Why private capital should fuel the accelerating energy transition

Energy security has been dragged into the spotlight by Russia’s invasion of Ukraine. How does this impact the energy transition?

It seems certain that the build-out of renewable energy projects in the UK and across Europe is set to accelerate, as countries move to replace Russian gas with reliable, cheap domestic renewables. But the story is more nuanced than that. In the UK, legally binding 2050 net zero targets have meant that this replacement was inevitable. However, the invasion has created a new urgency. Measures that were set to be implemented later in the journey are being advanced considerably.  

So, what does the UK’s energy future look like?

The UK’s Committee on Climate Change (CCC) has long foreseen that electricity would be the first step in decarbonizing the economy. This has begun with the near-total removal of coal from the grid and the widespread deployment of wind and solar, with biomass also making a contribution. The carbon intensity of UK electricity has dropped from around 500g of CO2 for every kWh of electricity generated to less than 200g today, and is forecast to be under 50g by the early 2030s. Most of this reduction will come from increased penetration of wind – largely offshore – and solar.

Energy supply is only one side of the equation. How will decarbonization affect electricity demand?

While decarbonization of electricity is underway over the next decade, the CCC expects demand to remain largely flat and the cost of decarbonizing ground transport (largely cars) and space heating to decline. This would likely be achieved through technological advances in EVs and heat pumps.  

In the mid-2030s, as these switches start to roll out widely, demand for electricity will rise accordingly, doubling by 2050. By this time, electricity will supply most of the UK’s energy needs, displacing gas and oil. The CCC forecasts that clean hydrogen will be needed to decarbonize hard-to-treat parts of the economy, with hydrogen electrolysis driving yet further electricity demand. It is less certain how that doubling in electricity demand will be met. Renewables will play a large part, but the government is also placing bets on new nuclear and CCUS (carbon capture, usage, and storage).

You say the story is nuanced. Can you provide more detail on how challenges in power generation will differ around the world?

Each country committed to net zero is seeking to square the new "trilemma" of achieving net zero, maintaining energy security, and transitioning in a way that is affordable for its people and its industry.  

Different areas will follow different routes, depending on their energy usage, their sun and wind resource, and geographic specifics. In Spain, a kilowatt hour of solar electricity is about half the price of production in the UK because, as holiday-makers know, Spain receives twice as much sun. It also has large open spaces and an excellent wind resource, so will likely have lots more onshore wind.  

In New Mexico in the US, peak energy demand is in summer afternoons, making solar and batteries a clear choice. On the Gulf Coast in Texas, morning and evening ocean winds make it an ideal location for low-cost hydrogen production. France will rely on nuclear for the foreseeable future.

Overall, which generation technologies will have the most impact?

For most countries, the answer will be wind and solar in the near-term and, in some, nuclear later on. The UK government’s recent commitment to 24GW of nuclear power doesn’t currently have a clear target date, with Sizewell the only short-term option – mid-2030s – after Hinkley comes online toward the end of this decade. And yes, there might be some new technologies invented by then, but without wind and solar, we cannot expect to reach net zero targets within the relevant timescales.

The US climate envoy John Kerry talks about "backslide" risk. Can you tell us about that?

Mr Kerry said there is risk that moving away from Russian gas may cause a "back-slide" to coal in some countries. For example, the phase-out of coal in Germany will now take rather longer, because the replacement of relatively cheap Russian gas by more expensive LNG from Qatar or the US will be mitigated by domestically sourced coal being used for longer.

Another example is Japan, which is densely populated due to its mountainous terrain, resistant to nuclear energy since the 2011 Fukushima disaster, and unsuitable for solar or wind energy. In addition to coal, Japan will likely have to enter into long-term LNG supply agreements, which would further delay the net zero transition, to which Japan is only a recent convert.

Why should investors consider renewables?

The financial benefits of renewables infrastructure in the current environment are clear. Comments like those from Bank of England Governor Andrew Bailey on the central bank’s inability to prevent inflation from reaching 10% have not been heard by a generation of investors. It’s unnerving, but it means that long-duration assets with secure, inflation-linked income – such as renewables – will be in high demand, providing reliable hedges to liabilities, as well as holding their value.  

Renewables are obviously sustainable, but where do they fit with wider ESG goals?

Investing is about more than financials now. We’re still early on in what will be a long journey to create a green financial system in the UK, Europe, and beyond. In the UK, for example, the government’s Roadmap to Sustainable Investment set out three phases: informing, acting, and shifting. As an economy we’re still mostly in phase one, which is to deliver ‘decision-useful’ information on sustainability to asset allocators.  We expect the next stages to drive further capital into green investments. 

Beyond the generation of clean electrons, Schroders Greencoat is extremely rigorous in its ESG processes and ensures social and governance aspects are held to the highest standards. Our ESG assessment is ‘full spectrum’ and incorporates biodiversity, diversity & inclusion, social challenges, cyber security, supply chain transparency, workplace safety… the list goes on, and we are proud of its length!

This article was first published on Prequin.com