The energy transition dream clashes with a reality in which the funding and behavioral changes necessary for deep decarbonization of the global energy system are grossly underestimated.
That’s one of the key messages of JP Morgan’s 2021 Annual Energy Paper published days after the International Energy Agency (IEA) said that if the world were to reach net-zero emissions by 2050, it would have to stop investing in new oil, gas, and coal supply immediately.
Overwhelmed by enthusiasm about electric vehicles and solar and wind energy, many enthusiasts, and even analysts at the IEA, believe that new technologies about carbon capture, hydrogen production and its industrial use, surging solar and wind power installations, and constantly growing energy efficiency could be enough to transform the world of energy over the next few decades.
Don’t get ahead of yourselves, Michael Cembalest, Chairman of Market and Investment Strategy for JP Morgan Asset Management, warns in the bank’s paper.
The world still depends a lot on fossil fuels, and even with record growth, renewables are solving just a tiny part of the carbon footprint problem—electricity generation. But electricity accounts for just 18 percent of the total final energy consumption globally, Cembalest notes.
Four Big Obstacles To Deep Decarbonization
“In other words, direct use of fossil fuels is still the primary mover in the modern world, as the demise of fossil fuels continues to be prematurely declared by energy futurists,” Cembalest wrote.
The rise of renewables is moving the world in the direction of decarbonization of electricity generation, but wind and power still account for just 5 percent of global primary energy consumption, JP Morgan says.
“Absent decarbonization shock treatment, humans will be wedded to petroleum and other fossil fuels for longer than they would like,” is the lead sentence of the bank’s 44-page-long paper.
Since no one wants a “shock” transition and a massive disruption to the global economy, energy systems, and people’s lives, the world will need oil and gas for much longer than environmentalists want.
But it could also be much longer than policymakers committed to net-zero by 2050 would like, because, JP Morgan reckons, new technologies in decarbonizing sectors other than electricity generation face steep challenges. These challenges will also arise because those policymakers have likely grossly underestimated how much money and effort the energy transition would really cost.
“The overarching message of this paper is not climate nihilism; it’s that the behavioral, political and structural changes required for deep decarbonization are still grossly underestimated,” Cembalest notes.
The decarbonization is going at a slow pace, despite the hype of rising renewable capacity and EV sales or hydrogen and carbon capture projects.
JP Morgan has identified four big obstacles to faster deep decarbonization. These are slow EV penetration, the required enormous upgrades to transmission infrastructure, the challenge with geologic carbon sequestration, and electrification of industrial energy use.
The world’s “most EV loving nation” Norway, where EV sales account for more than 60 percent of new passenger car sales and which is often cited as the poster child of the EV boom, is not the global average, it’s the exception, JP Morgan says. To compare, the EV share of light vehicle sales in the United States was just 2 percent in 2020, according to data from California State University cited by the bank.
Then there are the “transmission dreams” versus transmission realities, in which “Grid expansion can be a hornet’s nest of cost, complexity and NIMBYism, particularly in the US,” Cembalest says.
Carbon capture, on which many energy transition forecasts rely, could face “the steepest climb of all,” because CCS turns out to be a very complex process at the few locations that implement it, according to the bank.
As far as deep decarbonization of the industrial sector—the largest fossil fuel end-user globally—is concerned, “Even assuming greater renewable electricity, only some industrial processes can be easily electrified,” JP Morgan’s Cembalest notes.
Stranded Oil Assets?
In view of the huge challenges ahead for decarbonization, especially in light of the expected growth of global energy demand, “the world is not on track to strand a lot of oil and gas in the future and is much closer to the IEA Stated Policies scenario than its Sustainable Development scenario,” Cembalest says.
In the IEA’s Stated Policies scenario, no oil and gas assets would be stranded in 2070, the bank estimates, since the world will still need a lot of oil and gas for its growing energy consumption. The Stated Policies scenario is not the status quo: it reflects some far-reaching and ambitious targets that have been legislated or announced by governments, JP Morgan notes.
Earlier this year, Wood Mackenzie said that the energy transition could put as much as $14 trillion upstream oil and gas assets at risk.
“But the world will still need oil and gas supply for decades to come, and the scale of the industry will remain enormous,” Wood Mackenzie vice president Fraser McKay said.
The Energy Transition Needs Big Oil
Due to the huge—and grossly underestimated— challenges to deep decarbonization, “the companies we all rely on for dispatchable, thermal power and energy will need to survive and prosper until we get there,” Cembalest writes.
The bank doubles down on its bullish call for oil and gas from last year and recommends investors to stick with the industry.
“Big Oil” return on capital fell to single digits by 2016 due to excess competition; we expect these returns to rise back to 1990’s levels of 10%-15%,” JP Morgan says.
Finally, “peak oil demand forecasts may end up being just as wrong as peak oil supply forecasts were a generation ago,” the bank noted.