SERIES – The Net-Zero Transition in the Wake of the War in Ukraine: A Detour, a Derailment, or a Different Path? PART 4

In this series, we attempt to offer a more granular view of what might be in store. We examine the possible effects of the war and its ramifications on the key requirements for a more orderly net-zero transition. We explore the war’s potential effect on key sectors and how shifts in energy and finance markets could play out in the aggregate, both globally and within major regional blocs. Finally, we suggest steps that stakeholders could take as they navigate this turbulent period while continuing to drive toward as orderly a transition as possible. 

To get a clearer idea visit PART 3 of the series, SERIES – The Net-Zero Transition in the Wake of the War in Ukraine: A Detour, a Derailment, or a Different Path? PART 3 – Earth5R.

In the near term, the impact on effective economic and societal adjustments would vary across geographies.

The economic and social adjustments needed to reach net-zero in a more orderly manner depend on the management of demand shifts and unit costs, compensating mechanisms to address the socioeconomic impacts of transition, and effective capital allocation and financing structures. In the near term, management of demand shifts and unit costs could be positively affected, as increased energy costs move forward to the break-even point for decarbonization solutions for many hard-to-abate industries, and commodity shortages boost movement toward increased recycling. However, the war in Ukraine has introduced new domestic priorities in many countries—including increasing defense spending, blunting the regressive impacts of rising energy prices—and providing humanitarian aid. This could negatively affect compensating mechanisms, particularly with respect to the flow of capital from the Global North to the Global South. Even before the war, the flow of capital to developing nations was already almost 20 percent below the developed nations’ pledge of $100 billion in annual aid by 2020.

Overall, we believe that the dominant near-term impact on economic and social adjustments would be a shift in capital allocation and financing structures toward increased fossil-fuel production in response to rising prices.

In Europe, rising energy prices would drive an increase in short-term capital allocation to fossil-fuel production and consumption, particularly from existing or recently decommissioned assets. This is not because renewable alternatives are not economical or available or cannot be deployed. Rather, these alternatives would take time to deploy, and the rise in energy prices poses an immediate economic and political crisis that must be addressed. Furthermore, a move to diversify sources of fossil-fuel imports is likely, in the interest of both price and energy security, although diversifying away from Russian gas would require time to overcome logistical hurdles, contract negotiation, pipeline-capacity restrictions, and import-facility development, as demonstrated by Europe’s purchase of more than $46 billion in Russian gas since the invasion of Ukraine. Finally, where the lowering price is not possible via increased domestic production or source diversification, a shift back toward cheaper but more emissive fuels, such as coal, is likely, and already being observed in, for example, Germany. As for parallel investments in accelerating the deployment of net-zero technologies, there may be contention for resources with other immediate needs such as defense, mitigation of the most regressive impacts of energy price increases, and humanitarian action.

In the United States, the near-term trend is also likely toward increasing fossil-fuel production to address domestic price rises and to support the diversification of European supply. The medium- to long-term trend is less certain. Given abundant domestic fossil-fuel reserves, the United States is less susceptible to energy price increases, but equally exposed to shortages of key net-zero materials. The economics of transition may not improve as much in the United States as they could in Europe, nor would the concerns about energy security be as severe. One potential impact on the medium-term energy landscape in the United States could be an acceleration of the displacement of more expensive and more carbon-intensive oil on the global market with Permian oil from the US Southwest, which is a key step for a successful net-zero transition, given that some level of oil demand will remain through to the late stages of the transition. We would also note that the United States also faces a unique opportunity to reduce its fossil-fuel consumption through the implementation of a broad energy-efficiency policy, discussed in more detail below, which could lower costs for consumers, improve energy security, and make progress toward its climate goals.

Finally, in Asia, there is a risk of a shift back to coal in the near term. If sanctions reduce access to the pipelines Russia primarily uses to transport oil and gas to Europe, it will take time for Russia to build alternative pipelines to tap the Asian market. With the market for natural gas likely to tighten substantially, the resulting price rise could push less economically robust consumers in Asia out of the market and back toward coal, which is abundant, cheap, and more lightly regulated.

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Source: McKinsey

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