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May 3, 2022

Frédérique Carrier
Managing Director, Head of Investment Strategy
RBC Europe Limited

Russia’s predatory move on Ukraine is pitting energy security against energy transition for many countries. Governments are shifting energy policies back in favor of fossil fuels in the short term, raising fears the energy transition may end up on the back burner.

But the new focus on energy security doesn’t irrevocably threaten the climate change mitigation agenda, in our view. Rather, the green energy transition, while slowing in the near term in some aspects, is very likely to accelerate in others, particularly in Europe. We explore the investment opportunities arising from the friction between security and climate goals.

Perilous dependency

Russia’s war on Ukraine has made energy security a pressing priority. It is not only the moral issue of replacing a rogue supplier that is using energy profits to finance an unprovoked war. Governments around the world also wish to shelter their citizens and economies from harmful spikes in global energy prices. The Russian invasion has exacerbated an existing uptrend in energy prices, with oil and gas prices leaping as much as 30 percent and 150 percent, respectively, before retreating.

Exposure to Russian energy

Europe is most exposed to Russian energy

Country/region Percentage of all imports produced by Russia
Oil Natural gas
Notes:
(1) 2020 data.
(2) 2019 data; under a deal signed in February 2022, Russia aims to deliver 48 billion cubic meters (BCM) of liquefied natural gas to China by 2026. Gazprom estimates this will represent about one-third of China’s total gas imports in that year.
(3) 2021 total petroleum including oil.
(4) Canada has not imported crude oil from Russia since 2019.
Europe 25% 40%
UK (1) 17% 5%
China (2) 15% 3%
Japan 4% 9%
U.S. (3) 3% 0%
Canada (4) 0% 0%

Source - International Energy Agency, U.S. Energy Information Administration, GOV.UK, Eurostat, Canada.ca

Many countries are refocusing their energy policies, particularly—but not exclusively—those with a heavy reliance on Russian oil and gas.

  • Shortly after the invasion, the EU issued its new energy plan, REPowerEU, a roadmap to reduce Russian natural gas imports by two-thirds by the end of 2022 and to cut off Russian fuels completely by the end of the decade. Much of the implementation of this plan is left to the bloc’s member states. Most are looking for alternative suppliers of gas and to extend the life of coal-fired power plants to fill the gap in the short term. At the same time, the push for renewable energy is being jump-started.
  • The UK, having banned Russian energy imports entirely, issued its new British Energy Security Strategy in April. The plan focuses on more drilling for oil and gas in the short term, but it also calls for offshore wind and nuclear power to make up the shortfall over the long term.

Even countries that don’t rely much on Russian energy are reevaluating their energy strategies, looking for ways to boost energy output in an effort to alleviate elevated energy prices and to help countries scrambling to replace Russian energy.

  • The U.S. has reshaped climate and energy discussions since the Russian invasion due to crippling energy prices. Fossil fuels are no longer seen in as bad a light, and recognized as having an important role to play in mitigating the energy crisis. President Joe Biden, who recently signed a deal for the U.S. to supply Europe with liquefied natural gas (LNG) until at least 2030, has called for more fracking, and has gone as far as considering imposing fines on companies that do not use their federal leases to drill for oil. Still, no long-term changes to the U.S.’s energy policies have been announced, though key climate provisions within Biden’s Build Back Better legislation have stalled.
  • Unrelated to the invasion, the Canadian government issued a 271-page document at the end of March calling for a 42 percent reduction in the country’s oil and gas emissions from 2019 levels by the end of the decade as part of its 2030 emissions reduction goal. The document reiterates Canada’s commitments to climate change mitigation and the energy transition.

Going against the grain?

With a sense of urgency and in an effort to find a short-term fix, several strategies to increase energy supplies are being touted, including more drilling, diversifying LNG suppliers, and expanding the life of existing coal power plants. All would slow progress toward achieving net-zero emissions in the short term and seem like a step back in the energy transition.

More drilling

The realization of the importance of energy security and the reaction to elevated energy prices have both led to calls to increase drilling in key oil-producing countries, such as the U.S.

In Europe, oil- and gas-rich Norway and the UK are also considering increasing domestic production. RBC Capital Markets sees potential for a significant jump in the UK’s North Sea activity in 2022, following a steady decline in capital expenditure since 2013. Many projects previously deemed uneconomical are becoming attractive in today’s elevated price environment. The emphasis is likely to be on gas developments given European gas prices are likely to stay firm over the coming years and Europe remains a significant importer.

Interestingly, if the additional drilling comes at the expense of LNG imports, it could actually lower carbon emissions. In its recent report “The European Energy Trilemma” RBC Capital Markets calculated that LNG imports are at least three times more carbon-intensive than domestic gas production. Moreover, supporting domestic energy supplies is typically a cheaper alternative to imports.

Furthermore, additional drilling does not necessarily mean unbridled drilling. The Canadian government’s recent approval of a $12 billion offshore oil project off the coast of Newfoundland sets out 137 legally binding conditions, including the requirement the project reaches net-zero emissions by 2050. Canada also released an energy plan in March 2022 that suggests rolling out a tax credit for carbon capture and storage, a process that can reduce 50 percent to 70 percent of carbon emissions from industrial processes. We would expect broad deployment of this tool to moderate carbon emissions.

While there are mitigating circumstances and additional drilling may not be as much a setback to climate goals as initially feared, the risk is that the world could remain locked into fuel dependence.

Diversifying the LNG supplier base

To replace Russian energy in the short term, many in Europe are focusing on diversifying natural gas supplies before the next winter. The second-round effect of this strategy may be to unintentionally increase carbon dioxide emissions.

For instance, the U.S. has upped its LNG shipments to the region and Canada has pledged to increase exports to Europe. Meanwhile, Germany has reached out to Qatar, the world’s largest exporter of natural gas with 15 percent of global exports, about obtaining more supply to meet its gas needs. Italy is also ramping up gas imports via its recently completed deal with Algeria, its second-largest supplier after Russia, for alternative supplies.

Whether LNG is received from one supplier or another may not by itself increase carbon emissions. But the RBC Capital Markets report noted that a diversification of European LNG imports would likely mean that shipments are diverted away from Asian countries—perhaps leaving them with little alternative than to burn more coal to meet their energy needs. Coal is a cheap but much more polluting alternative to natural gas, producing 50 percent more emissions.

As such, merely tapping other sources of LNG supplies may have unwelcome knock-on effects for the energy transition.

Expanding the life of coal-fired plants

A number of countries, including the UK and Germany, are considering expanding the life of coal-fired power plants previously designated for closure.

Bloomberg estimates that burning additional coal instead of Russian gas would increase the EU’s carbon emissions by about eight percent. But it points out that as Europe isn’t planning to construct new coal power plants as part of its response to the crisis, any pollution created by new coal and oil imports could be offset by the scaling up of green energy.

Nuclear: The comeback kid?

The fortunes of nuclear power may be about to improve as some governments are attracted by its emissions-free attributes.

In the 15 years to 2020, nuclear energy’s share of global electricity production fell from 17.5 percent to just over 10 percent. Nuclear accidents and leaks are one reason. Nuclear energy is not only slow to build and more expensive to produce but costs have also been going up, unlike most other energy sources. Then there is the thorny issue of how to dispose of nuclear waste. Finally, the materials used, from the steel that is manufactured to construct the power plant to uranium ore, aren’t renewable though nuclear energy itself is emissions-free.

As such, the EU’s decision to label nuclear energy a “sustainable investment” earlier this year was controversial.

Despite nuclear energy’s drawbacks, several governments and corporations are considering nuclear expansion. Recently, the UK, suffering from gas shortages and prone to a dearth of wind, announced it is looking at expanding the share of this energy source. France, which derives more than 70 percent of its electricity from nuclear power, more than any other country, announced the “renaissance” of the French nuclear industry, and plans to construct up to 14 new nuclear reactors by 2050. Both countries are also considering extending the life of existing nuclear plants.

Next-generation nuclear reactors known as small modular reactors may hold some promise as they are cheaper and quicker to build. Four Canadian provinces have announced plans for the new breed of small reactors.

In Poland, where 70 percent of electricity production burns coal, energy-intensive companies are spearheading the drive for greater use of nuclear energy. They are eager to reduce carbon dioxide emissions, the cost of which has increased relentlessly over the past few years.

To the extent that energy security means a diversified portfolio of energy, nuclear does have a role to play in the energy transition, given that many renewable energy sources are intermittent. China is planning at least 150 new reactors in the next 15 years, or more than the world has built in the past three decades.

Cost of electricity by source

Electricity from renewables became cheaper as capacity increased; electricity from nuclear and coal did not

Cost of electricity by source

The chart shows how the cost of electricity produced by offshore and onshore wind, solar photovoltaic, nuclear energy, and coal evolved in the period 2010 to 2019. It shows important decreases in the cost of electricity produced by wind and solar in particular. By contrast, the cost of electricity produced by coal didn’t change much, while the cost of producing electricity from nuclear energy actually went up in the period.

Electricity source Price per megawatt-hour in 2010 Price per megawatt-hour in 2019 Learning rate (cost decrease per doubling of capacity)
Solar photovoltaic $378 $68 36%
Offshore wind $162 $115 10%
Onshore wind $86 $53 23%
Nuclear $96 $155 No learning rate - nuclear has become more expensive
Coal $111 $109 No learning rate - coal has not become significantly cheaper

Solar photovoltaic (PV)

2010: $378 2019: $68

At each doubling of installed solar capacity, the price of solar electricity declined by 36%; 36% is the learning rate of solar PV.

Offshore wind

2010: $162 2019: $115

Learning rate: 10%

Onshore wind

2010: $86 2019: $53

Learning rate: 23%

Nuclear energy

2010: $96 2019: $155

No learning rate – nuclear has become more expensive.

Coal

2010: $111 2019: $109

No learning rate – coal has not become significantly cheaper.

Note: Price per megawatt-hour of electricity is the global weighted average of the cost of electricity generation for a generating plant over its lifetime, without subsidies; prices are adjusted for inflation. Cumulative installed capacity is shown on a logarithmic scale to make the analysis of the large range easier.

Source - Our World in Data, IRENA 2020 for all data on renewable sources; Lazard for the price of electricity from nuclear and coal; International Atomic Energy Agency for nuclear capacity and Global Energy Monitor for coal capacity; adaptation of work licensed under CC-BY  by the author, Max Roser.

Redoubling green energy efforts

Beyond harnessing fossil fuel energy in the short term, and making difficult and at times controversial decisions to rethink their plans for nuclear energy, many governments are redoubling efforts toward energy efficiency at the same time. Developing a low-carbon economy could be a very effective energy security strategy. This is an opportunity in Europe, and it also may be so in the U.S.

Ramping up wind and solar energy

According to Ember, an energy think tank, 50 countries around the world, including the U.S., China, Japan, Germany, and the UK, generate at least 10 percent of their energy needs from wind and solar. Denmark remains the leader, generating more than 50 percent of its energy from these sources.

Renewables’ contribution is likely to grow further. RBC Capital Markets points out that the pace of renewable energy development in Europe has become increasingly important in recent months as the urgency for a shift from natural gas picks up.

Under the REPowerEU plan, investments to reduce emissions by 55 percent by 2030 relative to 1990 levels will be frontloaded, increasing the average deployment rate by 20 percent. Another 80 gigawatts (GW) of renewable capacity has also been targeted by 2030 to enable the production of more renewable hydrogen. Germany has brought forward its target of reaching 100 percent clean energy by 2035, or 15 years earlier than initially planned. Many countries lacking large deposits of fossil fuels will look to do the same as wind and solar are, after all, omnipresent.

This should help to ensure that the European Commission’s target of 40 percent renewable energy sources in the EU’s overall energy mix by 2030, twice the 2020 level, is reached earlier.

In the UK, one of the main objectives of the new British Energy Security Strategy focuses on offshore wind. The government has increased its target for offshore wind generation to 50 GW by 2030, up from 40 GW, with a new target of 5 GW coming from floating turbines.

Removing hurdles such as streamlining the lengthy and stringent planning permission requirements for renewable projects could arguably prove even more important than the increase in the rollout targets. The EU is set to publish a recommendation on fast-tracking the permitting of renewable energy projects in May. The UK government has likewise promised to implement reforms to cut approval times in half.

Wind and solar technologies are not magic wands, of course, as these will also need more infrastructure, including transmission lines, batteries, and charging stations for electric vehicles. Much of this will require mining projects in metals critical to building a green economy, such as aluminum, cobalt, copper, lithium, nickel, silver, and zinc. Such mining will likely damage local environments and is often located in countries with high political risk.

Hydrogen revolution brought forward

High gas prices are also changing the cost equation for hydrogen. Previously, “green hydrogen,” or hydrogen produced by electrolyser machines powered by solar and wind power, had long been considered too expensive to produce, costing up to four times as much as the cheaper, fossil fuel-derived “grey hydrogen.” It was thought that “blue hydrogen,” which uses carbon capture to remove the bulk of CO2 emitted during production processes, would be the type of hydrogen most likely used in the short term to help achieve the green energy transition.

But given the increase in the price of natural gas, the premium cost of green hydrogen has markedly declined. BloombergNEF, an energy consultancy, recently calculated that green hydrogen could be cost-effective today—cost parity had previously not been expected until the end of the decade.

The reduced cost differential is happening at an opportune time. In late 2021, the EU launched a €2 billion partnership with industry to accelerate research and development in green hydrogen, which involved scaling up green hydrogen electrolysers from a megawatt to gigawatt scale to bring down the cost of the technology even further. The reduced price premium on green hydrogen makes the EU’s target for hydrogen to supply at least 10 percent of the bloc’s energy needs by 2050 appear more achievable.

Sensing the opportunity, H2 Mobility Deutschland, a private German company, recently raised $120 million to more than triple the number of its hydrogen refueling stations by the end of the decade to 300. The aim is for these facilities to meet the demand for heavy-duty and long-haul transportation in Europe. The goal is to expand the hydrogen network along several popular transportation corridors and in cooperation with public authorities and fleet operators to ensure offtake for the stations, according to Bloomberg.

In short, the hydrogen industry, which until recently was struggling much like the wind farm industry had a decade ago before costs dropped and installations proliferated, is likely to enjoy stronger growth going forward, in our view, just as its wind energy predecessor did when the cost equation tilted in its favor.

Energy efficiency in focus

With much effort being made toward increasing energy supply, the demand side should not be forgotten, and we expect energy efficiency will be increasingly in focus going forward. Measures such as switching to heat pumps and better-insulated houses also can reduce energy demand and hence the dependence on natural gas. While the British Energy Security Strategy disappointed many by omitting these measures, the recent budget announced by Chancellor of the Exchequer Rishi Sunak abolished the sales tax on energy efficiency measures such as home insulation and solar panels. Canada’s new energy roadmap includes an additional CA$500 million for the existing greener homes program, which helps cover the costs of similar energy-saving improvements.

Portfolio implications

The imperatives of energy transition and energy security need not compete with each other. Developing a low-carbon economy could be a very effective energy security strategy. The current crisis may ultimately reveal itself as an opportunity, much like the energy crisis of the 1970s did, to foster energy innovation in a variety of areas including low-carbon technologies such as green hydrogen, nuclear, as well as carbon capture and storage, and the promising but still expensive direct air capture. On the demand side, much more can be done to reduce demand via energy efficiency.

While the energy transition has become more complex and multifaceted, the energy security imperative has given it more impetus in certain areas. We continue to see many opportunities in the SusTech theme, particularly in GreenTech as many of the drivers of energy security are critical to fighting climate change.

Industries likely to benefit from energy security

The pursuit of energy security could benefit a wide range of industries

Category Energy security measure Industry
Fossil fuels More drilling Oil and gas companies
Diversifying the LNG supplier base Oil and gas companies
Extending the lifespans of coal-fired power plants Carbon capture and storage
Grey area More nuclear
Manufacturers of power plants and power-generating components
Mining companies
GreenTech Ramping up wind and solar energy production
Independent wind farm operators
Wind turbine manufacturers
Utility companies with expertise in renewable power
Solar panel equipment manufacturers
Semiconductor manufacturers
Software
Monitoring systems
Battery systems operators
Battery manufacturers
Hydrogen revolution
Electrolyser manufacturers
Industrial gas companies
Transforming transmission
Transmission system managers
Electric cable manufacturers
Power equipment manufacturers (e.g., substations, transformers)
Electricity distribution companies
Electric vehicles
Manufacturers and operators of charging infrastructure
Parts manufacturers
Energy efficiency
Industrial conglomerates
Building materials companies

Source - RBC Wealth Management


In Quebec, financial planning services are provided by RBC Wealth Management Financial Services Inc. which is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RBC Dominion Securities Inc.


Frédérique Carrier

Managing Director, Head of Investment Strategy
RBC Europe Limited