energy transition

Gabriel Brazil, London

Despite continued growth in clean energy investments, the phase-out of fossil fuels needed to meet net-zero goals remains elusive. Unfavorable macroeconomic conditions, high interest rates and geopolitical competition will hinder the development of complex renewable projects and disrupt technology sharing, policy coordination and access to critical resources.

Energy conversion or adding renewables?

Clean energy production is increasing rapidly. According to the International Energy Agency (IEA), renewable capacity additions will increase by approximately 50% in 2023, marking the twenty-second year in which such an indicator has reached a new record. However, there is effectively no change if consumption and investments in fossil fuels continue to increase, which remains the case despite the increased urgency of the climate crisis. According to IEA data, investments in clean energy have outstripped investments in fossil fuels over the past three years, but these have continued to rise.

Although the IEA expects consumption of fossil fuels to peak by 2030, this is considered an overly optimistic estimate by some industry players as new, large-scale oil and gas projects continue to be implemented around the world.

The persistence of investments in fossil fuels is a global phenomenon, reflecting the consequences of the Ukraine and Gaza conflicts and related energy security and affordability concerns in developed and emerging economies. It also reflects the consistently strong economic fundamentals for oil and gas projects from traditional and emerging producers including the Middle East, the US, Canada, Brazil and Guyana. All of these producers retain significant short-term financial incentives without phasing out their growing production as they enjoy the benefits of increased exports and better energy security opportunities.

As a result, relative prices for fossil fuels will pose challenges to many renewable projects, as fossil fuels may be a favorable choice for countries and businesses looking to secure energy supplies without raising costs in the short term.

Renewable expansion

As the overall demand for energy (especially electricity) continues to rise, this does not mean that the expansion of renewable capacities will slow down. Instead, positive technological developments, policy support (albeit vague) and economies of scale will continue to fuel the surge in clean energy investment in the coming years. Solar and wind will continue to be key leaders of growth, while green hydrogen and nuclear power have significant potential, and governments and investors are working to de-risk such projects.

Renewable energy capacity has increased in recent years in many regions, particularly in Europe, the United States, and middle powers such as India and Brazil. However, China has shown the most significant growth: for example, China will have the world’s solar power on by 2022, and by 2023, while additions from wind have increased by 66%. With its significant domestic policy coordination capabilities and dominance in critical supplies (including minerals and equipment), China will be a major force for clean energy globally in the coming years. This will further fuel its growing strategic rivalry against the US and its allies.

However, the pace of overall renewable development will be erratic as it continues to be subject to volatile geopolitical and macroeconomic conditions. As governments weigh the so-called „energy trilemma” of energy security, affordability, and sustainability, these conditions can be relatively crippling for sustainability, especially when geopolitical antagonism persists. This will ultimately prevent governments’ more ambitious green rhetoric from being translated into concrete, renewable policies. Meanwhile, elevated interest rates due to stubborn inflationary pressures will hamper the economics of more complex projects, at least over a one- to two-year outlook. Although rates have peaked in developed economies, they will remain high for a long time as supply chain disruption slows inflation.

Cooperation decreases

Geopolitical competition will continue to be a major problem for the energy transition. This poses risks to both businesses directly involved in energy projects, as well as those that are not but still need to decarbonize their supply chains reliably and quickly.

As repeatedly emphasized by the scientific community, global cooperation will be key to mitigating climate change. From technology sharing to policy coordination and establishing fluid flows of trade for critical resources, Recent COP agreements Considers diversity as the backbone of an orderly green transition. However, precisely because of its strategic nature, the energy transition has become a competitive battleground, as great powers act to preserve self-sufficiency and prevent the development of adversaries’ comparative advantages.

This mainly manifests in trade restrictions focused on critical minerals and emerging technology, the weaponization of regulations (for example ESG issues relevant to both mining and energy projects) and domestic subsidies, particularly electric vehicles (EVs). Recent examples of the energy transition include China’s ban on rare earths processing technologies, US Inflationary Reduction Act (IRA) subsidies for domestically produced EVs, and EU scrutiny of Chinese subsidies for solar panels.

There are a few exceptions, but even they underscore the pace of growing competition, as partnerships have formed along a clear „US allies vs. China” mold. For example, on April 10, Japan and the United States announced a partnership to accelerate developments in engineering, manufacturing and other fields related to floating wind farms.. On April 5, the European Union, the United States and the other members of the 14-member Mineral Security Partnership (MSP), Kazakhstan, Namibia, Ukraine and Uzbekistan, announced the creation of the so-called MSP Forum, which will be crucial. A platform for collaboration in the critical minerals space. On the other side of the geopolitical divide, the BRICS+ alliance continues to work to reduce dependence on Western economies, for example by creating devaluation and alternative investment channels (in countries such as Africa, South Asia and Latin America).

AI enters the stage

Electricity is a key element that drives energy conversion and, at the same time, makes it so complicated. Significant adoption of EVs combined with the electrification of industrial systems will enable countries and businesses to rapidly decarbonize their energy matrices. New AI-based tools will further enhance the opportunities for positive technology shocks that can advance the energy transition.

However, the energy requirements of these technologies often lead to overloading of electricity grids, which are generally ill-prepared to absorb the growing demand in developed and emerging economies. According to the IEA, global electricity demand will increase by an average of 3.4% per year over the next three years. The demand for datacenters, cryptocurrency and AI will especially double during such a period, which will be a significant part of the overall demand growth.

Increased power demand coupled with frequent and severe heat stress due to climate change will raise operational risks related to power shortages. These have increased in both frequency and duration around the world – and will intensify in the coming months and years as global temperatures continue to rise.

Business risks

As with all things climate change, the main risks of the energy transition are related to global action not being swift and strong, as the climate crisis affects businesses and everyday life around the world. Additionally, an erratic energy transition would add instability to already fragile geopolitics (and vice versa), implying increased disruption risks to the global economy.

Against this backdrop, businesses are exposed to a set of interconnected risks, including regulatory instability and operational disruption. Decarbonization will be essential for companies looking to future-proof their investments and meet growing regulatory compliance requirements, but such a process will require a proper assessment of geopolitical trends, robust economic planning and a long-term-oriented mindset. Without it, businesses may pursue decarbonisation targets that become technically or politically unattainable. However, successful navigation of such a landscape can often be a strong competitive advantage, as it can help businesses overcome the energy trilemma and significantly improve operational resilience.

Gabriel Brasil is a Senior Analyst at Control Risks, a global specialist risk consultancy.

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