Two Easy Wins, Three Challenges And A US$65 Trillion Bill

Prakash Sharma, Vice President, Multi-Commodity Research at Wood Mackenzie

This year’s climate event comes at a time of uncertainty like no other. The pillars of the energy trilemma – affordability, security and sustainability – look precarious. Governments are struggling to prioritise and keep them in balance.

In the run up to COP27, we look at the five themes that could shape the future of energy and natural resources.

1. Fewer countries tightened NDC goals in 2022 but no U-turn expected

Last year, as part of the Glasgow Climate Pact, 193 countries agreed to strengthen their pledges by the end of 2022. However, only 26 countries have actually strengthened their ambitions to date. This is not surprising given high commodity prices, geopolitical challenges posed by Russia’s invasion of Ukraine and fears of recession.

Announced pledges point to a 9% decline in emissions by 2030 from 2010 levels, compared to the 45% reduction needed to stay on course for a 1.5 °C world. Targets for 2030 will be harder to achieve but progress can still be made at Sharm El-Sheikh. We don’t expect countries to dilute or cancel their pledges during COP27.

The UN body responsible for the Paris Agreement stated last month that the world is currently on track for a global temperature rise of between 2.4 °C and 2.6 °C, and this aligns with our base case view. We believe there are credible pathways to meet the goals of the Paris Agreement. However, these would require a significant increase in capital allocation to develop and adopt new technologies.

2. Voluntary carbon markets advanced faster than compliance regimes in 2022

Article 6 resolution was a key achievement at COP26. It increased transparency in carbon markets over the past year and helped triple the size of the market for offsets. On the other hand, compliance markets came under pressure due to high commodity prices. Average price growth in regulated markets (such as the EU and UK Emissions Trading Schemes) has been subdued since the Russia-Ukraine war began in February 2022.

The voluntary market has boosted in the last year, owing to its increased reliability and liquidity. Countries responsible for 14% of global annual emissions have bilateral agreements in place to trade carbon offsets, and another 12% are planning to do so. Further support at COP27 on tighter accounting, independent verification, and additionality rules would improve market transparency and benefit both more traditional nature-based solutions and marginal technologies such as CO₂ capture, liquefaction, shipping, and storage/utilisation projects.

3. Methane savings could narrow the 2030 gap in carbon emissions reduction

Methane is way more potent than CO₂ but has a shorter residence time in the atmosphere. So any action that quickly reduces its concentration can be of enormous benefit, especially since 2030 carbon emissions goals look challenging to reach.

The Global Methane Pledge has been endorsed by 125 countries, committing them to reduce methane emissions by 30% by 2030 from 2020 levels. The pledge collectively covers nearly 75% of the global economy and more than half of methane emissions.

A recommitment to the pledge could be an easy win for COP27, neatly steering countries away from more controversial topics. The US took a major step in August by legislating the Inflation Reduction Act (IRA), which introduces a methane fee, rising from US$900/t in 2024 to US$1,500/t in 2026. Methane capture and abatement technologies are well established, and other countries might also announce supportive policies during COP27. Meanwhile, top emitters like China, Russia and India could come under pressure at COP27 to commit to the global pledge.

4. Coal is on the rise despite pledges to phase down – but investment in future-facing technologies is gaining momentum

Given the acute energy supply deficits faced today, several countries chose to restart mothballed power plants, including coal. This will translate into a longer time needed to fulfil their pledges to phase down unabated coal-fired power.

But momentum in CCUS and hydrogen will partly make up for the temporary increase in unabated coal. These technologies are vital for meeting long-term climate goals. In our Accelerated Energy Transition 1.5 °C scenario, CCUS and hydrogen provide about 35% of the required emissions reduction by 2050. The larger the 2030 carbon emissions gap becomes, the more crucial the role these technologies will play to keep the world within 1.5 °C warming by 2100.

Even during the peak of Covid-19 and the Russia-Ukraine crises, announcements of low-carbon hydrogen and CCUS projects continued. We estimate the project pipeline has grown around 25% since COP26. About 10 projects have already taken FID and another 40 are likely to do so by 2023.

Corporates in hard-to-abate sectors have revised their net zero targets since COP26 and are actively piloting new technologies for production of low-carbon steel, cement, chemicals, ammonia, aluminium and flexible power generation. We estimate more than 30 offtake agreements have been signed in 2022 to step up adoption.

On the public investment side, three policy statements are worth a mention here. The Inflation Reduction Act, REPowerEU and Japan’s Green Transformation (GX) have outlined incentives and targets that could rapidly increase capital flows to the technologies of the future. Together, these policies could help to build the critical mass essential to drive costs down and boost the competitiveness of these technologies compared to incumbent fuels.

5. Adaptation finance is a contentious issue

Floods, storms and heatwaves have increased both in frequency and intensity in recent years. It hurt more in 2022 because of the ongoing energy supply crisis, high prices and recessionary fears. Developing countries are most exposed to these challenges and will make every effort to flag the inadequacy of climate finance as a key obstacle to progress. In fact, COP27 has been touted as ‘the African COP’ and these countries are expected to intensify their calls for more funding.

Developed economies have once again fallen short of the annual US$100 billion support – in 2020, they contributed US$83 billion. The developing world argues that the amount needs to be increased because it is insufficient to meet climate goals. Some experts point to the cost of adaptation alone being over US$400 billion a year.

We believe there is enough capital worldwide to close the finance gap but the policy framework and incentives are too weak to drive efficient allocation and resolve the energy trilemma. We estimate US$65 trillion would be needed by 2050 in cumulative capex to build new supply across energy, power and renewables, metals and mining, EV infrastructure and low-carbon technologies.