The energy crisis creates three key risks for the energy transition

Why the energy crisis could also hit the energy transition 

The world is currently staring down the barrel of a number of crises, from war in Eastern Europe and looming inflation, to supply chain bottlenecks and the ever-present (and growing) scale of the climate challenge. Intertwined with all of these is the current volatility in energy markets, which will continue to have sizeable economic and political ramifications across the globe.

There is no easy fix to the current price spikes and it seems unlikely that the market will return to ‘normal’ patterns anytime soon.

Whilst one seemingly logical response to the crisis may be to accelerate the deployment of renewable energy technologies to reduce our reliance on fossil fuels, the reality may be somewhat trickier.

Wholesale prices and fossil fuel assets

First, high wholesale energy prices place huge pressure on governments to protect consumers from massive rises in their bills, at risk of precipitating severe social and/or political instability. When allied to geopolitical considerations about strategic security of supply and dependence on hostile regimes, one potential remedy is to double-down on oil, gas or coal use from domestic or familiar sources. Adding fiscal burdens to ramp up renewables finds itself lower down the order of priorities.

The UK is currently discussing accelerating further extraction of oil and gas from the reserves under the North Sea, as well as potentially looking to restart the curtailed development of fracking. Given the time horizons of these investments and extraction processes, this will lock in fossil fuel-backed energy sources for the foreseeable future, leaving less space for renewables. 

Raw materials

Second, the major renewable energy technologies are all dependent on a steady supply of crucial raw materials, ranging from rare earth minerals to steel. These supply chains are not well developed in many cases, making them vulnerable to instability. Acquiring these resources at reasonable cost has become increasingly difficult over the last 18 months, first during the pandemic, then during the bumpy economic restart and then during the geopolitical fallout from the Russian invasion of Ukraine. The combination of global supply chain shocks and an increasing prioritisation of securing supplies of strategic resources has led to notable price increases.

The current energy crisis is compounding these existing difficulties, especially where extraction and production of raw materials are energy-intensive. The steel sector is affected on multiple fronts, as both Russia and Ukraine are major steel producing countries. This is difficult news for the wind sector, where over 70% of a turbine blade by weight is steel.

Increased concern over the costs of production hampers the pace of renewables deployment, as well as hitting the bottom line of the established and aspiring renewable energy majors, which has led investors to cool their enthusiasm for previous stock market favourites. 

The risks to trade

Third, high global prices are not only affecting major producers of renewable energy, but also the commodity trading giants who are key players in the smooth functioning of the international energy market (and markets for raw materials). Between them, the four largest commodity firms move an equivalent of more than $700 billion worth of raw materials each year.

The high volatility in recent weeks and months has left many of the major players searching for additional liquidity in order to cover their positions and satisfy their financing needs. The industry mainly operates on lines of credit to purchase cargoes of oil, gas, minerals etc. Currently, these credit lines are in short supply, with many of the usual financiers unwilling to take on the heightened levels of risk.  

Pressure on energy traders (or even a collapse of a bigger player unable to deal with the price spikes) could lead to increased market turmoil, further exacerbating the short-term effects of the crisis.

The most obvious case-in-point right now is the nickel market, which has effectively seized up entirely. The world’s largest supplier had taken a giant short position, causing it to miss a margin call when Russia’s invasion caused a 250% spike in prices. With other long positions - including from the electric car industry - contributing to the spike and regulators on the London Metals Exchange panicking at the potential collapse of several trading houses, nickel has provided a case study in the confluence of geopolitics and the energy transition.

In a letter of 8 March 2022, the European Federation of Energy Traders, a trade body for the industry, warned that, "The current extreme market conditions lead to liquidity shortages which endanger the functioning of European energy markets." Uncertain market conditions will serve to amplify the problems facing the renewables sector, creating increased risks and costs in the short term.

Conclusion

It is hoped that a global energy system with a much higher proportion of renewable energy sources will, in the longer term, insulate the market from some of the volatility we are currently seeing (as well as massively reducing carbon dioxide emissions). In the short term however, the energy crisis is causing a number of headwinds for the renewables industry, checking our progress towards Net Zero.

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