The Need for a Wiser Energy Transition

In recent years, there have been calls for a just and urgent energy transition to combat climate change. This has led to a flurry of regulatory changes, market interventions and changes in capital allocation from investors pertaining to energy investments. The fact that a large portion of the world’s energy comes from countries with governance challenges and potentially hostile countries is also well established.

Given the urgency, the perceived need to perform within the electoral cycle, and ideological purity (in some circles), the decisions over the past few years have come to bite us in the rear in the forms of surging inflation and systemic vulnerability.

This has resulted in widespread pain, not just for residents of major powers (like the USA) but also for small and middle powers who are largely price takers of commodities and finished goods. In some other countries, the risk of power cuts in the deep of winter loom.

As much as it is tempting to blame politicians (to fuel rage in self-righteousness), such behaviours do not contribute productively to the solutions. Rather, we should approach this with a spirit of humility, acknowledging that even in the best situations, it is challenging to forecast what the future will bring.

Recent events can teach us a few lessons that can be applied across a range of domains

• National security is primarily the responsibility of governments: Governments may co-op companies into National security efforts but governments would be negligent if they should totally outsource that responsibility. After all, companies will do what is in the best interest of their shareholders: to maximise profit and minimise losses.
• The risks of transition have to be carefully considered and managed:  A common refrain of people advocating for urgent climate action is that we have to consider the cost of not acting. The direct costs of acting are quite easily identified. Some indirect costs, especially those on communities have been identified in recent years, leading to a call for a just transition. That is to be applauded. However, systemic risks throughout the value chain of critical goods and services are still poorly identified and managed.
• Concurrent /sequential scenario planning is helpful: As much as there is acknowledgment that scenario planning is a critical tool in identifying how organisations and counties may be exposed to climate physical and transition risks, there appears to be a lack of the use of scenario planning to identify the risks of transition. It is also wise to consider the concurrent occurrence of multiple events to gauge one’s vulnerability. In the case, it is not concurrent events, but rather, a sequence of events without adequate time for the system to recover. Sequential events should also be considered in scenario planning.
• It is always time to plan for war: There is a saying “In times of peace, plan for war”. I suggest changing this to, “always plan for war” (figuratively at least). The world had just started to emerge from the pandemic-induced supply chain crunch before the expansion of the war in Ukraine. There was barely any time to take a breath! We cannot afford to take our eyes off monitoring and planning for risk events.
• Do not over-rely on countries with poor governance and unaligned values: Recent history has taught us that increasing or maintaining reliance on countries with poor governance practices and unaligned values serves to enrich them, allowing them to build up their arsenals. Countries should weigh up the short term benefits in terms of profits and lower costs against the longer term threat. Countries with weak institutions (think governments, democratic institutions, press, education etc.) can also prove to be unreliable allies. The risk of relying on such countries should also be managed.
• Regulatory certainty is important to facilitate transition: The rise of ESG investing, social pressure and  government intervention in the market (in the form of regulation and rhetoric) has affected the deployment of capital. This has caused companies and investors to shy away from investing in traditional energy infrastructure such as refineries in fear that their assets would not be built (due to green tape and social opposition) or be left stranded. Building on the previous point, if the risk identification highlights a critical national security risk from the lack of critical energy infrastructure, governments should work closely with the private sector to enable traditional energy infrastructure to continue operating (and adapted) till such a time when the alternatives are adequately robust and the secondary risks adequately low. The regulatory framework should facilitate this transition.  Should such assets be required in the future, governments and asset owners should work together to develop industry roadmaps to help adapt the assets to future market requirements. Examples include “hybrid solutions” such as making petroleum refineries compatible with the production of sustainable fuels and flex fuel (gas and hydrogen) turbines. Having governments working with private enterprise helps assure investors that they are not fighting the government. Sovereign risks of investments also have to be reduced, ideally by having an apolitical body be in charge of planning and regulating the development and operations of critical assets.
• The price of resilience and a lack thereof: Risk mitigation may increase costs to companies and consumers. However, this could be seen as insurance premiums, which will shield consumers and shareholders from extreme cost shocks when risk events occur. Government leadership is critical in communicating the rationale and obtaining the buy in from their stakeholders.
• Rethinking the fungibility of commodities: Commodities such as oil, gas and minerals are traded internationally (as long as the transport infrastructure is there). However, surges in global commodity prices have led to high local commodity prices and shortages (and pain for local customers). Export controls and local reservation of these commodities have been implemented as reactive measures during times of extreme shortage or prices. These introduce sovereign risk and disrupt fulfilment of contracts.

Governments/regulators may consider including local reservation of commodities as part of the extraction licences. They may also consider having the locally reserved commodity trade as a different good/market from the international market. This allows local industries and customers to be shielded from the wild fluctuations in global commodity prices (and hopefully from the paws of speculators).

• Less grandstanding and more cooperation required: The challenges of climate change and national security are too big for one group to solve. Pitting parties against each other in hope of scoring political points is counterproductive: no one has a monopoly on ideas and no one has the ability to identify all risks.  This is the time to embrace diversity in perspectives. It is critical that governments take the leadership to reach across the aisle, partner with the private sector, community and NGOs to derive solutions. However, fundamental to cooperation is the need to come to a common understanding of what is “good”. This is a huge challenge in societies that place the interest of individuals or groups over the collective. Being focused on a common goal is critical for national security. Afterall, if a nation is already divided, it does not take a significant external force to cause the country to fall apart. But that is a separate topic…
• Think carefully before openly making enemies: Virtue signalling based on morals and self-righteousness is cathartic and may appeal to one’s base. However, such actions are not helpful when one has not clearly evaluated systemic risks and effectively mitigated them. It is wiser to address the systemic risks before making enemies (if at all). A more nuanced foreign policy may serve the country better than pounding the pulpit.

These lessons from energy transition are relevant to other cross-boundary challenges. Unfortunately, unless calmer, wiser heads prevail, we are doomed to make the same mistakes over and over again.

Questions for discussion

What other lessons can we learn?

How can we avoid the same costly mistakes? 

How would you apply these lessons in other domains outside energy?

 

About the author: The author comes from the water industry but is generally interested in politics, international relations, #climatechange and economics. He comes from a small Southeast Asian country which is easily rocked by global events.

Note: Specific recent events are alluded to without being specifically identified given the hyper-partisan environment and sensitivities.

#energytransition, #energypolicy, #governance, #ESG, #energyinvestment, #wisdom, #riskmanagement