We are living in interesting times. As nations around the world continue their fight against Covid-19 and the Omicron variant, they also have to wrestle with the existential issue of pre-empting climate-induced collapse.
Between 31 October and 12 November, policymakers convened in Glasgow to thrash out an agreement during the COP26 climate summit. Different viewpoints have emerged on the outcome, and COP26 has been portrayed either as a glass half-empty or half-full. For those in the latter camp, the event led to a number of important outcomes such as reasserting the 1.5°C warming target, phasing down fossil fuels, and protecting forests and biodiversity.
Another surprise and welcome “win” was the climate agreement reached between the United States and China to cooperate on critical industrial challenges such as green design, resource reuse and direct air capture of carbon dioxide. Given that the world’s two largest economies are also the biggest greenhouse gas emitters – accounting for nearly 40% of global emissions – worldwide efforts to decarbonize would fall short if the two governments were not to cooperate on this issue.
It may be all well and good on paper as far as reaching a consensus is concerned, but the world will be looking on with interest to see how the targets will actually be met.
Policymakers are grappling with the challenge of pursuing the Paris Agreement’s objective of limiting the global temperature rise to 1.5°C. Meeting this target means reducing the use of traditional fuels – the demand for and cost of which have recovered strongly from the historical lows recorded at the height of the pandemic. Notably, natural gas prices in Europe have nearly quadrupled last year while Brent crude oil prices hit seven-year highs of more than US$86 per barrel in October. This was before the emergence of Omicron in late November put the brakes on climbing prices.
At the same time, coal prices have experienced a return to strength, doubling their level last year. Interestingly – and somewhat ironically – U.S. President Joe Biden called on OPEC to pump more oil before he headed to COP26, ostensibly to stem the surge in energy prices.
Higher energy prices have fuelled global inflation, which is already under the spotlight thanks to supply chain bottlenecks. There is a combination of factors contributing to rising prices.
First, global demand for goods and energy has spiked as economies gradually reopen from a state of suspension caused by the pandemic. In its World Economic Outlook published in October, the International Monetary Fund expected the global economy to grow 5.9% and 4.9% respectively in 2021 and 2022, following a 3.1% contraction in 2020.
The second factor contributing to higher energy prices is supply constraints caused by cutbacks in investment by energy companies due to the pandemic. Efforts to reverse course by increasing production to meet heightened demand will take time.
All these have been complicated by a variety of location-specific issues. In the case of Europe, geopolitics may have contributed to the reduced supply of natural gas from Russia. At the same time, Europe experienced a long period of dry conditions and low wind speeds through summer and early autumn last year, badly affecting wind-generated energy. In the U.S. and Brazil, prolonged drought conditions have led to a drastic reduction in hydropower output.
The third factor is the global push to decarbonise, mainly through a two-pronged approach of incentivizing the use of renewables and deterring carbon emissions. This has had the effect of disrupting market dynamics that had long operated on the basic principles of supply and demand. Under this supply-and-demand framework, oil and gas producers would simply ramp up production in response to stronger demand and higher prices and, in doing so, tamp down inflationary pressure.
The transition to clean energy and reduced emission goals has, however, affected this formula, with a halving in global spending on oil and gas exploration since 2015. Such a reduction in investment suggests that while fossil fuels still account for 80% of the world’s energy demands, economies around the world are increasingly competing with each other for underdeveloped and unstable sources of green energy.
In their efforts to find a solution, policymakers may be tempted to fall back on accessible but sometimes problematic tools such as price caps and subsidies.
Price caps, which limit the amount energy suppliers can charge, prevent costs from being passed on in their entirety to customers. Perversely, such price controls may actually add to households’ overall costs, as suppliers can agree on a price that is close to the regulatory price, even when this is higher than it would be without the price cap.
And although some suppliers may be able to hedge against higher costs, others are likely to collapse or simply exit the market if increases in wholesale energy price become untenable, ultimately resulting in less choice for customers. In Britain – where there is an energy price cap that is subject to review twice a year – more than 20 energy firms have gone bust since August as a result of rising wholesale gas prices.
Like price caps, subsidies are intended to shield consumers against soaring prices, but can end up using funds that would otherwise have been invested in education, infrastructure and healthcare. Subsidies also encourage excessive energy consumption and reduce the incentive to invest in green alternatives. Once introduced – often intended as a temporary relief measure – subsidies are difficult to remove, saddling public finances with an additional burden.
The path to decarbonisation will not be easy and the current energy crunch will hopefully help focus attention on addressing the “energy trilemma” of affordability, security and environmental sustainability. As highlighted in COP26 discussions, there are lingering differences among nations, especially on such critical issues as who should foot the bill and the pace of achieving the net-zero goal.
Despite the world not being on track for the 1.5°C goal, ongoing concerns to avert climate events of crisis proportions will ensure that climate change remains a headline item on the global agenda. It remains to be seen whether world leaders can find the sweet spot in striking a balance across all elements of the trilemma.
Wilson Chong, [email protected]