Net Zero 2.0

The world is a different place following COP27 (the United Nations Conference of the Parties annual climate change convention) than after COP26, with war in Ukraine, global inflationary shocks, food & energy shortages and deglobalization. Managing these crises without compromising on net zero emissions targets will be challenging. The world has seen increased fossil fuel use to overcome short-term energy shortages for example, must now invest in a range of alternatives more quickly for economic and political reasons and investors face tighter access to capital. However, we believe this backdrop could actually accelerate the energy transition as net zero is no longer just about saving the planet.

Faster investments could bring forward cost parity of many clean energy alternatives. Nations are deploying these alternatives at a greater scale to reduce emissions, but also to target energy security, economic resilience (by reducing long-term energy prices) and to reindustrialize their ailing economies given the vast investment required (between $100-$275 trillion (tn) to 2050 per Bloomberg New Energy Finance (BNEF)/McKinsey).^1,2

Managing crises without compromising net zero is tough in short term

To deal with the current energy crisis, near-term policy choices are being made that may appear at odds with net zero goals. Subsidized energy bills, diversified energy sources, demand destruction and extending the use of fossil fuel and nuclear assets are some of the options on the table. European governments alone have already committed to protecting businesses/customers from the worst effects through subsidies/bailouts and are expected to spend on new and expanded fossil fuel infrastructure and supplies, such as imported gas & coal to fuel previously mothballed power plants (source: Breugel, Ember Climate, Financial Times). Zero-emission alternatives may be unable to fill the gap to avoid this in the short term, but the motivation to increase their adoption is now far greater.

Economics and Policy align for a ‘Clean Techceleration’

The new geopolitical world order emerging could be the net zero missing link, in our view. Environmental goals are now aligned with political interests to achieve energy security. The economics of renewables and clean technologies continue to be favorable, decreasing by as much as 90% since 2010, becoming the most economical choice, or with a clear pathway to get there with greater scale. Moreover, the incentive to reshore supply chains even faster and secure resource independence has grown. Europe aspires to replace 40% of its gas formerly imported from Russia; the U.S. aims to balance China's dominance of cleantech and critical minerals, such as the 60% of rare earth production that comes from China.

>$150tn cost but incentives go beyond the environment

Net zero will be costly. The estimated investment cost of decarbonization is likely to go up owing to cost of funding and inflationary pressures. But this could be partially absorbed by a green economy GDP (Gross Domestic Product) and jobs boost where every $1 spent on renewable power generation requires up to $1 invested in energy infrastructure. Furthermore, regional superpowers are prioritizing investments to achieve these targets by ramping up 'Climate Wars' competition and a race for 'cleantech sovereignty'. The Inflation Reduction Act and RePowerEU highlight that energy in particular is now a matter of national security, as are the technologies and resources required to decarbonize.

Clean energy to the rescue in long term; policy and economics combine

The good news is clean energy increasingly offers a real alternative that’s economical as well as climate-friendly. Policy and investment are key to achieve it and pulling in the same direction. All three components of the “energy trilemma” – security, sustainability and affordability – could align long-term, given the increasing competitiveness of clean energy alternatives as they scale. To achieve it and remain on track for net zero, a significant ramp up in energy transition capital investment is required – 6x the annual investment on average 2026-30 compared to 2021 per BNEF.¹ This would see a trebling of renewable power additions, 60% of car sales being electric, 6x increase in Carbon Capture and Storage (CCS) capacity and >300x in electrolyser capacity for green hydrogen by 2030. Nuclear could also make a comeback; 55 new power plants are already under development, with innovation in Small Modular Reactors (SMRs), Nuclear Fusion and co-locating hydrogen production (pink hydrogen) with nuclear all potentially adapting the role it could play in net zero longer term.

Clean technology: from climate change, to cost parity, to energy security

The cost of several clean energy technologies has fallen to the point of being at or close to the most economical choice in many markets. This is particularly the case for renewable energy (where solar and wind power costs fell 88% and 68%, respectively, in 2010-21) and electric vehicles (EVs, where battery costs fell 89% 2011-21). In other technologies like green hydrogen, the cost competitiveness has been brought forward by >10 years as subsidies and gas prices increase and disincentives to use fossil fuels appear. To reach net zero, though, we need to see costs fall for many more clean technologies – the likes of: heat pumps, biofuels, carbon capture, new (smaller) nuclear and even food technologies. The race is on internationally to advance innovation and reach the economies of scale required to achieve this, given 46% of decarbonization targets rely on such technologies that are not yet fully commercialized per the IEA (International Energy Agency).³

Climate policy is finally here, but with consequences for industrial policy

Global superpowers continue to increase their respective targets and stimulus packages to implement and scale ‘clean technologies’. Industrial policies incentivizing or mandating local manufacturing and supply chains are increasingly part of these measures, as policymakers attempt to challenge and reverse the largely Chinese dominance in these industries thus far. RepowerEU in the EU and the Inflation Reduction Act in the U.S. are significant proposals both near and long term – the IRA will increase U.S. climate spending by $130bn to 2025, doubling spend as a % of GDP to 1.2% for example (vs a similar 1.4% in the EU policy), both with industrial policy rhetoric around which sectors and products are applicable for this support.

Decarbonization will likely accelerate, as investments rise ahead of original targets – but with a wider range of technologies and infrastructure to ensure resilience. Diverging decarbonization approaches may be taken between countries as a result, based on their available raw materials, technologies and industrial capability.

China dominates clean energy and continues to rise

Whilst full deglobalization is unlikely, industrial policy is increasingly evident in climate policy to incentivize reshoring, “ally shoring” (shifting trade to countries that share the same values as those sourcing) and the local supply chains for the technologies required to decarbonize. It will come at a price, though ($262bn by 2030 for U.S./EU per Bloomberg New Energy Finance). China continues to dominate these markets in terms of scale, adding more wind and solar capacity and producing more electric vehicles in 2021 than the rest of the world combined. Moreover, it still has its own ambitions to continue increasing capacity significantly for domestic requirements and export. Thus, despite efforts to build local supply chains in other regions like EU/North America, they’re unlikely to eliminate dependence on China for the majority of clean technologies in the short term at least and the raw materials required for them.

Action on climate a geopolitical opportunity – and risk

Whilst the technologies required to decarbonize present an opportunity for countries to reduce greenhouse gas emissions and reindustrialize their economies, they’re already showing signs of great competition between global superpowers as their scale and importance rises. At all stages of the value chain from the critical minerals, processing, manufacturing and delivery of clean technologies, the race is on between countries to extract as much value for their citizens and businesses. Whilst this is likely positive in mitigating climate change in the long term, the risks posed are trade disagreements, dual supply chains and cost inflation as input prices rise across several clean technologies.

The road to net zero isn’t easy; speed, scarcity and geopolitics key challenges

Challenges lie ahead, namely: 1) the time lag before clean technologies are available at scale (meaning more fossil fuels and demand destruction in the short term); 2) the sheer volume of resources and investment required (requiring a 6x rise in mined commodities in particular, causing structural deficits in many metals post 2025); and 3) the geopolitical fallout of each global superpower prioritizing similar technologies to achieve net zero goals in similar time periods, ramping up rivalries. This could speed up innovation, but the likely fragmented supply chains, deglobalization and shift in trade partners risk slowing progress/collaboration and increasing near-term prices as a result.

Data Sources:

¹Bloomberg New Energy Finance (BNEF)
²McKinsey (The economic transformation: What would change in the net-zero transition January 25, 2022)
³IEA (International Energy Agency)