Despite the ongoing global energy crisis, Houston-based consultancy Wood Mackenzie provided five reasons to be cheerful in 2023 in its “Silver Linings Playbook” report.
The crisis – driven by reduced energy flows from Russia after its invasion of Ukraine – has pushed up energy costs and stoked inflation from the U.S. to Europe but could spur policy initiatives and investments to transform the way energy is used to power the planet, the consultancy announced in the report Dec. 8.
Five Wood Mackenzie analysts agreed that key developments could lay the foundations for over a decade of sustained opportunity and better outcomes for reliable, affordable and sustainable energy.
The U.S. and green commodities
Depending on natural gas as a transition fuel without security of supply will not end well, according to Wood Mackenzie’s Multi-Commodity Research Vice President Prakash Sharma. Similarly, wind and solar power alone cannot deliver a reliable zero-carbon energy system.
Lawmakers understand that a diverse range of low-carbon technologies beyond variable renewables is needed to achieve deep decarbonization while maintaining a secure energy supply, the executive said. Policy foundations laid span low-carbon hydrogen, carbon capture, utilization and storage (CCUS) and advanced nuclear power.
The low-carbon hydrogen and CCUS project pipeline has grown almost 25% in the last year, according to Wood Mackenzie. Around 30 projects have announced final investment decisions and another 170 aim to by the end of 2023. To date, nearly 30 hydrogen offtake agreements have been signed, and a market for green commodities, like low-carbon ammonia, is taking shape.
“With expected cost declines in hydrogen and CCUS technologies and abundant low-cost energy resources, there is an opportunity for the U.S. to become a manufacturing powerhouse. It could become a dominant producer of green commodities – hydrogen, ammonia, steel and chemicals – serving the needs of Europe, Japan and South Korea,” Sharma said.
More U.S. LNG for Europe
The European market now has a huge supply gap due to a reduction of approximately one-fifth of current global LNG supply due to the Russia-Ukraine conflict. U.S. LNG has come to the rescue, and Wood Mackenzie’s Gas & LNG Research Vice President Kristy Kramer expects two-thirds of all U.S. LNG cargoes to reach Europe this year.
Almost 25 million tonnes per annum of U.S. LNG capacity has been sanctioned this year, with more capacity expected in 2023-2024. The abundance of low-cost gas reserves, the relatively short time to market for new volumes and its competitive commercial structure continues to make U.S. LNG attractive, the executive said.
U.S. LNG exports have gained tremendous traction due to contractual flexibility, Kramer said, which has allowed off-takers to pick and choose between the European and Asian markets. However, Europe’s major headwinds relate to regasification capacity while significant new volumes aren’t expected online until the second half of this decade.
“U.S. LNG has been following the money, but the commercial structure means it is primarily the off-takers rather than the developers that are getting the biggest share of the pie.” – Kristy Kramer, Wood Mackenzie
“U.S. LNG has been following the money, but the commercial structure means it is primarily the off-takers rather than the developers that are getting the biggest share of the pie,” Kramer said.
While Europe’s demand for gas is likely to decline in the future, it will play an important role in Asia’s decarbonization push, thus allowing the U.S. to still reign in the LNG export markets for some time to come, she said.
Refining stress to ease
In the past, shortages of crude have been linked to higher fuel prices rather than a lack of refining capacity. This time, “supplies have been ample, as worst-case fears of significantly lower Russian volumes after the invasion of Ukraine proved unfounded,” according to Wood Mackenzie’s Refining, Chemicals & Oil Markets Vice President Alan Gelder.
Gelder argues that this year’s premium of 2.5 times the average of the previous 10 years for road diesel to Brent at the refinery gate in northwest Europe reflects refining system stress as the global economy still recovers from the COVID-19 pandemic and faces uncertainties around Russian crude and product exports.
“Over the next 12 to 18 months, as the new capacity becomes operational, we expect refining margins to return to historical norms. There is an important caveat, however: Much will depend on whether the key projects can start on time and ramp up to full capacity on schedule.” – Alan Gelder, Wood Mackenzie
Refining system stress is set to ease in 2023 as major new refining projects in the Middle East, Africa and Asia become fully operational, the executive said. Also, China’s decision to relax restrictions on the export of refined products as government policy shifts to support near-term economic activity will also help the situation.
“Over the next 12 to 18 months, as the new capacity becomes operational, we expect refining margins to return to historical norms,” Gelder said. “There is an important caveat, however: Much will depend on whether the key projects can start on time and ramp up to full capacity on schedule.”
Finance and fossil fuel
The issue of financing fossil fuel projects remains topical, and a more measured approach has emerged to reflect the real-world headwinds confronting lenders and corporations and their financing and capital allocation decisions, according to Wood Mackenzie’s Corporate Research Director Kavita Jadhav.
“The past year has made abundantly clear that energy supply and demand need to move in sync for economic stability and minimal price volatility,” Jadhav said. “And, crucially, immediate divestment from fossil-fuel positions would serve only to move financial-sector portfolio emissions elsewhere rather than achieve any significant real emission reductions.”
Companies with rigorous energy transition plans will have a clear advantage over others that don’t. Companies that fall into the latter category “will face higher cost of and/or restricted access to financing,” the executive said.
Previously, global financial institutions grouped together through the Glasgow Financial Alliance for Net Zero (GFANZ) were required by the United Nations Race to Zero to phase out all financing of unabated fossil fuels
The current crisis has forced a major reset and forced GFANZ to clarify that it doesn’t require an immediate end to fossil-fuel financing but encourages more financing and more engagement to support a transition to Paris-aligned business models and a managed phase-out of high-emitting assets.
The implementation of goals challenge
Decarbonized electricity is at the heart of Europe’s energy transition but the sector’s ability to deliver was put firmly in the spotlight, according to Wood Mackenzie’s Europe Power Research Director Peter Osbaldstone.
“Setting targets is easy; it is the implementation that will prove challenging,” the executive said. “Indeed, several key tests have already come to the fore this year.”
Europe’s renewable project pipeline, which is expected to add 42 GW in 2022, is showing signs of strain, as evidenced by recent undersubscribed government auctions due to rising equipment costs. Levelized costs of electricity for solar and onshore wind are 38% and 31% higher respectively compared to two years ago, while auction arrangements, including price caps, have not kept pace with market trends, Osbaldstone said.
“Setting targets is easy; it is the implementation that will prove challenging.” – Peter Osbaldstone, Wood Mackenzie
Other challenges include market design and the enduring form and function of markets, as well as issues around providing secure and reliable supplies through the transition.
“The transition must focus on all the tools at our disposal – including hydrogen, long-duration energy storage, nuclear and CCUS,” Osbaldstone said. “Power-market redesign – a key enabler of the accelerated change that will drive sustained investment – cannot be undertaken lightly.”
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