COVID recovery plans are likely to accelerate the transition to a low-carbon future and in the process change the operating dynamics – in some cases business models – of every industry. In this blog I explore what this could mean for some of the world’s largest sectors (Energy, Transportation, Buildings and Construction, Heavy Industry, Agriculture, FMCG and ICT) and how businesses can prepare for this shift.
As I wrote in a previous blog, there are strong signals that governments and leading economists are keen to ensure that the postcorona recovery will embrace the energy transition already underway, such as the ‘zero-carbon by 2050’ commitments made by the United Kingdom and the European Union.
But none of this is new to anyone who has been following the energy sector over the last few years. With increasing carbon assets ‘stranded’ as they won’t exploited as a result of a combination of price, regulatory and physical challenges, it was clear before COVID that the long game is not in fossil fuels. But the crisis has further changed things in favour of the energy transition:
- We are facing a world that will need to be recapitalised in order to overcome the damage inflicted on the economy by COVID. With a very high demand for capital and a very low supply of it, the providers of capital, whether public or private, will need to ask some very difficult questions such as:
- How resilient is your business model/industrial strategy/economic policy?
- How future-proof is it to the next shock, whether viral, resource or climate related?’
- Where will your growth come from?
These questions are likely to shift the balance towards growing businesses that deliver sustainable and resilient solutions. The current crisis is offering clear evidence that low-carbon technologies have an advantage over fossil fuel investments: While the renewable energy sector is growing at a very healthy rate – low carbon energy sources are set to reach 40% of global energy generation in 2020 – and has been relatively unaffected by the crisis, fossil fuels have suffered, with the price of oil turned negative during the crisis due to the drop in demand. As Fatih Birol said in releasing the IEA’s 2020 World Energy Report, “[COVID-19] is affecting demand for electricity from coal and natural gas, which are finding themselves increasingly squeezed between low overall power demand and increasing output from renewables.”
- When a sector near its structural peak hits a cyclical downturn the demand peak is typically advanced by a few years. The oil and gas sectors were already nearing their peak due to concerns about carbon emissions, about stranded assets and the price competitiveness of renewable energy. In fact it is likely the peak had already been seen in developing nations in coal and combustion engine cars.
In other words, the energy transition is arguably more likely now than before COVID.
How will the energy transition impact different sectors?
I will now turn to the impact this will have on a number of key industries.
As mentioned above, the demand for fossil fuels is nearing its peak, prompting many companies - and indeed nations - to review their approaches, seeking to diversify their portfolios rather than maintain their exposure to fossil fuels. A few recent examples stand out:
- The IPO of Saudi Aramco, which is at least to some extent prompted by the Saudi government starting to ‘cash its chips’ while the going is still relatively good, amid a laudable aim to diversify the Saudi economy. (In other words, to move away from fossil fuels).
- BPs aim for its entire business (operations, supply-chain and customers) to go carbon neutral by 2050, under the leadership of its new CEO, Bernard Looney. This announcement came with a commitment to invest more in low-carbon businesses – and less in oil and gas – over time. Most recently, BPs CFO Brian Gilvary, became the latest advocate for a green recovery, arguing at the recent FT Global Boardroom conference that “We have got to do the energy transition — this isn’t an option”.
Electrification is going to be a significant driver of this transition. According to McKinsey’s 2019 Global Energy Perspective, demand for electricity will grow seven times faster than other energy sources, driven by the electrification of the construction, transport and industrial sectors. Aligned with this are developments in decentralised energy generation and the growth of energy storage capacity which may shift the industry dynamics of electricity production, generation and distribution, potentially favouring new players over incumbents.
Ten years ago the transport industry was seen as one of the hardest to transition because it couldn’t rely on a greener grid given the need for fossil fuels to power the internal combustion engine. Roll forward to today and the situation is very different, particularly in the automotive sector. Many leading carmakers such as Jaguar Land Rover, Volvo and Volkswagen, have made external commitments to move towards electric vehicles, worrying the petrol stations industry in the process. These plans are still on track irrespective or COVID as is the UK‘s commitment to ban the sale of new petrol, diesel and hybrid cars by 2035.
It will take longer for the shift to occur in freight and aviation, though advances are being made in both areas. UK aviation has committed to cut its emissions to net zero by 2050 by focusing on developing low-carbon fuels – doable but with limited carbon impact – and the electrification of planes – potential high impact but quite a distant reality - and carbon offsetting. Meanwhile, the WBCSD has identified four solutions to reducing the emissions of the freight sector: Avoiding journeys where possible; Modal shift to lower-carbon transport systems; Lowering energy intensity and Reducing the carbon intensity of fuels, for instance through the use of biofuels.
Buildings and Construction
According to the International Energy Agency, the buildings sector is responsible for 28% of total energy-related CO2 emissions, mostly from electricity used in buildings. The growth of low-carbon electricity grids will significantly improve these figures over the coming years as facilities will take advantage of the reputational and cost benefits of green energy.
As McKinsey research highlights, the energy transition will also create significant opportunities for those companies that are able to support the development of smart cities including smart grids, improved public transportation systems and high-speed data networks, wireless charging and other emerging innovations. The growing support for zero-carbon and smart buildings which manage energy far more efficiently and are able to generate their own energy will provide further growth opportunities.
Finally, if policy support for residential energy generation through domestic solar panels and feed-in tariffs is increased, solar producers and installers will see significant growth.
Significant decarbonisation will be a challenge for heavy. Industry is responsible for a quarter global carbon dioxide (CO2) emissions, with the top three industry emitters, steel, cement and chemicals, accounting for around 16% of all CO2 emissions globally. But all is not lost, as there is a pathway to achieve close to zero emissions through a combination of energy-efficiency improvements, cogeneration plants, the use of hydrogen and biomass as feedstock or fuel, and carbon capture.
During the last century, and particularly since the second world war, agriculture has been increasingly reliant on fossil fuels in the growing of crops (nitrogen fertilizers, petroleum-based agrochemicals and diesel-powered machinery), access to water (energy required to get water to crops), processing of food products, and the distribution of such products along global supply-chains. Furthermore, livestock also has a direct impact on global greenhouse gas emissions from the natural methane produced by ruminants (yes, farts) which are responsible for 40% of the emissions of the livestock industry.
The energy transition will require innovation as the industry reduces its dependency on those processes that generate greenhouse gases. But as the FAO points out, solutions exist for the livestock sector involving improved feeding techniques, herd management and grazing lands. Similarly for crops, reducing tillage, expanding crop rotations, planting cover crops and reintegrating livestock into crop production systems can all reduce the carbon footprint of the sector. Digital solutions that create shorter “farm-to-table” routes will reduce distribution footprints. These are not straightforward solutions when the emphasis is on maximising yields over short timeframes, but given conventional industrial agriculture has historically resulted in the degradation of soils and that half of the planet’s topsoil has been lost in the last 150 years, solutions that reduce carbon footprints and replenish our soils will be popular.
But our need to reduce global carbon footprints is also an opportunity for the sector as biofuels, which are already the largest source of clean transport fuels, could see significant growth in the energy transition as long as they don’t compete directly with food crops.
Fast-moving consumer goods
As a result of the carbon impact in supply-chains, production and distribution, the FMCG sector has a high carbon footprint. For instance, the UK food supply chain accounts for about 20 percent of UK greenhouse gas (GHG) emissions. However, according to CDP analysis, “90% of the sector’s carbon emissions lie in the value chain, leaving companies exposed to raw material risks and product consumption risks”. Both COVID and the energy transition may result in an increase in transactions driven by three related trends:
- minimising exposure to carbon risks by shortening supply-chains
- maximising security of supply through local production
- growing consumer preferences for ethical brands
Consumer choice will also accelerate this shift as they become increasingly conscious of the impact of their purchasing decisions on the planet.
Information and Communication Technology
The energy transition on the whole presents significant opportunities for the ICT sector. Simply put, we can not decarbonise the planet without translating economic value from molecules to data, thus reducing our resource use and the energy that is needed for the extraction, production, distribution and use of products. It is one of the reasons policy measures that aim to achieve low-carbon outcomes often mention digitisation in the same breath, such as the EU’s suggested postcorona recovery plan.
But this increased digitisation is energy intensive, putting pressure on major tech companies such as Facebook and Google. In response many decided to vertically integrate low-carbon energy generation through the purchase of wind and solar generation to feed the energy thirst of server farms. This has lowered the carbon intensity of the industry. The energy transition is likely to continue this trend and see further vertical integration of renewable energy within ICT.
Implications going forward
As the cost of carbon increases in line with the energy transition, those companies that can achieve carbon reductions, and the industries that will enable them to do so will become increasingly attractive. This will lead to a shift towards investments in the development, commercialisation and scaling of low-carbon technologies and the development of low-carbon infrastructure with particular emphasis in energy, transport and ICT.
These are clear signals that a re-allocation of portfolios will continue the trend towards finance and M&A activity across sectors to decarbonise, increase resilience to future crises and find opportunities for growth.
As finance is a key driver of the transition, it is worth highlighting this analysis by McKinsey which identified six areas for financial institutions to consider to play an active role in the energy transition.
What should companies do?
In closing, here is a short list of what businesses can do to minimise risks and maximise opportunities arising from the energy transition.
- Develop energy transition plans to achieve zero-carbon by 2050 in line with commitments made by a growing number of nations, sectors and companies.
- Identify which parts of your operations and supply-chains are able to make the transition in the short-term and which will continue to require traditional fossil fuels to ensure continuity of energy supply in the medium-term.
- Seek out opportunities for profitable investment in low-carbon technologies and infrastructure.
- Carry out carbon due diligence of your business, target acquisitions and supply-chains to understand your exposure the carbon risk.