Russia’s shocking invasion of Ukraine is having horrendous consequences, and our thoughts are with the millions of people affected.
As climate change investors, we also have to consider the impact of the conflict on the energy transition and the global climate challenge.
Here we discuss our thoughts on the implications for three topics, although it is worth noting that the current situation remains in flux.
Energy: the war has reshaped energy policy
The war has thrown into sharp focus the fault lines in Europe’s energy system. Russia is the largest supplier of gas, crude oil and coal into the EU, accounting for 45%, 27% and 46% of imports respectively.
President Putin’s aggressions have triggered a rapid and fundamental reshaping of European energy policy, with energy security now the continent’s primary concern. In the short term, all options are on the table, including extending the use of coal-fired power generation and potentially intervening in the carbon market.
However, this should not be taken to mean that the energy transition has been side-lined: far from it.
Sustainability and resiliency can go hand in hand when it comes to energy, as decarbonising and electrifying the energy system is a way to end energy reliance on Russia. The logical conclusion of net zero always meant moving towards 100% renewable energy generation in Europe, so whilst that goal has not changed, this crisis has created an additional impetus to move to a future free of fossil fuels more quickly.
The European Commission aims to reduce reliance on Russian gas by two thirds by the end of 2022, and become fully independent from all Russian fossil fuels well before 2030.
The short-term measures focus on diversifying the gas supply, ensuring Europe’s gas stores are filled up ahead of next winter, and protecting vulnerable consumers and businesses against soaring power prices.
The structural measures are all about the energy transition: hastening the renewable build out, electrifying heating through the rollout of heat pumps, increasing the short-term targets on green hydrogen, and addressing the energy efficiency of buildings. These markets can’t be accelerated overnight (for example, it takes three to five years to develop an offshore wind farm), but there now seems to be real push to clear the procedural hurdles that have been slowing these trends.
Summing up the EU’s new stance, Executive Vice-President for the European Green Deal, Frans Timmermans said: “It is time we tackle our vulnerabilities and rapidly become more independent in our energy choices. Let's dash into renewable energy at lightning speed. Renewables are a cheap, clean, and potentially endless source of energy and instead of funding the fossil fuel industry elsewhere, they create jobs here. Putin's war in Ukraine demonstrates the urgency of accelerating our clean energy transition.”
The impact of raw material inflation
In this new energy reality, the tools of decarbonisation – wind turbines, high voltage power cables, solar panels, electric vehicles (EVs), energy storage, heat pumps – are needed more than ever. But the crisis is also exacerbating the cost and availability of some of the key raw materials required to make these technologies.
The price of nickel (widely used in EV batteries) and aluminium (used in solar panel frames, cabling, EVs) have both risen as the Ukraine/Russia crisis has unfolded.
Energy is a key input cost for these metals (particularly aluminium) and Russia is responsible for 7% of global nickel exports and around 6% of global aluminium exports, so there is a significant risk of supply disruption. Aluminium prices have risen by more than 20% in the year to date, having jumped almost 50% in 2021. Nickel prices spiked dramatically as concerns around disruption to Russian exports were then compounded by a Chinese metals producer covering its short position.
All of this means further cost headwinds for energy transition companies, which have already been struggling with higher costs following the pandemic, particularly in areas such as steel and logistics.
The bigger question is whether rising prices impact the economic viability of these technologies (leaving aside the geopolitical priorities for a moment). With European energy prices set to remain higher for longer, building new renewables will continue to be the cheapest option, even as their prices have ticked up to reflect rising costs.
Rising petrol prices improve the total cost of ownership of EVs relative to internal combustion engine vehicles, helping to more than offset the impact of rising battery and electricity prices. However, a consumer income squeeze is negative for auto demand generally, so whilst the structural case for EVs is not dampened by the crisis, the industry faces cyclical challenges.
The picture is further muddied by the fact that the post-pandemic semiconductor shortages constrained auto supply last year, so there may still be some pent-up demand to come through as an offset. Overall, we still expect growth in the European EV market in 2022 and beyond.
Finally, elevated gas prices have also driven the parity of green and grey hydrogen years earlier than anticipated. Given that we don’t expect gas prices to ease soon, this improves the economic case for creating hydrogen from electrolysers powered by renewable electricity.
The international community is focused on the war in Ukraine and the worsening humanitarian crisis. It was telling that two major climate announcements recently went almost unnoticed. The IPCC released its latest flagship report, warning of the rapidly closing window to prepare the world to adapt to climate change.
On a more positive note, in an agreement hailed as the biggest deal since the Paris Agreement, almost 200 countries agreed to work to develop a framework for reducing plastic waste around the world. A divided and distracted world is not conducive to the effort to address global warming. However, the fact that decarbonisation and electrification align so closely with the new plan to create energy independence from Russia means that in practice, policy is still pushing in the direction of addressing climate change.
The short term remains fraught with uncertainties, and some of the headwinds faced by some areas of the market are going to be tougher for longer. Companies with solid balance sheets will be best placed to withstand the near-term pressures. In the medium term, the key message is the acceleration of the energy transition.
Over the last two years, the proliferation of net zero policies showed that the world was waking up to the need to address climate change, but the actual progress on decarbonisation was painfully slow.
Perhaps it has taken Putin’s appalling war and the new energy security imperative to finally catalyse an energy revolution.