The green recovery

Peter Kiernan, Lead Analyst – Energy, at the Economist Intelligence Unit, looks at the energy sector’s expected pace of recovery from COVID-19 and highlights key trends for 2021.

The coronavirus pandemic upended energy markets in 2020, with lockdowns, crimped industrial activity and restrictions on travel causing global energy consumption to contract by an estimated 4%. Demand for oil, gas and coal all fell during what was a challenging year, although consumption of renewables, especially solar and wind, increased. At the close of the year, energy consumption was expected to rebound partially, by 2.6%, as global GDP growth returns in 2021, but not strongly enough to return to 2019 levels. However, this scenario assumes that the global pandemic is contained; if this does not happen, energy consumption will weaken again.

As a result, 2020 and 2021 will be ‘lost’ years for the three fossil fuels. Of the three, gas will be impacted the least, with consumption forecast to return to 2019 levels by 2022 as the economic recovery drives demand from the industrial sector. Gas will also continue to be competitive with coal in the power sector, especially in the US and Europe.

Oil consumption is expected to show a strong rebound in 2021, rising by 3.1%, but coming off a sharper collapse in demand than gas. Changed behavioural patterns, such as more people working from home and lower levels of air travel, are likely to continue into 2021, preventing a bounce-back to pre-COVID levels. It may not be until 2023 that oil demand returns to the level of 2019.

Meanwhile, following a severe contraction of nearly 6% in 2020, coal consumption will grow by a modest 1.8% in 2021, recovering only slightly from sharp falls in the US and Europe as power demand recovers. Demand for coal may now be in long-term decline unless renewed demand from Asia outstrips the structural declines in the US and Europe.

Policy drivers, priority on the grid and lower technology costs will make renewables a more attractive investment option going forward. Consumption of renewables (including solar, wind, hydro, geothermal and biomass) grew in 2020 and is expected to continue this trend in 2021, outpacing fossil fuels. Growth is forecast to be much stronger for both solar and wind in particular. The Economist Intelligence Unit (EIU) forecasts a combined increase of 13%, which reflects the resilience of low carbon sources even as the COVID-19 pandemic depresses overall energy consumption.

Four key trends for 2021

The EIU sees four key trends developing over the course of the next 12 months.

Government policy will support growth in renewable energy

Climate-friendly approaches to economic growth will dominate in 2021, although not everywhere. Of the four big greenhouse gas (GHG) emitters – China, the US, the EU and India – the EU will be the most focused on reducing climate change, using its stimulus spending to promote a green recovery. In 2021 it will set higher climate targets for 2030 and officially target a net zero GHG economy by 2050. In the US, the Presidential win by the Democratic Party candidate Joe Biden will see US climate policy aligning with the EU, as he has pledged $2tn in climate-related spending over four years.

China has also set its sights on reaching peak emissions before 2030 and carbon neutrality by 2060. South Korea, which has pledged carbon neutrality by 2050, is likely to advance its green agenda, as will Japan, which has pledged net zero emissions by the same year. However, the outlook for the rest of Asia is less certain. ASEAN member states want renewables to account for 23% of energy demand by 2025, but this seems like an ambitious target. Indonesia, Malaysia, the Philippines and Thailand have renewables targets on paper, but growth in solar and wind deployment has been slow. will remain subdued this year, as consumption will only recover partially from the falls experienced in 2020. There is also a question mark over whether oil producers will stick to OPEC production cuts into 2021. Overall, we expect oil prices (Brent) to average $45/b in 2021, only marginally higher than the annual average for 2020 ($42.16/b). US natural gas prices will average $2.74/b, reflecting a 43% increase from an all-time low of $1.92/b in 2020.

Low prices will weigh heavily on revenue streams of upstream producers of oil and gas, as well as coal companies, and hurt their market value. Traditional energy majors risk being upstaged by renewables companies. For example, in October 2020 it was reported that NextEra, a utility with significant solar and wind assets, had grown to rival ExxonMobil in terms of market capitalisation.

Restructuring and bankruptcies will affect US shale operators

The price slump will continue through 2021, placing pressure on oil and gas producers, especially those in the US shale patch. After some years of explosive growth, US oil production is expected to fall further in 2021, although not as severely as in 2020. The continuation of prices in the $40/b range means that many shale operators, especially those more exposed to debt, will struggle, and bankruptcies are likely to continue. A total of 36 shale operators went bankrupt in the first three quarters of 2020, compared with 42 in the whole of 2019. The rapid increase in shale output that was seen until 2019 is unlikely to be repeated. Meanwhile, oil majors such as BP, Shell and ExxonMobil have announced job cuts in response to the price slump, with no real recovery in prices expected until after 2021. Some oil majors will continue to slash costs as they steer towards renewable energy, and others will look to divest non-core businesses.

Investment in the power sector will outstrip that in oil and gas

Energy investment declined in 2020 amid the economic downturn caused by COVID-19 and this will continue into 2021. According to the International Energy Agency (IEA), investment in the power sector exceeded investment in upstream oil and gas supply in 2020 (although investment in both sectors fell), which suggests a shift in investment in the sector towards electricity supply. We expect this shift to become more prominent in 2021.

The decision by BP and Shell earlier in 2020 to target net zero emissions by 2050 shows that a growing number of upstream oil and gas producers think that there is a better business case for investment in low carbon sources of power. This is underlined by the fact that Trafigura, a large oil trader, has plans to set up a joint venture that would invest $2bn in renewables by 2025, focusing on solar, wind and energy storage.

Decarbonising oil and gas

Last year saw a marked increase in the number of oil and gas companies announcing commitments to cut back on GHG emissions, reflecting a change in upstream oil and gas sector attitudes regarding the transition to a lower carbon energy system. Nevertheless, there is a wide variation in both the level of details that have been announced, and what activities will be covered.

Some, such as BP, have included Scope 3 emissions as part of their net zero emissions target, while others have included only Scope 1 and 2 emissions, a much less ambitious task. Many operators have also only committed to reduce emissions by a certain amount by a certain year, and have not made a full ‘net zero’ pledge. Nevertheless, it is clear that, firstly, the energy transition has, in just a short period of time, become considerably more important to an increasing number of oil and gas operators, and, secondly, the transition will be viewed by them as a topic which needs to be taken into account when considering their longer-term plans.

The pathway to net zero emissions will be achieved in many different ways by operators. In addition to adopting more efficient, less emissions-intensive operations, oil and gas outfits will increasingly invest in several low carbon options, such as renewables, energy storage, hydrogen and carbon capture technologies to reduce their carbon footprint. The renewables sector may not always offer the same high returns as oil and gas, but the attractiveness of investment in this sector is that it is generally seen to be stable, and thus avoids the volatility that plagues commodity markets. Furthermore, interest rates are expected to remain low.

Countries will also become more ambitious on the climate policy front in the run up to November’s COP26 meeting, and beyond, as evidenced by recent net zero emissions announcements by China, the EU, Japan and South Korea. Therefore, developing a broad low carbon portfolio enables synergies with the direction of climate policy at a global level, if for no other reason than to avoid having carbon-intensive stranded assets.

The COVID-19 pandemic has also raised the possibility of a peak in oil demand sooner rather than later, which will likely enhance the focus on low carbon investments. While it is clear that oil and gas use will be around for some time to come, 2020 may come to be seen as the pivotal year in which the sector put the energy transition more at the forefront of its longer term thinking for the future.

What to watch for in energy in 2021

China’s upcoming five-year plan

China announced in September 2020 that it would target peak emissions before 2030 and carbon neutrality by 2060. If it achieves this, it is likely to alter the trajectory of global emissions and help the world to control climate change. The government’s next five-year plan for 2021–2025, which will be released in early 2021, will show how China plans to meet its new climate goals.

COP26

The 26th session of the Conference of the Parties (COP26) to the UN Framework Convention on Climate Change (UNFCCC) was postponed by a year to November 2021 because of COVID-19. The meeting, to be held in Glasgow, UK, will force member states to review their progress against the targets set at the ground-breaking Paris Climate Conference in 2015. The conference will therefore be decisive in determining the path ahead for global action on climate change.

The future of Nord Stream 2

The future of the Nord Stream 2 gas pipeline hangs in the balance in 2021. At the end of 2019 US sanctions halted construction of the pipeline, which will pipe gas directly from Russia to Germany (in addition to the existing Nord Stream 1). The US view is that the pipeline will increase Europe’s dependence on Russian energy supplies. Recent geopolitical tensions have increased pressure on the German government to abandon the project altogether. As Russia tries to complete the project by itself, the next US administration will have to decide whether it wants to prevent Nord Stream 2 from becoming a reality.