Ahead of the Curve: What to Watch as Transition Pressures Mount

The energy transition is certainly no longer in its infancy. Early-stage actions have given way to more nuanced, advanced strategies from governments and companies alike. With that, a number of fresh risks and growing pains have presented themselves.

As a result, 2022 could prove a deciding year for strides to continue and obstacles to possibly be overcome. In this special feature, we offer our take on 10 significant trends that will affect how the energy transition takes shape this year and beyond — on everything from climbing investor pressures to government policy to advancing technology.

1. China Not to Be Underestimated

Overlooking the speed of advancing technologies in China is comparable to being caught unawares by thieves in the night. Just as China has swiftly built up formidable production chains in solar modules and electric vehicles (EVs), the country is now also the world’s largest EV battery producer and most promising manufacturer of the electrolyzers needed for splitting water molecules to produce green hydrogen. Although China’s prowess in driving technology cost reduction is undisputed, many are still stunned by the pace at which low-carbon technologies have been reaching cost parity with traditional energy forms.

The battery story is very much like the solar one, in that China can capitalize on its mass production advantage to maximize economies of scale and cut costs. Electrolyzer production, on the other hand, is more akin to the wind turbine manufacturing sector in terms of size and volume. Therefore, just as China faces competition from European wind turbine makers in that sector, China might also face Western challengers in the electrolyzer manufacturing chain.

But the main driver for green hydrogen cost reduction is cheap renewable power more so than cheap electrolyzers. Energy Intelligence capital expenditure calculations show China’s market is about 30% cheaper for all power generation technologies, based on a full-size power plant. In this respect, China’s solar and wind cost advantage — due to factors like cheaper labor costs — might also stand it in good stead in the quest for green hydrogen competitiveness.

A wild card capable of slowing or offsetting the cost reductions from China is volatility in prices of the raw materials essential to producing batteries, cars, solar cells, electrolyzers and other green products. In 2021, hikes in the prices of polysilicon, lithium, steel and other metals have either forced price increases or delayed price reductions in their associated downstream products.

2. After COP Comes the Difficult Task

The focus this year will center around building on the progress from COP26 and turning pledges into concrete policy measures — which is perhaps the more difficult task. High energy prices have also highlighted supply security concerns, with policymakers having to balance ambition with pragmatism.

In Europe, questions over the role of gas and nuclear in the transition could prove a sticking point as the EU seeks to finalize its “Fit for 55” climate package released last year. While there’s still a fairly broad political consensus in Europe on the need for climate action, divisions are deeper in the US, with President Joe Biden already encountering congressional roadblocks. China faces fewer such impediments, but is focusing on economic recovery.

In the run-up to COP27 in Egypt later this year, countries are encouraged to increase their ambition. Climate finance is also expected to be high on the agenda there, while Egypt has also said it wants oil and gas companies to play a more active role at climate negotiations than in Glasgow. Opec and other oil-producing players are likewise hoping to use COP27 as an opportunity to reclaim a seat for the oil industry.

3. ESG Pressures Reach New Stages

Environmental, social and governance (ESG) pressure will increase further as investors — particularly those in the $130 trillion-strong Glasgow Financial Alliance for Net-Zero — advance their own carbon-neutrality strategies. This will involve pressing all companies in a portfolio to implement credible net-zero plans, while progressively adjusting holdings to reduce higher-carbon assets.

The first approach is seeing discussions move from high-level, long-term targets to demands for shorter-term, more granular disclosure and capex detail. Engagement will increasingly entail aggressive voting strategies, with board members at companies labeled as slow movers — including CEOs — threatened with removal if they do not act more decisively. Demands on Scope 3 emissions from products sold will be more pressing and, in some cases, translate into requests to reduce rather than just decarbonize production.

US companies may be treated somewhat differently from Europeans, but investors will still be demanding evidence of serious intent and action on low-carbon adaptation. The portfolio adjustment approach could see divestment move up the agenda, following recent decisions by two large mainstream asset owners, Dutch pension fund ABP and Norway’s oil fund.

4. Oil Companies React to ESG Demands

To show investors how solid their ambitious renewable strategies are, European oil companies will continue implementation efforts by growing installed capacity, acquiring power customers and developing related services such as EV charging. However, massive renewable development is not the obvious answer for all investors. Reasons include lack of synergies, lack of impact on absolute emissions and low margins. Proposals for sweeping corporate restructuring may therefore continue to pop up, ranging from limited flotation of a company’s renewable assets to its full spinoff into new independent firms.

Outside of Europe, oil companies will mostly stay away from power and continue to focus on carbon dioxide removal technologies such as carbon capture and storage (CCS) and direct air capture (DAC) — which European firms are also pursuing. US companies need to demonstrate low-carbon projects and targets to convince investors they are taking the energy transition seriously. But the US approach of deploying CCS/DAC, hydrogen and other technologies without shrinking oil and gas production could struggle with acceptance as investors’ net-zero plans advance. Hydrogen will continue to be a central theme across the global oil industry.

5. Crunch Time for Hydrogen

Expect another pivotal year for hydrogen. Ultimately, industry professionals will judge the success of hydrogen based on the scale and role it plays in the energy transition in 2030. To get there, three things arguably need to happen fast — a significant scale-up in production, infrastructure built and end-user markets created. A portion of the pipeline of announced projects costing more than $160 billion would need to be turned into concrete action on a commercial scale this year, given the time lag between conception and operation. Progress in 2022 will also give signals as to eventual leaders in this sector, including companies and governments.

Europe leads the way in electrolyzer projects, reflecting the bloc’s support for renewable electricity. The onus is on the Mideast and the US to move — and some advancements are indeed happening. China, the US, Australia and the Middle East also have a strong pipeline of projects, and as for blue hydrogen with CCS, the technology is gaining support in the US, China, the UK, the Netherlands and some Gulf states. Expect to see some positive momentum in the Middle East this year as record-low solar photovoltaic and wind projects provide the opportunity for lower-cost green hydrogen or green ammonia production, while abundant, relatively-cheap domestic natural gas should offer a competitive advantage.

Expect more governments to adopt stand-alone hydrogen strategies this year, while other governments add depth to their existing broad strategies to adopt concrete measures that will foster growth and push some projects toward final investment decisions.

6. Electric Vehicles Move to Fast Lane

EV uptake globally is certainly in acceleration mode — although it’s not yet reached full speed. EVs have jumped off the margins to become mainstream sellers, particularly in Europe and China, where EVs are approaching one-fifth of overall sales.

Falling battery costs are cited as the key to higher EV penetration. On one hand, battery costs saw their rapid historic decline slow in 2021, as a result of higher raw material costs. The downward trend of battery costs could further flatten, or even temporarily reverse, in 2022. Yet forecasts still see the symbolic marker for battery pack costs of $100 per kilowatt hour — an ideal point for EVs to become cost-competitive with internal combustion engines (ICE) vehicles — being hit by mid-decade.

Automakers have been fast-tracking improvements in battery performance, both in terms of density and efficiency, to manage weight and range issues. An example is Mercedes’ new EQXX concept, claiming a 1,000 kilometer (620 mile) range. “We can expect to see these kinds of improvements hitting the market between now and 2025,” says Alex Martinos, head of Energy Transition Research at Energy Intelligence. Observers should also watch for disruptive, breakthrough technologies, with solid-state and other next-generation batteries still in pursuit by some automakers.

In the next few years, policies could be an important marker of the pace and depth of the EV transition. Initiatives to watch include the mounting number of ICE bans set for the 2030s, as well as charging infrastructure plans in places like the US and Europe, with charging convenience still persisting as a concern among consumers.

Again, don’t underestimate the role of China. China-made EVs are blazing a trail not just in the domestic market, but also increasingly making inroads overseas via exports and helping to accelerate the erosion of transport oil demand on a global level. The China EV market now already accounts for over 50% of the global size. In 2021, China EV sales roared to a new monthly record of 450,000 units during November. At this rate, full-year EV sales for 2021 are set to edge close to, or even hit 3.5 million units for a year-on-year surge of around 150% — nearly double the global growth rate estimated at around 80%. In 2022, the China Passenger Car Association expects EV sales to surge by another 50%.

7. Carbon Markets: Stage Set for Deeper Progress

Carbon markets got a boost last year from stronger climate policy signals across the world — including agreement at long last on Article 6 of the Paris Agreement at COP26. This sets the scene for continued progress in 2022.

Prices more than doubled in Europe’s previously troubled Emissions Trading System, as reforms agreed in recent years helped to tighten the supply of credits. The release of an ambitious EU climate policy package also lent support. Further reforms to bolster the market are envisaged in the “Fit for 55” proposals, including its expansion to transport and buildings, which Brussels hopes to finalize this year.

North American carbon prices have also surged to new record highs, with investors increasingly viewing carbon permits as a good bet as climate policy rises on the global agenda.

China’s national carbon market has been slow to take off. Operational since July, trade in the market has been fairly thin. Chinese carbon prices closed 2021 at around $8.50 per ton — a fraction of EU levels and three to five times lower than those in South Korea and New Zealand. In the near term, a gradual or even slow ramp-up of carbon prices is to be expected because Beijing is prioritizing post-Covid-19 economic recovery.

8. Offsets Debate Rages

Expect the debate to keep heating up around negative emission technologies, such as forestry projects, bioenergy with carbon capture and storage and DAC. On one hand, most experts believe some amount of negative emissions actions — and corresponding carbon offset credits to prove such actions — is necessary to address the climate crisis. On the other hand, scientists and investors insist their usage should be strictly limited to residual emissions from sectors such as agriculture or limited segments of transport. This is because nature-based options, which are highly land-intensive, involve sustainability issues, while DAC remains largely unproven. Durability of biological storage in trees is also questioned.

By contrast, many oil companies, notably in the US and the Mideast, suggest negative emissions technologies could, together with plain CCS, address much of the climate problem and allow oil and gas to keep growing — or at least stabilize. In theory, this is true, but would rapidly be undermined by scale issues. CCS and DAC involve handling huge amounts of CO2 in yet-to-be-developed infrastructure.

9. Mounting Calls for Greener Gas

Natural gas’ role in the energy transition continues to face a mixed, and sometimes tumultuous, reception. Politically, natural gas escaped the vitriol of environmentalists at COP26 in November, with coal the standout villain. In some locations, a more expedient attitude toward gas usage in the 2020s has been seen, especially in Europe. Market trends cannot be ignored in all this: gas prices ended the year cripplingly high globally, with energy crises in multiple regions adding layers of controversy and complication.

In any case, scrutiny of gas is expected to mount in 2022 and beyond. This scrutiny should be particularly acute for LNG as more sellers provide details of the life-cycle greenhouse gas emissions of their gas exports. Given that LNG importers have a new verification system for assessing the carbon neutrality of LNG cargoes, 2022 could see much greener LNG in the marketplace. Expect more scrutiny of LNG projects this year as ESG measures become more important for investors and consumers.

Given the high-profile nature of the global methane pledge at COP26, there will also be closer oversight on the “greenness” of proposed LNG projects. Expect vocal objection to arguably “dirtier” projects in 2022. In Europe, where policymakers are drawing up rules and regulations on methane emissions, leak detection and repair, expect 2022 to be a year where more buyers distinguish between good and bad gas.

This year could also see a rise in power sector gas demand in Europe as countries shut down coal and nuclear capacity on environmental grounds. If prices remain high, as many industry observers predict will happen until well into the Northern Hemisphere spring, expect backlash against gas. Also expect strengthened calls for market rule changes, especially when consumers start to feel the feed-through impact of higher tariffs.

10. US Pursues Plan B

A lack of political consensus has kept President Joe Biden’s administration from delivering climate action on the grand scale he envisioned, despite some wins in the realms of executive action and low-carbon spending. Most recently, the White House was unable to find enough votes to pass the Build Back Better bill, which Biden administration officials had pitched at diplomatic gatherings as an important element in turning his climate pledges into results. It included key provisions aimed at accelerating electrification, reining in methane emissions and incentivizing more zero-carbon electricity, among other things. That’s not the only setback. Biden pledges to halt upstream leasing on federal lands have been hampered by legal precedent and political opposition, but the administration could still slow the pace.

Going forward, the Biden administration is bound to make a second push for at least some climate-related spending before the midterm elections in November 2022 and step up executive action. The administration recently finalized tailpipe emissions targets for light-duty vehicles and we expect forthcoming rules on climate risk disclosure and methane releases.