Energy Transition Destination Firmly Set, Despite Detours

The global energy transition is by no means marching forward like an orderly, disciplined line of soldiers. It’s taken on a rogue and untidy character, and this is particularly evident at the dawn of 2023 in the midst of overlapping global crises.

But the transition is marching on regardless, and disorderly doesn’t automatically mean deficient. Many forces have been threatening to derail the energy transition — from geopolitical tensions to supply chain logjams — yet these have mainly served as short-term obstacles, not long-term roadblocks.

In fact, the energy transition has seen some surprising momentum in spite of the challenges, in areas like government climate action and low-carbon technological investments. These advances come as public perception of fossil fuels has been tarnished further in the last year — amid gas supply concerns driven by the Ukraine conflict, oil producer-consumer strains, and a level of market volatility that’s grown glaringly obvious to consumers.

The long-term destination is still set toward decarbonization, although some detours should be expected this year. Here we offer our take on the top 10 most important pieces to watch closely in 2023.

1. The tug-of-war between energy security and climate action will go into extra innings this year and underpin the climate narrative at the national and international levels. In Europe, notably, where many politicians expect Russia to significantly reduce gas flows via Ukraine fairly soon, energy security and high prices are very much seen as interlinked problems. “I doubt that this attitude will change in 2023,” says Sam Burman, a senior analyst with Energy Intelligence. The perception is that the intertwined challenges can be calmed with renewables, hydrogen, and reduced consumption — with government and corporate moves along these lines bound to continue this year in Europe and beyond.

On a more global scale, the energy crisis has hardened geographical divisions on energy transition policies, which suggests government actions will, more than ever, resemble a patchwork rather than an orderly row. But movement is unfolding nonetheless, and it will be important to watch this year how policies agreed-upon in 2022 are set into motion in 2023. These include the doling-out of technological incentives approved in the US’ Inflation Reduction Act, the implementation of ambitions set out in the EU’s REPowerEU plan, moves by countries like India and Turkey to delve into carbon pricing, and the international climate loss and damage fund greenlit at COP27, which promises to mend some of north-south divisions in climate diplomacy.

Despite the momentum, the international political landscape will be as unpredictable as ever for companies to navigate. “The energy industry will face an untidy patchwork of differing market dynamics, varying regulation and diverse social pressures, complicating business decisions,” Energy Intelligence Research & Advisory warns in a recent energy transition analysis. And the conversation is constantly seeing new twists: “Divergent views on energy — including strained relations between oil and gas producers and consumers — are also part of a wider rise in geopolitical tensions.”

2. The next UN climate talks in Dubai in late November will likely prove pivotal — and so could the months leading up to it as countries face pressure to dial up domestic climate actions. COP28 represents the first global "stocktake" after the 2015 Paris Agreement, which will "take stock" of progress so far in meeting the promises set out there. This is likely to highlight the need to increase efforts to keep the 1.5°C or even 2°C goals in sight, increasing pressure on countries to strengthen their climate pledges. It will also focus attention again on climate finance, to help poorer countries increase their climate ambition.

As always, at these events, progress on the sidelines can be as important as the official discussions, including bilateral and multilateral cooperation in key areas like hydrogen, methane emissions, and carbon removal. Watch for new international alliances and pledges in those areas, and also watch for more Just Energy Transition Partnerships for developing nations, similar to those already arranged for South Africa and Indonesia.

3. Momentum for low-carbon technologies may be the most assured source of energy transition advances this year, with commercial interest often moving faster than the supply chain can accommodate. Low-carbon hydrogen, especially, has gained outsized enthusiasm. If 2022 was a year of hype for this sector, then 2023 could be a year where more substance backs it up. Although the vast majority — more than 95% — of announced projects are pre-financial investment decision (FID), there are signs that serious interest is being shown in green and blue hydrogen. Pilot projects are getting greenlit and numerous MOUs inked. Mideast producers and US Gulf-focused oil and gas players are largely eyeing huge blue hydrogen/ammonia projects, while Chinese NOCs and European oil majors are targeting green hydrogen.

Cost remains a barrier as gray hydrogen is much cheaper than blue hydrogen on a levelized cost of hydrogen basis, while green hydrogen is typically more expensive than blue. In the short term, watch for signals that production may be scaling up, with more major project FIDs, plus also greater policy support and clarity, as well as further development of midstream transportation/storage infrastructure and new end-use demand. Experts say there’s no shortage of proposed production projects — but observers are increasingly watching for progress on concrete new offtakers, and more certainty on transportation options — in order to justify taking FID on those big projects.

In China, the hydrogen scene is bustling in sectors like electrolyzer and fuel cell equipment manufacturing. Upstream production is still in the experimental or demonstration stage and a market for hydrogen trading is far from sight. Sinopec is making progress on its upstream hydrogen ambitions and recently bagged approvals to construct two new green hydrogen projects in Inner Mongolia.

4. Carbon-removal projects and technologies could also see pivotal advances. Direct air capture is gaining a wave of traction, with massive plants in the US due to start up mid-decade. Key questions around project financing include potential new equity investors, the attractiveness of using CO2 for enhanced oil recovery and the growing demand for carbon offsets. Beefed-up tax credits in the US will likely drive even more investment in CCS there. But permitting remains a major bottleneck and creates risk for project timelines, while public opposition simmers.

Governments and regulators globally will continue to have a large role to play in incentivizing CO2 capture by establishing carbon-pricing systems and setting favorable permitting and monitoring guidelines for permanent storage. And while the appetite for voluntary carbon markets appears to be strong, buyers of credits will need ways to credibly verify the net-zero credentials of their purchases. The IEA’s net-zero scenario assumes an average 130 million tons per year of CCS capacity is commissioned through 2030.

5. ESG pressures will not retreat even if messaging becomes increasingly mixed and opaque. Energy security concerns associated with fossil fuels in light of the Russia-Ukraine war have stolen some climate momentum around fossil fuel financing and corporate strategies, but we see the biggest flashpoints in this near-term energy security/long-term climate security tug-of-war centered around pace, not direction, of financial climate action. Risks of a slowed pace are greatest in the US given the increasing politicization of ESG. Here, we’ll watch for signs of tangible reversal in investor climate commitments, versus a loss of transparency to avoid scrutiny (the more likely outcome, in our view).

Elsewhere, particularly in Europe, banks and investors will likely continue quantifying medium-term plans to reduce fossil fuel exposure. But we’ll watch closely how institutions respond to stakeholder demands for swifter cuts to fossil fuel lending, including total financed emissions and exclusions of specific segments of the oil and gas industry, such as new oil resources, despite newfound energy security concerns. Regardless of outcomes, oil and gas companies are expected to at least maintain current low-carbon strategies in 2023, given significant momentum and lead times required to meet longer-term climate objectives, which remain intact.

6. Natural gas finds itself on shakier ground. Question marks obviously include supplies from Russia, the issue of methane leakage and, more generally, gas' public image as a fossil fuel. Many oil and gas majors maintain their ground that gas is a key transition fuel, but 1.5°C-2°C scenarios suggest investing in new infrastructure now involves a substantial risk of stranded assets. This highlights a dilemma for investors considering LNG projects and the tension between short‐term growth and uncertain longer-term demand.

It is striking to see how several scenarios — such as the IEA and BP outlooks — have slashed potential gas demand in their 2022 versions. Key reasons include a stronger than previously anticipated growth in wind and solar capacity due to energy security concerns, the US’ Inflation Reduction Act speeding up renewable deployment and energy efficiency investment, as well as high natural gas prices slowing coal‐to‐gas switching in many emerging markets. Competition from low-emissions gases such as biomethane and low-carbon hydrogen is also set to intensify.

7. China to lead electric vehicle (EV) growth, inside its borders and beyond, posing deepening risks for oil consumption in auto transport. EVs reached a milestone 33.8% of national automobile sales in China this past November, defying economic headwinds and Covid-19 outbreaks throughout 2022. Softening oil prices and a termination of central government EV subsidies this year could slow the pace, with analysts predicting a moderation in the 2023 EV growth rate to around 30%-35%. But this may be conservative: the pace of China’s transition has been underestimated in the past, both in the EV sector as well as the solar market. China is also primed to expand its global influence as an EV exporter this year.

The US has seen incremental but steady upticks in EV penetration, with EVs reaching 7% of the light-duty market this past November, up from 4% annual market share in 2021. This year, it will be crucial to watch for implications from the EV elements of the Inflation Reduction Act (IRA). US car buyers can now receive EV tax breaks of up to $7,500 as an instant rebate of sorts, naturally improving sales, yet the IRA also includes provisions limiting the credit’s eligibility based on the origin of the batteries and related minerals, potentially limiting sales in the near-term but boosting the domestic battery industry in the long run.

In Europe, EV registrations had reached 21% of overall auto sales as of the third quarter of 2022. In 2023 watch out for policies at a national level in Europe and automaker investments to improve the case for EV adoption — with a particular focus on boosting charging networks. Barriers include the possibility of EV subsidy cuts from cash-strapped governments and high prices to charge EVs in many areas. Yet the overall trend toward greater adoption should continue, underpinned by strong policy support as the EU starts to implement its "Fit for 55" climate and energy package. "In the most advanced EV markets like Norway, with the clouds of Covid-19 clearing, we may start to get a better picture of how high EV adoption is starting to impact oil demand," predicts Alex Martinos, head of Energy Transition Research at Energy Intelligence.

8. High fossil fuel prices and energy security motivations will support renewable energy deployment this year, especially wind and solar photovoltaics. Potential headwinds come from elevated metals/equipment prices, rising interest rates and very tight supply-chain margins. Permitting and grid connection issues could also dampen growth acceleration this year, although governments, especially in Europe, are trying to tackle this problem.

For the first time since the 2007-08 commodity price boom, renewable costs have increased in 2022, Energy Intelligence's data on the levelized cost of electricity show. But the data also shows that renewables have never been as competitive given how expensive fossil fuels currently are, and long-term trends remain unchanged: solar PV and wind farms will continue to increase their cost competitiveness against any other form of power generation. The IEA expects global renewable capacity additions to almost double through 2027 compared with the past five years but insists this should accelerate further to bridge the “net-zero gap.”

9. China’s renewables buildout is going strong and provides evidence of the long-term direction of decarbonizing the electricity sector, despite a near-term trend of resorting back to coal. The energy crisis forced China to double down on domestic coal as a means of cutting reliance on expensive LNG imports. Its LNG imports have plunged by 20% year on year in the first 11 months of 2022. While it did increase imports of pipeline gas, the cost of which was cheaper than LNG by more than 50%, the piped volumes were not sufficient to offset the reduction in LNG purchases. Beijing also agreed to import an additional 10 billion cubic meters per year of piped gas from Gazprom, but the absence of details of the deal is widely seen as suggestive of it having greater political significance than commercial viability.

The coal emphasis, however, is likely to be an interim measure to prevent immediate energy crunches while awaiting the completion in the medium to longer term of massive capacity additions for nuclear and renewables. China approved 10 nuclear reactor newbuilds this year, the highest count in a single year in some 14 years. The country is also building giant wind and solar farms totaling in the hundreds of gigawatts in its vast Gobi desert and other wilderness regions.

10. Watch to see how the US uses unprecedented clean energy spending in the Inflation Reduction Act and Bipartisan Infrastructure Law to kick-start progress in areas like hydrogen hubs, carbon removal, and EV batteries. Most of the Biden administration's focus will be on finalizing these roughly $260 million in clean energy tax credits and other key provisions, as well as imposing a methane tax on oil and gas operators.

Although partisan divides on Capitol Hill could prevent significant new legislation this year, watch to see how discussions unfold on permitting reform. Bureaucracy is increasingly blamed for thwarting infrastructure projects needed to support the energy transition, from transmission lines to new critical minerals mines. Further, the 2024 presidential election cycle will take some early shape this year, providing signals of where the candidates stand on climate and energy. The US is also to be watched for its role as an international climate negotiator, proven by its cooperation with Europe on the Global Methane Pledge. Watch for further US influence in alliance-building and diplomatic brokering as COP28 in Dubai approaches.