Decarbonisation requires balanced, synchronised global action

It has become increasingly clear over the years that the world not only has a moral imperative to decarbonise, but also an urgent practical incentive. If we continue on the current trajectory based on a global fossil fuel-dependent energy system, we will breach the global temperature limit identified as necessary for our ecological sustainability within the next decade. 

The science of climate change is undeniably urgent and requires action by all economic participants from market issuers, asset managers, asset consultants and asset owners to regulators and media. The Paris Climate Accord and COP26 reinforced this message through identifying and setting the global climate change limit to 1.5ºC in an attempt to avoid significant climate disruptions that could worsen hunger, conflict and drought globally.

While we have seen significant progress in worldwide decarbonisation efforts, it is essential that it be done in an orderly fashion. The recent increase in oil and gas prices and the energy crunch in Europe (even before the Russia/Ukraine crisis) is a clear indicator of the repercussions a disorderly approach to the transition from fossil fuels could bring if it isn’t balanced with enough production from renewable sources to meet global demand.

Individual economic actors — such as pension funds and other asset owners, banks and other lending institutions — are each decarbonising in various ways, with each actor behaving rationally and for the right reasons. However, as a collective, the impact has potentially severe unintended consequences. 

The resulting material reduction in capital investment in fossil fuel provision (by some estimates a halving of investment in recent years) means less fossil fuel supply at a time when it will be many years before renewables can take up the slack, at the current production rate. This has had dire consequences for energy prices. 

A secondary effect is the cut in the production of fossil fuels is raising the cost of steel and other commodity resources that are needed to construct renewable energy infrastructure such as wind and solar farms.

Escalating sanctions and reduction of European and US oil trade with Russia to curtail the conflict is a further aggravating factor in the situation.

The conflict has created a powerful imperative to accelerate European and US investment in all forms of energy production from fossil fuels to nuclear to renewables to reduce dependencies on Russian oil and gas.

As long as the West retains any form of material dependency on Russian fossil fuels, the less their ability to constrain Russian aggression and the associated threat to global peace and stability.

A transition whereby investment in fossil fuels is managed appropriately while renewable capacity is ramped up would be a desirable and important outcome. However, governments are not stepping in to manage it properly. The increased pace of the transition into renewables necessary to ease the rising price of fossil fuels is much more difficult to achieve sensibly without government direction. Perhaps the urgency of the Russian threat will expedite European and US government intervention in this regard, but to significantly manage the transition and rising fossil fuel prices, there would need to be a synchronised global effort.

For investors, there is likely a continued opportunity to achieve capital gains in fossil fuel companies as commodity prices rise, which means economic owners are now less inclined to disinvest. This is hindering the transition to renewable energy as the primary source of global energy and the sector’s establishment as a viable source of higher returns. For now, it is also critical for investors to continue to engage fossil fuel and related companies to influence change and help with an orderly energy transition. 

If we are to address rising fossil fuel prices, we need to see significantly accelerated investment in all renewables, as well as more investment in both energy storage (batteries at scale) and base load energy provision — for example, nuclear energy. The challenge is still the pace of change and how quickly an orderly transition can be implemented. But despite the horrors of war, if a holistic, ordered approach can be achieved, then we may just be entering a new era of clean energy entrenched as the world’s leading source of fuel.

This article was paid for by Old Mutual Investment Group.