Is the IEA Net Zero Emission ("NZE") Roadmap realistic - or do we need to weigh "Impact/$" higher?

The International Energy Agency (IEA) recently published its "Net Zero by 2050 - A roadmap for the global energy sector" report. A very interesting, well thought through and ambitious report with several specific action points which need to be addressed in the coming years, if we are to reach net zero emission[1] by 2050 - or anywhere near net zero emission by 2050.

Let it be clear, we do indeed need to be ambitious, if we are to get anywhere near the 2050 net zero emission target. The following is thus not intending to argue against the need for an ambitious plan.

However, the risk is that if a plan becomes too ambitious, it may become counterproductive, i.e. if the goal is to reduce the emission as much as possible, as fast as possible - and we realistically do not have the means to carry out the full plan, then it may very well be recommendable to allocate more resources where the "impact/$" is the highest.

I will in the following focus on the electricity sector, as the sector with the highest Co2 emission.

What will it take for the electricity sector to reach its 2050 NZE target?

For the electricity sector to reach its NZE targets and maintain a stable supply of electricity which can cope with the increasing peak capacity and the increasing demand as more and more of the energy consumption switches to electricity, investments will have to be made in both (i) the conversion of the generation capacity fossil fuel to renewable, (ii) system reinforcement (including technology upgrade) and (iii) technology developments in order to improve both storage solutions, PtX solutions and CCUS (carbon capture, utilization and storage).

(i) Generation capacity conversion

Massive investments are needed for the replacement of the existing old fossil fueled powerplants with new renewable capacity. Whereas wind- and solar plants will make up for a great part of this new capacity, it is clear that reserve capacity will remain imperative for a stable supply. It thus seems inevitable that some new nuclear power capacity will be needed (although likely to be smaller, modular and based on a new and safer design), just as the gas fired power plants are likely to remain an important reserve capacity, subject to a refit which will enable them to fire with a gas mix including biogas (methane) and hydrogen, as these green gasses become available in larger volumes. The gas fired power plants and the gas exploitation should further be equipped with CCUS solutions, as the CCUS technology further develops. 

(ii) System upgrades

As more and more energy consumption is converted into electricity consumption and as the generation capacity is converted from traditional fossil fuel power plants with the ability to produce reserve capacity when needed to renewable energy capacity which injects peak capacity into the system, the current grid infrastructure will soon reach its limits.

In fact, in many countries we already see capacity constraints today in the form of curtailment of peak capacity or black outs. Black-outs and curtailments obviously carry a cost. Black-outs incurs a cost on the society due to lost production and efficiency - and curtailments incurs a cost in the form of lost production for the owners of the capacity (or the society, if the owners of the generation capacity are compensated).

The massive peak capacity not only challenges the grid, it also means that we need to ensure alternative reserve capacity for the hours when the sun is not shining and the wind is not blowing, as mentioned above. However, we will also need massive storage capacity and a further technological development, as the cost of the storage capacity currently available would trigger not only massive investments, but also a significant price hike on electricity.

Further, to keep attracting private investors, it is critical that they can be offered a reasonable risk-weighted return on their capital. However, as the peak capacity volumes increase the electricity spot prices during the hours when the wind is blowing, or the sun is shining will drop significantly. Additional storage capacity may even out the fluctuations somewhat and to some extent delay the issue. However, we already see negative prices in countries like Denmark and Germany today …and the trend will spread, and the periods are likely to extend. Negative electricity prices may at first look as a win for society. However, if investors do not get their expected return on their investments, they are likely not to make the investments needed. We thus need to consider how we best ensure that it remains attractive to invest in the green transition.

(iii) Technology developments

To realize the goals described in no. (i) and (ii) above, we will need for further technology advancements. As more and more corporate and private consumers convert more of their energy consumption to electricity, we will not only need grid reinforcements, better storage solutions, more efficient PtX (hydrogen) technology and improved CCUS technology, but also advanced smart grid technology to allocate as much of the consumption to the periods with high peak loads so that the off-take profile gets closer to the future dispatch profile of the renewable generation capacity.

So what is the cost of following the roadmap?

The IEA NZE roadmap recommendation will to no surprise require a significant rise in the global investments.

According to the IEA the total global investments in electricity generation, energy infrastructure and low carbon technologies has been in average USD 1,300 bn annually over the past 5 years. The IEA NZE roadmap will require that the investments are increased by USD 2,900 bn annually, which will bring the total annual investment up to approximately USD 4,200 bn annually (not counting demobilization costs related to the shut down and removal of the old fossil fueled power plants and the increased maintenance costs of renewable capacity).

To put these numbers into perspective, the Stockholm International Peace Research Institute has calculated the total global military spending for 2020 to USD 1,981 bn. The total global spending on military in 2020 was thus less than 50% of the spending required annually to reach the IEA NZE target by 2050. If easier for the perspective, the required annual spending to reach the IEA NZE target by 2050 would be > x5 the US military spending in 2020.

There is no doubt that the climate change and the green transition is very much on the political agenda and that the green agenda has a lot of political goodwill attached to it - but these numbers are simply too high to be realistic …and for many countries it will simply be unrealistic for them to carry such burden. No political leader in an emerging market can find - or defend an amount anywhere near the spending needed for it to meet its individual goals to reach NZE by 2050.

We may thus all need consider whether we prioritize our own agenda - or whether we shift some of the focus to investments with the highest "impact/$" and thus prioritize the global climate goals.

This issue is by no means ignored by the IEA. In a short article "Mobilizing clean energy investment in the developing world must be a top global priority" dated 21 June 2021, the IEA conclude that the annual investments in developing and emerging economies alone need to rise from less than USD 150 billion annually to more than USD 1,000 billion. A goal that they hope to reach through "stronger policies, more robust financial markets, and coordinated international efforts" which should in turn draw more private investors to the investments in developing and emerging markets.

Is there a solution to the issue of attracting more capital to the developing and emerging markets where the "impact/$" is the highest?

There is no doubt that if developing and emerging economies can show stable political regimes, strong economies (sovereign as well as a strong local corporate environment) and a clear and comprehensive legislative framework providing protection to the investors, then private investors will to a much larger extend look in their direction when allocating their investments.

Many of these countries already have come far in the development and implementation of robust legal frameworks and it is also a fact that as many of these economies have an urgent need for the replacement of their current old - and often obsolete generation capacity, they welcome private investments. Investments that not only replace old obsolete generation capacity, but also ensure much needed additional capacity and often also provide a lower (although often still high) cost of electricity. Investments in developing and emerging economies thus both check all the "fundamentals" boxes in the assessment of an investment - and often offer better risk-weighted returns on the investment.

So why are investors then still hesitant to invest? Investors (arguably for good reasons) often prefer to invest in their own geographic region where they have a better feel for the development of the market and the political environment. There are many perceptions related to Investments in developing and emerging economies, so even if the risk-weighted return may be very attractive, it may be hard to assess for decision makers who are unfamiliar with such markets. 

Further, as the grid infrastructure in these countries is often old, under-dimensioned and at times in need of maintenance, these economies will quickly reach a constraint for how much peak capacity there can be loaded into the system without causing instability and thus curtailment. Investors may thus not only have to overcome a thorough analysis of a new (complex) market, overcome various perceived risks and mitigate actual risks - they also must accept that the window of opportunity for each of these markets may be fairly short. Investments in many of these markets is thus often not a good fit for a direct investment by a western financial institution.

So how do we overcome these hurdles - and make it easier for more private investors to make investments into developing and emerging markets, where the "impact/$" is the highest - and we at the same time can promote developing economies by ensuring both sufficient and more stable power?

If the international society is truly committed to a coordinated effort, a way forward could be for the international society to provide funds to the World Bank or a similar institution for such institution to offer a guarantee structure to investors to off-load some of the perceived and real risk related to investments in developing and emerging markets.

As such guarantee will undoubtedly ensure a contraction of the current required yield of the investors - and thus ensure a significant drop in the cost of energy - while also ensuring further investments, the cost of such guarantee structure could potentially be covered by sweeping part of the cost of energy savings as a guarantee premium to make the guarantee structure (ultimately) cost neutral.

It may further be recommendable, if such guarantee structure required a certain participation by the host country in order to ensure a continued political commitment of the host country, just as the guarantee should not offer a 100% cover to the investors, as it could trigger an irrational behavior (moral hazard) by the investors.

As the new capacity is aimed to replace fossil fuel fired plants - and such fossil fuels are generally paid for in USD, such guarantee structure will, if made in USD, also not create further Fx liquidity issues in economies which may often fall short of foreign currency.

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Kromann Reumert

Kromann Reumert is a leading Danish law firm with offices in Copenhagen, Aarhus and London.

Kromann Reumert's energy team advises on both the equity and debt side of renewable energy projects and related infrastructure. Over the years, Kromann Reumert has been involved in >50 GW of renewable energy capacity across >70 jurisdictions.

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[1] “Net-zero” refers to reaching net-zero carbon emissions by a selected date, but differs from zero carbon, which requires no carbon to be emitted as the key criteria. Net-zero refers to balancing the amount of emitted greenhouse gases with the equivalent emissions that are either offset or sequestered.