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The energy industry is complex, and understanding the major trends changing the industry can be challenging. Today energy landscape is changing rapidly with far-reaching implications for global energy industries and actors, including oil companies.
All analysis on energy agrees about four things: first, that a growing, richer global population will demand more goods, services and activities that require energy; secondly, that there is an energy transition from fossil fuel sources towards cleaner energy sources going on; thirdly, that large investments are needed to grow and improve the global energy system; and fourthly energy security & access is at the centre stage for geopolitics.
This edition of Matter of Fact intends to provide a briefing on the Energy Transition focussing mainly the above facets with focus on current Energy Transition underway.
This seemingly easy question is quite difficult to answer satisfactorily.
Even Noble Prize winners have found difficulty in doing so. Celebrated Nobel laureate Richard Feynman (1918-1988) in his famous “Lecture on Physics” stressed that “it is important to realize that in physics today, we have no knowledge of what energy is. We do not have a picture that energy comes in little blobs of a definite amount”.
Being lesser mortals that we are, of course, we will not try to answer this question in entirety here. But let’s first look at the history of defining energy.
The “Energein” was created by Greek Philosopher Aristotle (384 – 322 B.C) in his book Metaphysics. According to Aristotle, every object’s existence is maintained by energeia related to the object’s function. The verb Energein thus came to signify motion, action, work and change.
For nearly two subsequent millennia, no significant change in the above definition has been seen. The term over time has become synonymous with power and force. In 1807, Thomas Young probably gave the first formula for energy. He defined energy as the product of the mass of a body and the square of its velocity (restricting the term to only kinetic energy).
All in all, energy is probably the only universal currency: one of its forms needs to be transformed to getting anything done. It is fundamental to the way we live and human civilisation/history/ evolution is intricately linked to usage and storage of energy in its various forms.
Coming nearer home, what does the BPCL tag line “Energising Lives” mean? To us, it means the happiness, vibrancy, the empowerment that BPCL brings into people's lives through the products and services we provide.
The general meaning of transitions—as passages from one condition or action to another—is simple, straightforward and easy to understand. But adding energy to transition complicates things.
Firstly, there is no formal or generally accepted meaning of energy transition and it means different things to different people based on context. However, the most common definition is:
The Energy Transition is used to describe the change in the composition (structure) of primary energy supply sources over long periods of time.
Primary energy demand means energy coming from natural resources such as coal, oil, natural gas etc. In simple words, Energy Transition is the time that any primary energy resources take to increase in market share significantly from its introduction (significant market share is considered by many scientists to be in excess of 20% of the global energy supply).
The interrelated factors involved in driving energy transitions generally include:
Tangible element of the energy ecosystem including technology, infrastructure, markets, equipment’s, consumption patterns and distribution chains.
People related and involved in Energy systems who form new strategies, investment patterns, form coalitions
Socio-technical systems such as formal regulations, policies, institutions & their mind-sets/belief systems etc.
The Energy transition is generally multidimensional, complex, non-linear, non-deterministic, and highly uncertain. Energy transitions are a result of the interplay of multiple factors including technology, society (and its agents), institutions, natural resources availability etc. Energy transitions also take a lot of time (generally decades) and scientists/experts generally track speed of the energy transition (mainly measuring the speed of changes in the tangible elements of the energy system).
As the author, Vaclav Smil writes, ‘all energy transitions have one thing in common: They are prolonged affairs that take decades to accomplish, and the greater the scale of prevailing uses and conversions, the longer the substitutions will take.’ Fast transitions, when they occur at all, are anomalies, limited to countries with very small populations or unique contextual circumstances that can hardly be replicated elsewhere. Now let’s look at the history of energy transitions.
Energy transitions are global and local (national). Broadly there have been three global energy transitions:
Let’s look at the chart below to better understand these transitions:
Few insights that we derive from the earlier global transitions are:
All energy transitions have taken substantial time. For E.g. Crude oil was first discovered by Col Drake in 1840s, however, it took almost a century for crude oil to become the largest energy source for the world. Nuclear Energy became a reality only after about 70-80 years of research.
It is difficult for anyone to predict the outcomes of energy transitions. Nuclear power was pegged in the 1970s to become the universal source for energy. However, it still has limited global market share.
Predicting the outcomes for Energy Transitions is extremely difficult, mainly due to complexity, a large number of factors and long time periods involved.
Global transition and national transitions could be different. For E.g. India is heavily reliant on coal for electricity production, although globally the picture is different.
Past energy transition shows that new energy sources have a substantial impact on demand. Historically, new energy sources (i.e. revolutions on the supply side of the market) have unlocked new sources of energy demand, meaning that when new energy sources enter the global mix, energy demand growth has accelerated.
Global effects of unbridled energy usage in the form of climate change and global warming are being observed now.
The current energy transition describes the fact that the world over the next several decades is aiming to achieve a dramatic transition away from reliance on fossil fuels. This transition is being sought considering the effects of climate change due to the global warming on account of higher Green House Gas (GHG) emission (mainly due to burning of fossil fuels for power and transportation requirement.
Over the past 200 years, especially during the Industrial Revolution, fossil fuels have been essential for the growth of prosperity achieved in the world. The current energy transition is required to limit global warming to below two degrees centigrade above preindustrial levels (explained later), while at the same time providing all the necessary energy to deliver prosperity for everyone.
So how does the world expect to move away from fossil fuels? Well, the easy answer everyone will give today is that we shall largely move towards electricity which is produced by Solar / Wind & extensively use Electric Vehicles for transportation. However, the current Energy Transition is not towards renewables, but rather towards a low carbon future.
Before gazing into the crystal ball for the current energy transition, let’s look at how much energy the world consumes today and what are the challenges we face today.
Globally Approx. 14.31 Billion Tonnes of oil equivalent primary energy is supplied today, mainly from Oil and Coal. It may be noted that Wind/Solar supply only 293 MMTOE out of the Global Primary Energy Supply of 14314 MMTOE, which is a mere 2%. For Solar/Wind to come to have a significant market share, a dramatic change is needed.
Let’s look at Final Consumption now.
Globally oil products (Petrol/Diesel/Lubricants/Others) still dominate final energy consumption, with Electricity being the second.
The difference between Primary demand (14314) & Final Consumption (9955) is due to energy consumed in transformation /transportation and own use in energy-producing industries (e.g. Refineries, Power Plants etc.).
So where is this consumption being used? Let’s look at this table below:
So the major consumption of energy is Industry (mainly manufacturing) followed by Transport (mainly oil products) and Residential (mainly electricity & gas for heating).
Let’s look at some of the recent trends and try to understand what is happening:
The world energy demand has almost increased by 50% in the past 15 years! Rate of change for natural gas, coal, and renewables is higher than that of other sources.
Global Markets shares of fuel types are plotted below.
Crude Oil from a high of almost 50% has dropped to ~35%. Coal has also lost ~10% share, whereas Natural Gas has increased ~10% in share. Share of Nuclear has stabilised at ~5%. On the other hand, the trend for Renewables shows an increasing trend.
If we look at the regional distribution of fuel requirement (in the chart below), it is clear that every region has a different composition of the fuel mix. Asia Pacific countries are more dependent on coal even today, whereas North America / Europe is more dependent on crude oil! These regional difference play a crucial role when global agreements and plans have to be made & when international energy treaties are to be signed.
Keeping in mind the differences between Global and let’s look at India’s energy demand and consumption:
Indian primary energy demand has almost tripled in the past 17 years, with almost every fuel type increasing significantly. Oil and Coal have increased almost 4 times since 1990, with Coal having the largest share of supply for India (whereas for the global supplies, oil has the largest share). Other sources are not very significant for India.
Indian consumption is mainly in the form of Oil Products (4X since 1990), Biomass (1.2X since 1990), Coal (3X since 1990) & Electricity (5X since 1990).
For India, Industry is the largest consumption of energy (as it is for the world) followed by Residential usage and then by Transport (whereas for the Global sector consumption Transport is second largest).
Drivers for the Current Energy Transition The current energy transition is expected to be driven by three things:
The societal mandate to reduce CO2 / GHG emissions to reduce the effects of climate change due to global warming.
Technology changes in the world including a significant reduction in the cost of Solar Modules, Electric Batteries and higher digital penetration.
Economics & democratisation of energy – Power generated from large-sized utility-scale renewable power project is today cost-competitive with conventional thermal power plants. There is a need for providing energy access to millions of people through cheaper & economical means. Oil supplies are no longer constrained by production from a very large oil field. Thanks to a new technology called Hydraulic Fracking, oil is now produced from distributed oil reservoirs. Further with the increase in the distributed generation of solar / wind power, a new class of energy “Prosumers” (i.e. both a Producer and a Consumer) is rising.
The earth’s climate is changing, after more than 10,000 years (time of the human civilisation) of relative stability. Scientists have been studying the changes in climate for a long time, the most important group studying this has been the IPCC (Intergovernmental Panel for Climate Change) constituted in 1988 by the United Nations. One of the major aspects of climate change is Global Warming (long term rise in the average temperature of Earth’s climate system). It has been demonstrated by the instrumental temperature record that global warming of ~1 0C since the pre-industrial period (the bulk of the increase of 0.9 0C has occurred post-1970). IPCC, in its landmark Fifth Assessment Report (2014), concluded: “It is extremely likely that human influence has been the dominant cause of the observed warming since the mid-20th century."
Many of the physical effects of climate change/global warming are already visible including extreme weather effects, glacial retreat, sea-level rise, changes in seasonal events etc. IPCC states “Continued emissions of greenhouse gases will cause further warming and changes in all components of the climate system. Limiting climate change will require substantial and sustained reductions of greenhouse gas emissions”.
On the environmental front, while agreements and negotiations around emissions reductions have been taking place for the last three decades, the landmark Paris Climate Agreement, signed in 2015 and involving 197 nations representing more than 88% of global greenhouse gas (GHG) emissions, was a game-changer. Each nation ratifying the agreement has submitted “Nationally Determined Contributions” (NDCs) detailing its commitments, aligning the capabilities and circumstances of each individual country with the goals of the global Paris Climate Agreement framework.
The Paris Agreement's long-term temperature goal is to keep the increase in global average temperature to well below 2 °C above pre-industrial levels; and to pursue efforts to limit the increase to 1.5 °C, recognizing that this would substantially reduce the risks and impacts of climate change.
The Paris Climate Agreement helps in formalising some of the policy directions of the top GHG emitters, which is not only important from an environmental perspective, but also from a global energy mix perspective, as the top emitters (US, China, India & Europe) also happen to be the largest consumers of energy in the world.
The world’s primary energy intensity (units of energy per unit of GDP) has been declining on average by 1.4% per year for the last two decades. One of the main reasons for this is the accelerating electrification of the energy system, as electricity use is more efficient than burning fossil fuels directly, owing to less heat loss.
Many governments have now formally stated policies on reducing emissions levels (especially post-Paris Climate Agreement) and are targeting more renewables in the energy mix up to a 2030 horizon.
Going forward, few tipping points in the energy scene which are expected to come in a few years are:
Cost of Renewables can come down further where new-build solar or wind capacity is cost-competitive with the fuel cost of existing conventional plants (it is already cost-competitive in few regions). As a result, further ramp-up of renewables would happen. Cost of Solar PV modules have dropped almost 90% from 2010 levels.
Similarly, the cost of Lithium ion batteries is expected to continue declining significantly in the next 5-10 years. EVs & Battery Storage could then reach economic tipping points. Lithium ion battery costs have already reduced ~80% from what they were 10 years ago and price decrease continues downwards similarly to Moore’s law (where every two years capacity doubles and cost decreases by half).
Continued economic growth & growing global population increase energy consumption significantly, with a concurrent explosion in electricity consumption.
The world today faces what BP’s Chief Economist says “Dual Energy Challenge”. The society needs more energy but at the same time lower CO2 emissions.
According to a 2018 special report of the Intergovernmental Panel on Climate Change, global anthropogenic emissions (i.e. emissions due to humans) will need to drop to net-zero by 2050 to limit the global temperature increase to less than 1.5°C above the pre‑industrial level. The energy system contributes two‑thirds of global emissions and lies at the heart of this challenge.
Further as per the World Energy Council’s “Energy Trilemma”, World Leaders will have to evolve the energy transition while balancing 3 dimensions:
Energy security – management of primary energy supply from domestic and external sources, reliability of energy infrastructure, ability to meet current and future demand
Energy equity – accessibility and affordability of energy supply across the population
Environmental sustainability – reduction in energy and CO2 intensity, the transition to renewable and low-carbon energy sources
Maintaining this balance in the context of a rapid transition to decentralised, decarbonised, and digital systems is challenging with the risk of passive trade-offs between equally critical priorities.
If we look at the Human Development Index & Energy Consumption per head, it is observed that around 80-100 GJ (Giga Joules) of energy per head is needed for a reasonable standard of living. One GJ is approx. equal to 278 kWh (unit) of electricity (One ton of oil equivalent equals approx. 42 GJs). Almost 80% of the global population today is below this critical mark and getting the majority of mankind to a reasonable standard of living is one of the key challenges society & policymakers shall face in the coming years. India’s consumption is ~25 GJ per head per year vis-à-vis 200 for US & 130 for the European Union.
Which implies that for India the challenge would be to provide more and affordable energy while for Europe, it would be more efficient (i.e. come down from 130 to 100) and for the USA it will have to be cut down on energy consumption (from 200 GJ per head). Hence the driver/challenge for each country is different.
This is further complicated by the fact that countries/regions have significantly different energy mixes, implying that a global strategy would have to be localised. Different local strategies would be required to dovetail into the final global objective.
For many countries, this transition is also an industrial or economic transition. Current activities and ways of energy production, goods productions/transportation, and people transportation will have to change to newer forms/ways. For E.g. China is actively now looking at moving away from a manufacturing-based economy to a service-based economy. Hence their pathway towards decarbonisation shall be significantly different than for a country which is increasing manufacturing.
One of the key challenges would be to remove or reduce Carbon from electricity production. Solar and Wind are intermittent energy sources (both depend on the time of the day and have seasonal variations) and to use them effectively affordable utility-scale energy storage would be a necessity. Combining Solar/Wind with electric battery storage over the next 15-20 years could possibly outdo fossil fuel-based electricity production. In addition, even if we consider EVs to revamp transport and electricity to be a key for residential heating/lighting, there would still be many economic functions which cannot yet operate on electricity such as producing steel/cement, making aeroplanes fly, Heavy goods transport etc. For these, there are no solutions currently in sight yet. Plus these systems have a long life to the tune 40-50 years. So even if in future we get to green-field solutions which can electrify above functions, we still would have large brownfield capacities idling! Such a change of processes or plants shall require additional Capex cost and management of resultant redundancy!
The way energy flows between nations, infrastructure is set up, conceptualised & stored today is built mainly for fossil fuels. E.g. Cross country electricity flow is minimal, while Crude Oil /Coal/NG flow is well established. So for the energy transition, revamping the backbone of the energy infrastructure etc. would be a significant challenge.
Further aligning, social/political & behavioural aspects for new energy systems would be technically challenging. As we write this report the US is engaged in a trade war with China & is also exiting from the Paris Agreement and the global supply chains / demand has been impacted by a virus attack in China. Impacts and challenges arising from such actions or situations could at best delay or at worst derail the transition.
The pace of global energy transition from fossil fuels to sustainable energy has profound implications for all stakeholder. For humanity, the difference between a gradual and rapid transition will determine the climate future of humanity. A gradual transition will mean that the goals of the Paris Agreement will be badly missed, while a rapid transition will give humanity a chance to meet the goals of the Paris Agreement and keep the temperature well below 2 degrees Celsius.
World Economic Forum (WEF) has built an Energy Transition Index (ETI) which benchmarks countries on the performance of their energy system and their readiness for the energy transition. As per WEFs March 2019 Report – Fostering Effective Energy Transition, ETI 2019 rankings have not substantially changed and it observed that globally the energy transition has slowed. The report quotes that the year on year increase of global average score on ETI was the slowest in the last five years.
Recent evidence highlights the complexity of the transitioning. For example, even with the increased level of attention, the Paris Agreement brought to this issue, global CO2 emissions increased by more than 1.7% in 2018, the highest in recent times while they were flat in 2019. Since the production and consumption of Oil and Gas contributes to ~40% of the global GHG emissions, oil and gas companies face mounting pressure for change.
With the changing energy landscape & fuel mix, oil companies would need to understand, adapt & evolve if they wish to remain successful. Along with the challenges of the energy transition, come multiple opportunities.
Considering the difficulty in crystal glazing, many companies / agencies have developed scenarios to understand what the future could look like. International Energy Agency (IEA) has built 3 such scenarios:
Stated Policies Scenario – Takes into account all current policies / regulation & announced future ambitions/ targets / policies.
Current Policies – Takes into account all current policies/regulation.
Sustainable Development Scenario – It is an outcome-oriented scenario, where three of UN’s sustainable development goals (universal energy access, reducing the impact of air pollution, tackling climate change) are achieved.
In the first two scenario’s Oil and Natural Gas demand is expected to expand along with overall increase in energy demand, whereas in the Sustainable scenario energy demand as well as oil and gas demand shrink substantially.
Overall Indian energy demand as well as the crude oil and natural gas demand increase in all the three scenarios.
It is expected that power sector transformation from renewables would impact the coal demand initially, followed by gas demand.
Today the internal combustion engine faces an expiry date as the transportation sector moves decidedly towards electrification. Plastics and heavy transportation will not sustain high oil demand on their own. The expected increase in renewables is expected to take a few decades poses an existential threat for oil companies. However considering that the transition shall take a long time, Oil companies can prepare themselves for leading the transition instead of reacting or adapting to the transition.
Till date, the climate-related setbacks have mainly been financial in nature for large oil majors as Institutional investors, hedge fund managers, sovereign wealth funds concerned about the longer-term positions of fuel fuels in the overall energy mix, have pulled back funding to the oil and gas sector.
Considering that the transition shall take a few decades, oil companies shall have to align their portfolios basis the changing energy mix. Statoil’s press release in May 2018 included “We changed our name to Equinor because we’re going from being a pure oil and gas company to become a broad energy major.” This was probably the strongest statement of intent on being leaders for a change. BP very recently has set a new ambition to become a net-zero company by 2050 or sooner, implicating that they intend to take the Energy Transition head on! Recently, Shell has linked executive remuneration to reductions in the carbon footprint and “really hard-wire this into the thinking of the company.” Hence, for safeguarding the social license to operate, oil companies need to engage and develop narratives on their roles in the new society especially with respect to the Energy Transition.
The initial steps of oil companies are to focus on reducing carbon footprint resulting from their own operations and their supply chains (scope 1 and scope emissions resp.). Indirect emissions (scope 3) that are generated by consumption of fuels that companies produce rests in the hands of Govt. & consumers rather than the companies own hand. View above, few industry leaders have expressed that Oil Companies today face risk on “Societal license to operate” considering that their products are increasing CO2 emissions.
Depending on the aggressiveness on carbon reduction policies, over the longer-term oil and gas companies would need to get their portfolio diversification strategies and timing right to ensure that current supply is not disrupted, continuing to pay high dividends and implementing a transition plan that ensures survival.
Most of the oil companies are diversifying their portfolios to become broad-based energy companies. Oil companies have started small in expanding into New Energy Portfolio. On an average large oil companies are investing approx. 2.5% of their total capex on renewables over the next five years, which represents a small fraction in the portfolio. Potential areas for oil and gas companies to enter include power value chain (incl production/retail sales of large scale renewable power), advanced EV / hydrogen mobility, new fuels (biofuels), CCUS (carbon capture utilisation and storage), circular economy (recycling plastics, waste to energy etc.). The technical, regulatory and market risks in these areas are different and are still evolving.
Considering that power sector shall be leading the energy transition, one of the key challenges for oil companies when they enter the completely different power/electricity business is adapting to a smaller scale and managing the heavy regulation inherent in the power business. Conventional oilfields cost several billions of dollars, but a solar or wind power plant costs a fraction of that.
For BPCL and other Indian oil companies, considering current low energy usage per capita and expected growth in GDP / economic prosperity in India, oil products demand is expected to remain high for a long time. Further diversifying into Petrochemicals, shall ensure that any reduction on fuel demand to a great extent will be offset by petrochemicals requirements. Further, as the transition unveils, tools such as scenario planning & stress testing can position unique opportunities.
Ultimately, we are all part of the energy transition and the decisions all of us make today & in the near future will shape the energy landscape for the future.
Raviraj Jadhav(Team Leader Corporate Strategy)
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