Roadmaps for energy transition

Examining the pathways to a net-zero world, how we can get there, and how we address the short-term challenges of shifting geopolitical shocks and the longer-term challenges around financing and securing a just transition, were the focus of a CERAWeek session featuring Jan Laubjerg, Global Head of Natural Resources at HSBC, alongside Amos Hochstein, Senior Advisor for Global Energy Security, United States Department of State, and Carlos Pascual, Senior Vice President, Global Energy and International Affairs, S&P Global.

When COP26 was held in Glasgow, Scotland, in the Fall of 2021, countries representing 90% of global GDP made commitments to achieve net-zero emissions by some future date.

While there was a recognition within those commitments that there could always be shocks that could shift the dial, few could have imagined the scale of the shock we now face or how soon it would occur.

The effects of Russia’s invasion of Ukraine have been far reaching. From the unfolding and terrible humanitarian tragedy to the threat to European security, the global economy, and the transition to net zero. With recent events highlighting the dependence of Europe in particular on Russian fossil fuels and the need to transform its infrastructure and open access to other markets in order to lessen that reliance, it has, in many senses, underlined the need to accelerate the energy transition.

Will capital markets ‘double-down’?

At the same time, it shows how early we are on that transition journey and that, certainly in the shorter term, access to fossil fuels is essential to ensure that economic growth continues. Despite these shocks, Laubjerg believes that in the medium to long term there will not be a material change in the direction financial markets are heading as it pertains financing the energy sector.

“While we are seeing an unprecedented degree of change in energy markets, I don’t think that the overall direction of financial markets in relation to the energy transition will fundamentally change,” he points out. “Arguably capital has moved faster than industry on the transition, and what we’re likely to see is those stakeholders adopting a ‘we told you so’ approach in the sense of, this is what happens when you have an overdependence on hydrocarbons that typically get transported from countries with, perhaps, high political risk.”

“While there’s likely to be a degree of pause and reflection in the very near term, which will probably slow down the provision of capital to the energy sector, beyond that, it may result in a doubling-down of a ‘let’s move forward’ sentiment from the capital and financial markets.”

Capital moving faster than absorption

Given the EU statement on accelerating the green energy transition in direct response to the Ukraine crisis, how quickly are we likely to see capital flows into that transition in view of the uncertainty around how quickly these steps can be achieved, and in the face of constraints such as high inflation and commodity shortages?

“There’s actually an excess of supply of capital to the transition agenda and a dearth of balance sheets that can actually consume that capital,” says Laubjerg. “So supply and demand are not balancing on price simply because capital has moved at a faster rate than the time it takes to build out projects and balance sheets to absorb it. And I think that’s likely to be the case for much of this decade.”

Forging closer relationships

Globally, it highlights the need for policymakers and administrations to work with private capital to make projects more bankable, for example, through appropriate policy frameworks, tax incentives and so forth – which in many cases also require a more constructive and collaborative approach between policy makers and energy companies.

“Over the past 20-30 years, the dynamics of the relationship between the oil companies and policymakers has often been adversarial, particularly in the west,” says Laubjerg. “In more recent times, we’d started to see that governments were increasingly acknowledging the need to build closer partnerships with energy companies to implement the transition, which requires the engineering and balance sheet capabilities of these companies. If we can take something positive from the current situation, it’s that this government-industry cooperation will likely grow given the increased focus on urgently securing energy security, while still achieving energy transition."

Greater financial scrutiny

"2022 is also likely to be a year when financial institutions materially accelerate scrutiny of the nature and type of investments being made by energy companies “Most major global banks are part of the Net-Zero Banking Alliance, and their level of financed emissions is a key metric against which they are accountable to stakeholders,” explains Laubjerg. “An oil company that has borrowed capital that reduces its emissions on the same level of production will look better when measured against those metrics that the bank needs to report on, for example, and will thus find it easier to access capital.”

And, he points out, there’s increasing convergence both within the banking sector and global capital markets, which rely largely on the same global banks, on these standards. While that concentration of capital supports a degree of regulatory standardisation, it inevitably impacts on the push for a so-called “just transition,” and the differing cost of capital between developed and developing markets that feeds into that."

The challenges of a just transition

To address this, Laubjerg says that the developing world will ultimately need to create its own pools of capital and banking markets, which will then enable the more competitive pricing of local risk, as opposed to the current state, whereby emerging markets have to access the deeper capital pools of developed countries to finance transition projects and pay more for capital to attract it away from developed markets.

He shares examples of how this has worked previously in the oil and gas industry where local markets developed to fund local projects. “This takes time. In the nearer term, we have partnered with the International Finance Corporation on a project called FAST-Infra to create a standardised label that’s essentially a validation of the quality of projects in developing markets so that they can access global capital pools faster. It’s a step in the right direction, but inevitably, the developing world will pay more for capital and get less of it.”

It is a significant risk to the global transition and highlights the range of roadmaps on the journey that different parts of the world share. The speakers agree that we are now at a critical stage in being able to reduce these barriers and find solutions if we are to ensure that the transition doesn’t increase the divide between developing and developed countries, if we’re to avoid developing a new dependence on a handful of countries that control the new energy production, and the geopolitical risks that come with it, and if we’re to ensure that global economic growth continues.

Further insights