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Episode 5: Energy transition today

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Transcript: Season 4, Episode 5: Energy transition today

Disclosure: The opinions expressed by Eurasia Group analysts in this podcast episode are their own, and may differ from those of Citigroup Inc and its affiliates.

Malcolm Spittler: Our general rule of thumb is when there's a gold rush, don't go digging for gold, invest in the makers of the picks and shovels.

Raad Alkadiri: It actually all comes down to one thing and that's money. Will there be the money for investment in renewables, in energy efficiency made available? And I'm not just talking about the industrialized world, I'm talking about globally.

Shari Friedman: Welcome to Living Beyond Borders, a podcast from Citi Global Wealth Investments and GZERO Media. On this program, we examine global risks and opportunities from the angles of both politics and economics. I'm Shari Friedman, Managing Director of Climate and Sustainability at Eurasia Group.

Today we're talking about a highly flammable topic, in more ways than one: fossil fuels and the transition to cleaner energy. In the short term, energy prices and energy security have dominated the discussion over the past year. It's mostly because of the ongoing war in Ukraine and the knock-on impacts of inflation, especially in Europe.

In developing nations, there's been an issue of availability and affordability of energy. The IEA, the International Energy Agency, reported that for the first time in decades, the number of people living without electricity rose last year, standing today at 775 million globally.

We're going to unpack all of this and discuss new regulations in the U.S. and Europe that are hastening the shift toward alternative energy sources. Joining me now are Malcolm Spittler, senior U.S. economist and strategist at Citi Global Wealth Investments. Welcome Malcolm.

Malcolm Spittler: Thank you very much for having me.

Shari Friedman: And Raad Alkadiri, Managing Director of Energy, Climate, and Resources at Eurasia Group. Hey Raad.

Raad Alkadiri: Hi Shari. It's great to be here.

Shari Friedman: So first, Raad, let's start off with you. There's a lot of talk about energy security and how it plays out in the current discussions. Let's start with defining what we mean by energy security.

Raad Alkadiri: That's actually ax more complicated question than you might realize, and I think it's like the old comment about the theory of relativity, that the more you think about it, the harder it gets. Generally, I think energy security is understood as having sufficient energy supplies to meet countries consumption needs and maintain economic growth. But really, when you start to sort of unpack it, that's far too simplistic a definition, I think, to do justice to the complexities of the issue.

Energy security means different things to different states depending on what those states are like, what's their resource base, what types of energy the economy is based on, the stages of development that a particular country has reached and crucially, I think whether a country is a net consumer or producer of energy. And I think that last facet is often very much misunderstood in the debate over energy security. You know, for a producer, state energy security is all about ensuring demand. It's got nothing to do with ensuring flows and supplies.

Shari Friedman: That's really interesting about the difference between an energy consuming state and an energy producing state in terms of energy security. And this difference also translates over with inflation. And Malcolm, while inflation is still an issue almost everywhere in the globe right now, where are we with energy prices, particularly in Europe, and where do we see that heading for the rest of 2023?

Malcolm Spittler: Yeah, Shari, that fits really tightly with what Raad is saying, that Europe is largely an energy importer, and they've had a really extreme experience in the last year where there's been obviously the conflict in Ukraine that has radically shifted where they're getting their energy from and it has had dramatic impacts on the economics of transition.

Basically, the price that is seen to be reasonable for green energy went up drastically and simultaneously, going back to that idea of energy security and its links to national security, the idea that Europe can continue to rely on its historic sources of piped natural gas from Russia, of transported oil across oceans. This is a radical remaking and a reimagining that we have to see happening where Europe is now deciding that it is worth basically investing in green energy and simultaneously seeing prices where green energy is very, very competitive. For those people who have already adopted green energy in Europe, there have been, if anything, windfall gains from this high energy price environment that has been going on.

That being said, the prices are subsiding a lot. Looking ahead at this coming winter: January, 2024, natural gas price futures in Germany are at about 60 euros. That's down substantially from where they peaked last August at 340 euros. This is an evolving environment where a lot of the big challenges that were facing Europe from this invasion of Ukraine and the utter disruption of business as normal, are actually being handled with surprising grace.

None of the worst-case scenarios that economists were anticipating for this last winter came to pass. The kind of large slush funds of cash didn't have to be tapped to backstop consumers in the same degree that was anticipated. And it's actually been a lot more of a, I don't want to say optimistic scenario, but a better scenario than feared.

Additionally, when we look forward, there is this idea that this is an untenable situation to be put into as an economy. And this gets into energy security and how it ties into national security, which is the idea of being a recipient of energy, whether you're India or China or any other nation-state that is entirely beholden on foreign actors is a dangerous scenario that we're going to likely see a lot of entities putting basically national security level dollars into energy security moving forward.

Shari Friedman: Raad, do you feel like we're out of the woods, specifically Europe, on the impact of having to transition away from Russian gas?

Raad Alkadiri: I don't think Europe's going to be out of the woods, no, for a while, and that's primarily because of how reliable, oddly enough, the supply of Russian gas was. And I think in hindsight there are questions that are being asked about European dependence, but the reality is that that Russian gas flowed for decades and it was relatively low cost. Where Europe is now is in a situation financially and economically of having to resource its gas from areas further around the globe and at higher prices.

And Malcolm mentioned the $60, that's still significantly more expensive than Europe was paying for its energy, paying for its gas prior to the war with Ukraine. So I think Europe has some way to go. It's really in many ways going to come down to a couple of things.

It's going to come down to the availability of alternative supplies on a regular basis and not just for Europe, but also for the markets that Europe has backed out. I think it's also going to come down to a question of politics in Europe and the extent to which Europe can drive energy efficiency gains and can drive gains in terms of seeking alternative supplies and entrench them, make them structural. Europe's done a great job of reducing gas demand by 18% last year. How much of that is structural and how much of that is actually by necessity and forced upon industries and consumers we have yet to see. But the more structural it becomes, the more it can be maintained, the less challenges Europe is going to have.

Shari Friedman: Following up also on what Malcolm was saying about kind of this shock making everybody realize that there is a risk on these highly integrated energy markets, how do you think, Raad, that the war in Ukraine has affected the overall energy story and how we purchase and the energy flows globally?

Raad Alkadiri: I think we could probably have a podcast or several podcasts on each of the points that come out of that but let me try and do something I'm not renowned for and be succinct. Look, I think if you had to look at it, there's probably three key ways at least that I would point to.

One immediate and two a couple more that are more structural. And I think they pull on what Malcolm was saying. That disruption of supplies from what was one of the world's biggest oil and gas producers. And not just the supplies that we lost, but the fears that those losses could be even greater, I think, is probably the most immediate impact that we've seen over the last 14 months.

And you know, that's what drove up prices for oil and particularly for gas, which is where we've actually, ironically, seen the biggest disruption. We haven't seen a great deal of loss of Russian oil. we have seen over 110 BCM of Russian gas loss from the system and replacing that is going to take time and is going to be costly. All of that disruption added to inflationary pressures, and that has had an economic impact, as I mentioned, and not least on energy-intensive industries and where those industries are going to place themselves. That was the immediate one, but I think the two structural ones are equally interesting.

What you've had as a result of this is a greater politicization of energy markets and that goes with the energy security issue. You've had a rewiring of the system and that's likely to last. And that rewiring has been shaped by politics, not markets. There's no market reason why Russian Urals barrels are going to Asia and not to Europe. If the market was left to its own devices, that wouldn't happen.

But you've also seen readjustments in what's not available to countries and the pricing out particularly of emerging markets and the implications that's had on energy policy there. Going with this greater politicization has also been something that is the greater political intervention in markets by consumers. I mean if you think about it, when OPEC makes a cut nowadays, the first question is will the U.S. use its SPR? That wasn't the case 14 months ago.

Shari Friedman: And SPR, that's strategic petroleum reserve, yes?

Raad Alkadiri: That's, that’s right. And as you've seen consumers using price caps, using SPR, using sanctions, et cetera to influence the flow and cost of energy and politics defining what is good and bad oil. I think the third issue and the second structural issue is also just how much I think this makes collective action on issues like climate and emissions more difficult.

I mean, again, this is a product of energy security and critically how energy security is defined differently. We've talked about the EU where it's been about availability. I mean, energy security in the U.S. is about price. In Asia, it's about the reliability of supplies. So as it's defined differently, it leads to different policies, and that has not only exacerbated, I think, the tension between the industrialized world and the global majority, but I think as consumers look inwards and as they're more short-term focused in what they are prioritizing, agreeing the type of long-term multilateral measures for solutions to climate becomes much more difficult.

Shari Friedman: So Malcolm, Raad was just teeing up this idea also of kind of integrating climate change into the idea of energy security, and this past year has also had this shift toward so-called clean energy. First of all, it would be good to discuss what we're talking about when we're talking about clean energy and what do you see this acceleration look like?

Malcolm Spittler: So generally we define clean energy and it is - it's difficult, some people include nuclear, some people don't. We generally see it as carbon neutral energy. I think this last year has been, if anything, an unambiguous win for the acceleration of this transition. So something that was really brought to fore by the events in Europe was that no country in the developed world that has the ability to deal with it will let its consumers go cold in the winter. That almost no price is too high to pay, whether it's through government subsidies, whether it's through kind of moving heaven and earth to bring energy into the country, this is seen as a central bedrock element of being a developed nation.

And that meant that over this year, prices that people were paying prices that governments were effectively subsidizing in many locations for heat were incredibly high. This means that I think one of the least sexy but most exciting technologies is suddenly having a moment, heat pumps. These are literally just a more efficient way to move heat from outside even when it's quite cold to the inside of your home. They've had a moment where the break evens in Europe have been reached and they are much cheaper to operate than a traditional gas heater in this type of high gas price environment that we're experiencing. And that has meant a dramatic shift.

The thing that we all fail to imagine when we're imagining energy security, and we're imagining energy in general because it is so kind of primitive feeling, is that almost half of global energy is used for heating. So an efficiency gain on how we heat, like heat pumps, which are currently in terms of state-of-the-art, about 300% efficient. That means you put in one joule of energy, you get out three joules of heat because they're actually moving heat instead of producing heat.

Well, there are already pipeline technologies that push that to 500%. And as a theoretical limit number, I've seen maybe 20 times efficiency - that's a theoretical physical limit as opposed to an engineering limit. But even if we just go to that five X efficiency that is currently in a testing stage for many of these companies, that would mean half of global energy could become an equivalent amount of electricity of 10% of the current global. That is a transformative event and that is something that has been hastened by these high prices and those are going to become more cost competitive over time.

This is not something that could happen quickly. Obviously, replacing the heating system in every building in the world is a many decades-long project, but it's a many decades long project that is now cost competitive. Renewables have really depended on things being shifted from consumable fuels to electrification and the heat pump technology that has suddenly reached a maturity means that nearly half of global energy consumption is now within reach.

Shari Friedman: Malcolm talked a lot about how we're going for some of the solution technologies and then the other piece of that is weaning globally ourselves off of fossil fuels, which is something that there's been a lot of contention of in the discussions on COP 27 and we anticipate continuing in COP 28. I'm wondering, Raad, as you've tracked these markets a lot, how realistic do you think it is in the short term and midterm that the world weans itself off of fossil fuels?

Raad Alkadiri: It depends how you want to define short and medium term. I mean, I agree with Malcolm absolutely. I think the Ukraine War has given a fill up to energy transition plans and to the acceleration, particularly in the industrialized world. But the experience of the last 14 months has also underscored something else that energy producers, hydrocarbon produces are very keen to point to. And that is that oftentimes energy security requires quick fix action and over the past 14 months it's been fossil fuels that have been relied on to fill the gap. Now that won't always be the case, but it reinforces, I think, their importance and it reinforces and shows the tension between short-term and long-term measures.

I think in the short term it is going to be difficult. And you know, hydrocarbons do have a role in energy transitions as well as transition fuel and also in final production. So beyond the host of countries that have a vested interest in keeping that production up, I think the importance of keeping economies going also points to you will use what energy is available.

But to me, it actually all comes down to one thing and that's money. As we are talking about these things, beyond the policy aspect, will there be the money for investment in renewables in energy efficiency made available? Is there going to be the money for investment in infrastructure? And I'm not just talking about the industrialized world, I'm talking about globally. Particularly in the global majority in emerging markets.

Shari Friedman: I mean this is a great place for Malcolm also to comment as an investor working at Citi, I'm wondering if you could talk about the timeframes. Are you seeing that there is an increase in investible low carbon solutions in emerging markets as Raad had noted? And where are you seeing maybe the timeframe where you're going to see this flip over where there will be more investment and a phasing out of renewable energy from your perspective?

Malcolm Spittler: Well, I believe we actually had the moment where globally, we have switched to having more money being invested in renewables than fossil fuels earlier this year. Obviously, that global figure is highly, highly concentrated in the developed market. But I think there's something that is so exciting about markets, which is basically they pile on. This is something that can be quite devastating, but it also means that as soon as it is cheaper across the board to produce new energy and for the developed world, it's about replacement. Whereas for the emerging market it's, to a very large degree, about producing increased capacity because they're still much lower consumers of energy than the developed world. So I get very excited looking at the developing world and thinking, okay, we now know it is cheaper to build a renewable solar plant or a renewable wind plant than it is to build a new coal plant.

So I don't see, I think to Raad's point, a phasing out in the developing world of fossil fuels nearly as fast as in the developed world. But what I do see is in new projects and kind of the expansion of the electrification in that world shifting more to these projects that now have a shorter payback and lower cost situation. Whether we see large amounts of money flowing in that direction from the developed world in terms of financing, there's an open question. But there is a lot of policy that is moving that direction and there's a lot of kind of political will.

I will also add that something that's quite different about installed renewable energy as opposed to flow-based fossil fuels where in a downturn, you can slow down the amount you're extracting of fossil fuels, you can pump less oil, you can dig less coal. It does not have the same kind of economic incentive to shut down solar plants. So we're actually going to see probably supply holding up on electricity from renewables through an economic cycle in a way that we haven't historically.

And I think that actually has the chance of increasing volatility in fossil fuel prices both to the downside during recessions, which is the stage of the economy that we see next for the United States and with a little bit of a delay into Europe, but also potentially to the upside and to the degree that fossil fuel participants in the market are already seeing this, namely OPEC has decided to already start cutting production even in advance of a start of a recession in the United States.

That becomes a good thing, not just for them and their ability to produce more energy, but also for their competition. Because in this scenario, energy prices stay higher through the business cycle and basically you get a boosted profit margin for renewables where fossil fuels are just fighting to stay even, which is a remarkable opportunity and something that I think we'll be playing out in every business cycle from here until we have moved past fossil fuels.

Shari Friedman: And as we look at this transition, there's longer term factors that are affecting the energy transition. We have climate change and all of the surrounding new regulations coming from policies like the Inflation Reduction Act and Europe's Fit for 55.

Raad, first let's talk about the realities of climate change and the now increasingly unlikely prospect of reaching 2030 goal for net zero. Are you seeing shifts in fossil fuel companies and energy-intensive industries that indicate that we are going to see a sufficiently rapid decarbonization?

Raad Alkadiri: I don't think we're going to see a sufficiently rapid decarbonization to meet 2030 goals, no. But I think you are seeing a shift in the hydrocarbon industry and you are seeing a shift in energy-intensive industries. I mean they're being brought along kicking and screaming in some cases and with a healthy dose of greenwashing in others. But the reality is that they are being brought along and you're seeing a significant shift in their business strategies. I think for them there's now suddenly a willingness to be part of energy transitions rather than to try and stop it. And obviously they're trying to ensure that they're not pilloried as the problem as opposed to being potentially part of the solution.

But in terms of their strategies in the oil and gas companies, for U.S. companies and for some of the national oil companies, the big ones like Saudi Aramco or Abu Dhabi's ADNOC, what they're focusing on is what they will call technology plays, it's decarbonizing hydrocarbons or making the barrel or the molecule cleaner. And it's essentially how do you reduce your emissions from production transport and the processing of oil and gas. And there you're seeing money going into things like CCUS to reducing flaring to stopping fugitive emissions.

And for some of them, and particularly some of the Middle Eastern national oil companies sort of looking at longer term solutions and more expensive solutions like direct air capture or how you can use carbon in a circular carbon economy. But their strategy is essentially how long can you produce oil and gas if you make it cleaner, if you make the process cleaner in terms of scope one and scope two, can that extend the life cycle of oil and gas and that's what they want to do.

I think the European companies and the super majors there have been trying to reshape themselves. They're more sort of on the energy provider track and that's involved moving downstream and focusing, as Malcolm mentioned, on electrons and focusing also on retail. But changes that Shell have introduced recently, that BP have introduced recently to their strategy shows how difficult it is to reinvent the business, particularly when you're trying to deliver the types of dividends and returns to shareholders that have been demanded by those investors and in the timeframe that they demanded. And that's the bit that is stymieing oil and gas companies, I think, is they have a responsibility to shareholders. They need to deliver returns either as profits or as national revenue, state revenue. And for that they are intent on investing in what they see in the short term as the most profitable assets and to develop the most profitable natural resources of the state.

Shari Friedman: So Malcolm, how do you see the fossil fuel companies reacting to both the potential for more stringent regulatory environment and the increasing extreme risks of climate change?

Malcolm Spittler: I think it really depends on the time horizon you are speaking about. And I think Raad is absolutely right on the short time horizon, they have this responsibility to their investors and actually a kind of sworn duty to do what is in the best interest of their investors. But that gets very complicated as we shift out in the time horizon, and this is where we see a lot of companies starting to try and position for a different world.

I'm going to step back and I'm going to step way back and think about when we first started seeing oil coming on. Basically, prior to the emergence of oil as an energy source, we were using a whole lot of whaling ships around the globe. They were going out and finding whales and producing energy for people's lights. And that was a major industry.

It took 60 years for there to be no more whaling ships after the first petroleum and the first kerosene product became available competing in that domain. But there were no new whaling ships for those 60 years. Basically it was a one-way ticket.

I think the companies that are looking at the future and saying, we want to be here when the century turns over are taking a very different course of action right now than the companies that are saying, let's enjoy it while it's good. And I think that's going to be something that plays out very dramatically.

There's just no way to maintain those really high margins for the next 60 years like they have been enjoyed for the last 60 years. And I think we're starting to see, and I think genuinely seeing in a real way, firms trying to build out a post oil future in their own imaginations.

Shari Friedman: And so this follows onto, I guess, in a short-term and a long-term perspective on how, Malcolm, you're looking at fossil fuel companies from an investor's perspective. What do you look at when you start evaluating a company? And how do you see this trend going?

Malcolm Spittler: Well, we're really evaluating it in two different timeframes. We have a relatively positive view on oil and gas companies in the short term, basically on the back of this Ukrainian crisis. But we don't have a very positive longer-term view. We see there are potential legal hurdles. I mean will there be lawsuits kind of like we saw in the tobacco industry that place large amounts of old profit up for grabs by nation-states. There would likely in that scenario be a major competition between different countries in trying to sue the major actors. This is a very complicated environment in terms of that sort of liability. There are a lot of kind of legacy assets associated with oil and gas that are going to become big question marks in the decades to come.

For instance, what's going to happen with all of the gas stations across the world as we move to electric vehicles? Clearly the number of gas stations is going to not need to be the same level 10 years hence as it is today and 20 years hence we probably will have almost none. Each one of those gas stations is a liability because it takes a substantial amount of work to take it offline, clean it up, and meet the standards of the locality, whether it's a high standards location like the United States or Europe or a place where it can be kind of buried and forgot, which is sadly going to be a very common phenomena.

But somebody is going to be held accountable for that. And it may, in many cases, end up being local governments. It may be nationalized. That's a big question. But it does mean that in the long term there are issues of accountability that could really cloud the profitability scenario for oil and gas companies even beyond the price picture.

Shari Friedman: So I want to zoom out a bit and leave the specific fossil fuel conversation and talk just about the energy transitions in general. There's going to be some nations that are better positioned for energy transition and some that are going to be caught in some of these liabilities that we've been talking about. So Raad, I'd like to start with you and who do you think is better positioned right now and who might be less well positioned in the near term and in the long term during energy transitions?

Raad Alkadiri: It depends on what the definition of winners and losers are in terms of this.

Shari Friedman: I didn't say winners and losers.

Raad Alkadiri: Who is better positioned and who isn't? I mean I think this possibly sort of goes with my Eeyore type mentality, but I think one of the biggest losers is the world at this moment in time. But that's partly because we don't look like we're going to hit 2030 goals. But more importantly, the difficulty from a political level of reaching common agreement and common action. I mean this is a global issue and it does require a certain level of coordination and that becomes more difficult as energy security comes to the fore and as you get sort of countries looking inwards as they protect their energy and national security.

But I think if you look at which countries are best positioned ironically or perhaps not as obviously given the emission levels there, I would say China is. Just simply because it is spreading its bets and it's putting a great deal of money into various different sources of energy to ensure reliability, but backing renewables very heavily. And there is a political agenda as well that is linked to the environment and that is linked to the quality of growth in China that will help that. I mean we keep going back to Europe and Europe is certainly better placed. The question there is going to be can Europe produce the regulation and the policy to go with its very, very high ambitions.

And I think the U.S. has clearly taken advantage of the past 14 months and the Biden Administration has used the changing situations globally and in energy to push its own agenda. I mean that is, in some ways one of the issues that the Ukraine War has changed and how it's helped energy transition fans. It's a second-order impact. But as it's exacerbated U.S.-China tensions, you have had this focus of us and the Biden Administration on industrialization, on onshoring, et cetera, which is given a push to green transitions because that's been an important element of it.

As for the countries less well produced, again, those that don't have access to the investment and certainly in the developing world, those that are priced out of some of the transitions and transition policies and that, you look at the cost of LNG and what that's done to countries like Pakistan, those kind of implications.

And one of the biggest losers out of all of this is going to be Russia. Having started this spat, Russia's lost influence in leverage. It's getting less for the hydrocarbons it's produced, those hydrocarbons are seen as politically tainted and it's going to struggle with sanctions for probably many years to come.

Shari Friedman: Malcolm, when you look at this from an investment perspective, how are you looking at energy transitions in terms of investing and how would you advise on both the institutional and also the individual level for companies who want to make sure that they have access to capital?

Malcolm Spittler: Yeah, I think it's really crucial to see this as a transformation, but it's also a transformation where there's a little bit of a gold rush element. And our general rule of thumb is when there's a gold rush, don't go digging for gold, invest in the makers of the picks and shovels. So we really like a lot of the entities that are producing the input materials and the input technologies to the new green infrastructure. Kind of the necessary outcome of an energy transformation is that energy prices will go down.

In fact, I would go out on a limb and say over all of human history, there have been little tiny wiggles, but otherwise energy prices go down. The amount of human work that is necessary to produce energy is on a multi-thousand year downward trajectory and I don't see any shift to that. And so ultimately this transition is one where I see the other side as having radical energy abundance and very low-priced energy. So kind of in the longer run I'm thinking who benefits from that more than energy consumers.

So we're wondering what entities are currently spending the most on energy and thus have the most to gain from that shift in the longer time. So short term, absolutely oil and gas, we have to meet the demands of today. Unambiguous there are business cycle dynamics that are at work and we have to focus on those and pay close attention. Medium term picks and shovels, long-term energy consumers. That's how we've been kind of framing it internally.

Shari Friedman: Malcolm Spittler, senior U.S. economist and strategist at Citi Global Wealth Investments and Raad Alkadiri, Managing Director of Energy Climate and Resources at Eurasia Group. Thanks to you both.

Malcolm Spittler: Thank you so much for having us.

Raad Alkadiri: This was great.

Shari Friedman: And that's it for this episode of Living Beyond Borders. Listen to all the seasons episodes by heading to and click on the Living Beyond Borders tab. Or you can find episodes in the GZERO World Podcast feed wherever you get your podcasts. For GZERO, I'm Shari Friedman. Thanks for listening.

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