This article first appeared as a contribution to the November 2021 edition of SEB’s The Green Bond.

By Gökçe Mete, Adriana Chavarria-Flores, Andrzej Błachowicz

Limiting global warming to 1.5°C above pre-industrial levels and setting the world on track to meet the goals of the Paris Agreement, requires an unprecedent level of ambition, political will, investment and international collaboration. Not only to drastically cut down greenhouse gas (GHG) emissions, but also to ensure a just transition for both developed and developing countries. In its roadmap to reach net-zero emissions by 2050, the IEA stressed that in order to limited global warming to 1.5°C, global coal demand is halved by 2030 and all unabated coal and oil power plants are retired by 2040.

Commitments by countries to phase out fossil fuels were softened at the end COP 26 due to opposition from major producing countries. The Glasgow Climate Pact[1] only spoke of a phase down of unabated coal. Oil and gas didn’t even make it the final agreement of COP 26. However, the agreement to phase-out inefficient fossil fuel subsidies is a step in the right direction as oil and gas transition is the next frontier for climate mitigation.

Energy crises in Europe is a result of well-known oil and gas price volatility

As many economies re-opened after the Covid-19 lockdowns, gas demand and consumption rose sharply in 2021, causing skyrocketing energy prices. In Europe, natural gas prices have risen by 400% since January[2]. The situation is worsened by gas supply shortages particularly from Russia, low renewable output, nuclear maintenance outages, and all-time high CO2 prices in Europe.

A power plant

The combination of these factors led to record-breaking electricity prices in the third quarter of 2021, which compared to the same quarter of 2020 increased 145% in all European markets, and 669% in the Nord Pool market.[3] The current crisis exposes the difficulty of financing renewables across the EU.[4] Policies under the EU Green Deal like the Fit for 55 package may also push CO2 prices higher and exacerbate the crisis further.

The sooner countries move away from fossil fuels, the sooner they can exit the price volatility trap, which is particularly high for oil and gas. Oil and gas price volatility not only impacts the consumers or importing countries. Exporters who are highly dependent on fossil fuels for state revenues and foreign exchange earnings can experience fiscal crisis due to crashes in oil prices, as happened during the spring of 2020 in Russia and Nigeria.

Subsidies prevent reflecting the true cost of oil and gas

Today in every country, oil and gas are subsidised to cut down the prices paid by end-consumers, either through direct subsidies or via tax breaks. A recent analysis by the International Monetary Fund[5] (IMF) found that the fossil fuel industry benefits from subsidies of a whopping USD 11 million every minute. In 2020, fossil fuel prices were at least 50% below their true cost for 99% of coal, 52% of diesel and 47% of natural gas. As noted by the IMF, a global reform on cutting subsidies to fossil fuels could reduce the world’s CO2 emissions by one-third.

Fossil fuel subsidy removal has long been on the G20 agenda, but not yet translated into effective policies. As mentioned above, the need to phase-out ‘inefficient fossil fuel subsidies’ was also included in the final text of COP26’s Glasgow Climate Pact. albeit without a firm date.

Until now, subsidies have created incentives for the continuation of oil and gas activities and deviated the attention from the true potential and value of renewables. Despite promising a green recovery, the world’s major economies have spent 41% of all public money they committed to energy-producing and consuming activities on fossil fuels, compared to 37% on clean energy since 2020.[6]

As renewable energy grows, investments in fossil fuels are becoming an increasing liability

Over the last decade, the cost of electricity from solar photovoltaics fell by 82% and the costs of onshore and offshore wind decreased by 39% and 29% respectively[7]. Renewables have the economic potential to push fossil fuels out of electricity generation as quickly as 2035 and out of total energy supply by 2050[8]. The IEA’s roadmap also foresees a steep decline in fossil fuel demand due to policy’s focus on climate change. Their analysis suggests that unabated coal demand may decline by 98% (less than 1% of total energy use) in 2050, gas demand by 55% (to 1,750 billion cubic metres) and oil demand by 75% (to 24 million barrels per day)[9]. This indicates that those assets will soon be stranded.

Wind energy in Copenhagen

Additionally, renewable energy investments are already delivering significantly higher returns than fossil fuels in several developed countries and renewable energy prices have been less volatile during the Covid19 pandemic. Over a five-year period, returns from green energy investments in Germany and France were as high as 178.2% compared with -20.7% for fossil fuels. In the UK renewables yielded 75.4% returns compared to only 8.8% for fossil fuels. In the US, renewables generated returns of 200.3% while fossil fuels generated 97.2%[10].

Those countries who take the lead will benefit the most from a managed and orderly transition. There are several social benefits from the shift to a low-carbon society alongside the economic advantages, and Petrostates are those most prone to risks from an unmanaged transition[11], particularly in developing countries. The longer investments in fossil fuel assets and infrastructure continue in these counties, the greater the risk of stranded assets and capital losses. International cooperation is key for these countries to leapfrog.

At COP26, 34 countries and four development institutions including the European Investment Bank and the East African Development Bank, committed to stopping public financing for fossil fuel projects abroad by the end of 2022[12], and to steer their spending into clean energy instead. This is a major step in the right direction.

There is no room for disconnected oil and gas production and climate targets: Lessons from the North Sea

The energy crisis in Europe comes on top of mounting climate impacts that worsen floods or heatwaves. This highlights that there is no more room for incoherence between climate ambitions and actions.

A managed and just transition is needed from oil and gas globally. This is an unprecedented and complex task, but countries like those in the North Sea region have the greatest potential to become first movers and can play an important role in the transition. The region is home to high income oil and gas producing countries, with the right financing landscape and technological capability to transition away from fossils fuels, as well as the resources to do so while minimising social costs.[13]

SEI and Climate Strategies are leading an evidence-based programme, Oil and Gas Transitions[14] – together with the University of Edinburgh, the University of Oslo and Aalborg University – looking at opportunities, barriers and co-produced pathways for oil and gas just transitions in the UK, Norway and Denmark. These countries are expected to spearhead the transition of this sector and can offer lessons to the rest of the world. The world will be watching them closely.

Currently, only Denmark has set an end-date to oil and gas production by 2050. The decision is a result of close cooperation between the government and the industry and a widespread buy-in among key stakeholders of the society. And compared to the UK and Norway, Denmark lacks a strong national or even regional ‘oil and gas identity’, today.[15] Furthermore, measures have been put in place in Denmark to manage the unwanted socio-economic impacts of the transition, by creating economic opportunities in the first of a kind Energy Islands located in the North Sea[16], and through an optimistic outlook for skills transfer in biogas, offshore wind and green hydrogen projects.[17]

While Denmark’s decision to phase out oil and gas may have been mostly motivated by economic rather than moral arguments, its leaders are outspoken about their intention to inspire other countries to follow their steps. At COP26, Denmark launched the Beyond Oil and Gas Alliance (BOGA)[18] initiative alongside the government of Costa Rica, and joined by France, Greenland, Ireland, Sweden, Wales, and the Canadian province of Quebec. California and New Zealand also signed on BOGA as associate members. This is the first international coalition of countries committed to ending oil and gas production and collectively giving up on future oil and gas revenues. Nevertheless, the group still lacks major producers, including the UK and Norway in the case of the North Sea.

COP26 event Oil and Gas Transitions

Photo: Climate Strategies

The UK’s oil and gas reserves are in a predictable decline, and production already peaked around 2000. At the same time, the country’s renewables are already outcompeting coal and gas fuelled electricity. The COP26 presidency, however, has neither taken a leadership role on ending subsidies for fossil fuels nor a decision to end future North Sea licensing rounds. Stronger cooperation between England’s central government and Scotland are urgently needed to bridge the gap between high-level policy intentions and local level practical delivery[19]. Several policies and roadmaps were announced between 2020 and 2021, including the Levelling Up Fund, the Lifetime Skills Guarantee and the North Sea Transition Deal. However, if the Maximising Economic Recovery (MER) policy of the UK prevails, these instruments will remain insufficient in supporting one another and fall short of supporting workers and communities for achieving a just transition[20].

In Norway, the notion of an end to oil and gas production has been the domain of political fiction. Change here is unlikely to be quick. The oil and gas sector is a major source of Norway’s national wealth and a pillar of its welfare state, and transitioning out of it will mean transforming the entire Norwegian economy[21]. Thus, opposition to an end to oil and gas exploration and production remains high. Furthermore, the political and social debate remains permeated by the “green paradox” which describes the argument made that Norway produces the cleanest oil and gas producers and less clean countries would fill the gap if the country stopped producing. At the same time, Norway is responsible for carbon leakage – claiming high renewable energy consumption nationally, but exporting oil and gas emissions internationally[22].

However, the space for debate is now opening up, and pressure particularly from civil society is increasing. This was demonstrated in the face of 2021 elections, where Norway’s oil rose to the top of the debate agenda as fears around the climate crisis grew among voters[23].

Public-private cooperation is needed to achieve a managed and just transition

The current energy crisis and COP26 commitments should be taken as a unique window of opportunity for policymakers, industry leaders and the financial sector to bolster and accelerate the oil and gas transition. The objective should be to effectively manage a just and timely phase out of fossil fuels.

It is important to note that oil and gas cannot be fully replaced with currently available technologies. There are not enough renewables, CCS technologies (for production of synthetic fuels for instance) or fossil free/ low-carbon hydrogen supply. Hence, public sector, companies, investors, and financial institutions should act in partnership, supported by science and research to accelerate decarbonization projects and make an impact in the real economy.

The EU’s announcement to invest over €1.1 billion from the Innovation Fund to support breakthrough technologies in energy-intensive industries, hydrogen, carbon capture, use and storage, and renewable energy is a welcome initiative in the right direction. These projects are in some of the countries most impacted by the current energy crises Belgium, Italy, Finland, France, the Netherlands, Norway, Spain, and Sweden.

The challenge in developing countries remains largely unaddressed. Poor nations have the potential to become some of the greatest beneficiaries from a managed and orderly transition away from oil and gas, as they have the largest ratio of solar and wind potential to energy demand, but investment is lacking. Both knowledge transfer and financial support will be key for them to achieve a just transition and benefit from the promises of a 1.5°C world.