Geopolitics and economy are stuck. Energy transformation

Gabriel Brasil, London

Despite continued growth in clean energy investment, phasing out the fossil fuels needed to achieve net zero emissions goals remains elusive. Unfavorable macroeconomic conditions, high interest rates and geopolitical competition will hamper the development of complex renewable energy projects and disrupt technology exchange, policy coordination and access to key resources.

Energy transformation or addition to renewable energy sources?

Clean energy production continues to grow at a rapid pace. According to the International Energy Agency (IEA), renewable capacity additions increased by approximately 50% in 2023, marking the twenty-second year in a row that such a rate has reached a new record. However, the reality is that there will be no transition if fossil fuel consumption and investment continues to grow, as it continues to do despite the increasing urgency of the climate crisis. Clean energy investments have outperformed fossil fuel investments over the past three years, according to IEA data, but they also continued to grow.

Although the IEA expects fossil fuel use to peak by 2030, some industry players have considered that assessment too optimistic as large-scale new oil and gas projects continue to be implemented around the world.

The persistence of fossil fuel investment is a global phenomenon, reflecting in particular the impact of the conflicts in Ukraine and Gaza and related concerns about energy security and affordability in both developed and emerging economies. It also reflects the continued strong economic fundamentals of oil and gas projects in traditional and emerging producers, including the Middle East, the US, Canada, Brazil and Guyana. All these producers retain significant short-term financial incentives not to withdraw growing production as they benefit from increased exports and improved energy security prospects.

As a result, relative prices to fossil fuels will pose a challenge for many renewable energy projects, as fossil fuels remain a favorable option for countries and companies looking to secure energy supplies without increasing costs in the short term.

Renewable expansion

This does not mean that the expansion of renewable energy capacity will slow down, as overall energy demand (especially electricity) continues to grow. On the contrary, positive technology developments, policy support (even if ambiguous) and economies of scale will continue to drive clean energy investment growth in the coming years. Solar and wind are likely to continue to be key growth leaders, with green hydrogen and nuclear having significant potential as governments and investors work to de-risk such projects.

In recent years, renewable energy opportunities have increased in many regions, especially in Europe, the United States and middle powers such as India and Brazil. However, China showed the most significant growth: for example, in 2023 China ordered as much solar energy as the rest of the world in 2022, while the share of wind energy increased by 66%. Given its significant domestic policy coordination capabilities and dominance in critical supplies (including minerals and equipment), China is likely to remain the world’s major clean energy power in the coming years. This, in turn, will further fuel growing strategic competition against the United States and its allies.

However, the pace of overall renewable energy growth is likely to be uneven as it depends on unstable geopolitical and macroeconomic conditions. These circumstances will provide a relative disincentive to sustainable development as governments consider the so-called “energy trilemma” of energy security, affordability and sustainability, especially in the face of persistent geopolitical animosities. Ultimately, this will prevent governments’ more ambitious green rhetoric from being translated into concrete pro-renewable policies. Meanwhile, elevated interest rates due to persistent inflationary pressures will make the economics of more complex projects more difficult, at least over the next one to two years. While interest rates have likely peaked in advanced economies, they are likely to remain higher for longer as supply chain disruptions could slow disinflation.

Cooperation is poor

Geopolitical competition will continue to be a key issue in the energy transition. This will create risks both for companies directly involved in energy projects and for those that do not, but still need to decarbonize their supply chains reliably and quickly.

As the scientific community has repeatedly emphasized, global cooperation will be the key to mitigating climate change. From sharing technology to policy coordination and establishing seamless trade flows for critical resources, the latest COP agreements envisage multilateralism as the basis for an orderly green transition. However, precisely because of its strategic nature, the energy transition has become a battleground for competition, as the major powers strive to ensure self-sufficiency and block the development of comparative advantages by their opponents.

This has mainly manifested itself in trade controls focused on critical minerals and new technologies, strengthened regulations (for example on ESG issues, which are relevant to both mining and energy projects) and domestic subsidies, particularly for electric vehicles (EVs). Recent examples in the energy transition area include China’s ban on rare earth processing technologies, Inflation Reduction Act (IRA) subsidies for domestically produced electric vehicles, and an EU investigation into Chinese subsidies for solar panels.

There are a few exceptions, but even these highlight the growing competitive dynamics as partnerships formed along a clear “US allies vs. China” axis. For example, on April 10, Japan and the United States announced a partnership aimed at accelerating the development of engineering, manufacturing and other areas related to floating wind farms. On April 5, the EU, the United States and other members of the 14-member Minerals Security Partnership (MSP), along with Kazakhstan, Namibia, Ukraine and Uzbekistan, announced the creation of the so-called SME Forum, which will be an important platform for cooperation in the area of ​​critical minerals. On the other side of the geopolitical divide, the BRICS+ bloc continues to work to reduce its dependence on Western economies, for example by working to promote de-dollarization and create alternative investment routes (e.g. in Africa, South Asia and Latin America).

AI enters the scene

Electricity will be a key element driving the energy transformation and at the same time complicating it. The significant adoption of electric vehicles, combined with the electrification of industrial systems, will help countries and companies decarbonize their energy matrix more quickly. New AI-based tools will further improve the prospects for positive technology shocks that could accelerate the energy transition.

However, the energy demands of these technologies are also likely to lead to increased congestion of power grids, which generally remain ill-prepared to absorb rising demand in both developed and emerging economies. According to the IEA, over the next three years, global demand for electricity will grow by an average of 3.4% per year. The agency expects demand from data centers, cryptocurrencies and artificial intelligence to double over this period, accounting for a significant portion of the overall demand growth.

Increasing demand for electricity combined with more frequent and severe heat stress episodes resulting from climate change will increase operational risks related to energy shortages. They have increased in frequency and duration around the world – a trend that will only intensify in the coming months and years as global temperatures continue to rise.

Business risks

As with all climate change issues, the main risk of the energy transition is that global action is not quick and decisive enough as the climate crisis increasingly impacts businesses and everyday life around the world. In addition, an irregular energy transition will increase the instability of an already fragile state of geopolitics (and vice versa), which will mean an increased risk of disruptions in the global economy.

In this environment, businesses will be exposed to a range of risks, which are likely to compound each other, including regulatory volatility and operational disruption. Decarbonization will remain a necessity for businesses looking to future-proof their investments and meet increasing regulatory compliance requirements, but the process will require a solid assessment of geopolitical trends, sound economic planning and a long-term mindset. Without this, companies may pursue decarbonization goals that may prove technologically or politically impossible to achieve. However, successfully navigating such a landscape will likely be a strong competitive advantage because it will help enterprises overcome the energy trilemma and significantly improve operational resilience.

Gabriel Brasil is a senior analyst at Control Risks, a global risk consulting firm