Economic uncertainties of the energy transition: a critique of NZE 2050 and its model 

By Rasul Bakhshaliyev

NZE 2050 (Net-Zero Emissions) is a roadmap for the Global Energy Sector prepared by the IEA (International Energy Agency), describing how net-zero carbon dioxide (CO2) emissions could be achieved by 2050. In its report, the IEA emphasizes the role of renewable energy and hydropower as the principal force behind the transition.  While it is true that from the perspective of today’s discursive reality NZE 2050 is a possible future scenario, economic uncertainties of a rapid energy transition remain unexplored. 

Just like all models, NZE is ultimately an approximation of reality. Modelling presupposes isolated assumptions to simplify and predict reality. Although there is no overarching consensus on whether assumptions of a model need be true and realistic, in the context of NZE, evaluation of suppositions is relevant to the telling of the IEA’s perspective on energy transition. 

Projections in the NZE are policy-driven, given that they rely on existing consumer preference towards cleaner and more efficient energy. Corresponding industry and government responses are further encouraging this transition with climate change demanding immediate attention. For instance,  the UNFCC (the United Nations framework convention on climate) has announced a “Race to Zero” global campaign, representing an alliance of actors who currently cover nearly 25% global CO2 emissions and over 50% GDP, committed to achieving zero carbon emissions by 2050 at the latest. Policies have already moved to achieve this: under the European Green Deal (EGD), the European Commission has set a target to increase renewables share in the energy production mix to 32% by 2030, a step that must entail a collective action at reducing greenhouse gas emissions, as well as promoting cleaner energy both discursively, and financially.  This change in policy to a greener outlook is intended to shift consumer habits in everyday life.

IEA estimates that 55% of CO2 emissions reductions require a mixture of low-carbon technologies and this active involvement of consumers[1]. If consumers reverse this newly found preference because climate change is no longer a global worry, or because of a substantial change in income levels, projections in the report would be seriously undermined. A global economic crisis is one example of a major event that could potentially divert consumers’ and producers’ attention from the climate agenda to more pressing, short-term issues, if they arise, such as the provision of welfare, the financial health of the state and international institutions, and poverty. The global Covid-19 pandemic – a priority issue for governments, producers, and consumers – has been identified as a major reason behind a one-third decline in renewable energy investments in the EU energy sector for 2020, compared to 2019. Although from today’s perspective consumer preferences are likely to remain strongly in favour of energy transition, a modelling approach that is overly reliant on potentially contingent consumer preferences is concerning. 

The model is also reliant on continued and improved cooperation from national governments. Pledges to reduce greenhouse gas to net-zero sound reassuring, but even IEA admits that fewer than a quarter of announced pledges are fixed in domestic legislation and fewer are underpinned by specific policies to deliver them[2]. Whether the EU meets its 2030 EGD targets for emissions reductions depends on the internal political debate in the EU nation-states. It is already evident that those national measures implemented by 2019 will not be enough to meet the 2030 targets of a reduction by 40% from 1990 levels. Government and consumer preferences can be unstable and inconsistent, so assuming fixed policy preference in its model could again cause inaccuracy. Present social preferences will change, as proven empirically, and thus weaken the predictive strength of the model. 

Observing the predictions of the model, higher demand for renewable energy is certain and expected to have a knock-on effect for the oil and natural gas industry. Unwanted hydrocarbons will reduce the incentive for fossil fuel exploration. In the NZE 2050 scenario, there will be no new oil and gas field searching, given the lack of sufficient demand to meet the costs of investment into hydrocarbons projects. In an environment where costs of exploration are not factored in the price of oil and gas, prices are increasingly set by the operating costs of the marginal project required to meet demand. Following the IEA logic, this is likely to result in lower long-term fossil fuel prices and hence disincentivize further hydrocarbon production. 

But what is not considered is an alternative scenario, where these lower fossil fuel prices make oil and gas more competitive vis-à-vis renewables and hydropower, leading to a higher demand for hydrocarbons, driving prices up and making new investments in the oil and gas sector more attractive. This is just one scenario showing that despite strong argumentation and modelling behind the IEA’s projections, it is worth considering multiple future pathways instead of limiting oneself to one. 

It is also often axiomatically implied in the model that increasingly more competitive renewable costs relative to coal, oil, and natural gas will lead to higher consumption of renewable energy. But the model fails to address an alternative reaction. The “rebound effects” – a term capturing consumer inefficiency, describes the extent to which some of the anticipated emissions reductions from energy efficiency measures will be eroded due to “irrational” consumer behaviour. Consumer’s failure to pursue cost-effective investments can be attributed to the low priority of energy issues among consumers in the face of other types of expenditures. Consumers’ perceptions of energy savings are known to be vulnerable to strong bias[3].

Biases and heuristics can lead to major misperceptions of risks and benefits when deciding whether to change energy consumption patterns. It must be questioned if producers consider consumers’ “irrationality” when planning out their energy strategy. We can anticipate that as energy transition is furthered, energy producers would have to pay closer attention to consumer “irrationalities”. Status quo bias, applicable to both consumers and producers, reflects a human preference to stick with a decision made previously. Energy producers and consumers might be reluctant to invest in renewable energy facilities due to industry-related uncertainties of such a rapid energy transition even when the actual costs of transition are not as fearful. 

Even when rebound effects are considered, most energy efficiency strategies are likely to be cost-effective and avoid emissions[4]. What is necessary is that we study the nature and extent of the rebound effects in energy sectors and design appropriate policies to assure that these negative externalities are accounted for. Given there is no sufficient experience and research on what policies would be useful to eliminate rebound effects, the status quo bias and other cognitive biases are likely to slow down the energy transition and cloud the model.

 When comparing renewable energy sources with hydrocarbons, it is often concluded that because the former is more efficient and cheap in production, the industry can easily switch from thermal power plants to renewables energy production. One reason why the energy industry might still be reluctant to switch from conventional energy sources could be that companies want to reduce sunk costs associated with abandoning existing thermal power plants, which saw significant amounts of investment throughout the years. To displace existing thermal power plants from the current generation mix, the cost of electricity must be lower than the operating cost of such plants. For this to happen, there is a need for even greater subsidies to make renewables cheaper. Although technology is important, policy and discourse are likely to remain the main drivers of the energy transition. 

There are also concerns that the energy transition disrupts liberalized electricity markets and undermines their economic foundations[5]. Once the energy transition to renewables is complete, supply becomes inelastic because of zero-marginal cost technologies. With zero-marginal cost technologies, the market price is no longer a signal to allocate new investments, which would otherwise increase supply and offset the price increase caused by a surge in demand. In a hydrocarbons-dominated energy market, an increase in energy demand meant that more funds were invested in oil and gas production, resulting in higher energy production and more stable market prices. Because of the inflexibility of renewable energy supply to changes in demand, this stabilizing mechanism is no longer available to counteract rapid price changes. An option to counter this may be to establish greater government control of domestic energy prices, but this is contrariwise to the push for liberalized energy markets.

An alternative solution to the inflexibility of renewable energy demand could involve batteries and storage technologies that would provide the extra capacity to meet the increased demand and stabilize prices. Alternatively, biomass and biogas are renewable energies that are said to be capable of mitigating this volatility. But given the inflexibility of renewable energy production technologies, a transition is likely to be difficult to implement immediately. 

Fossil fuels may still be maintained for periods where there is insufficient renewable energy to meet demand. With existing technology, the easiest solution to price spikes will be to have fossil fuel generators as the reserve margin to supply the system with cheap energy. Some sectors are also intrinsically difficult to decarbonize, like shipping, aviation, steel, cement, plastics, which represent 40% of carbon emissions in the current energy system[6]. Incomplete energy transition does not imply that carbon emissions cannot be very low, but to consider a model removing fossil fuel emissions is naïve. Hybrid systems should be considered, given the obstacles associated with complete energy transition. 

What marks our current energy transition from the previous ones is that it is not so much driven by technological advancements or industrial necessity as much as it is driven by a change in consumer preferences towards renewable energy influenced by the political debate on climate change[7]. This is made evident by the unprecedented pace of the current energy transition and a multiplicity of government, NGO projects aimed at a low-carbon future. While it is true that policy preferences can be very unstable and that the current trend could be slowed down or reversed, the nature of the current energy transition could imply a shift from an industry focused on a commodity to business models particularly perceptible to consumer preferences. This would fundamentally reshape the global energy industry, creating new business opportunities, but also unearthing dangers hardly studied before.

The views expressed in this article are the author’s own, and may not reflect

the opinions of The St Andrews Economist.

Image: Unsplash

[1] IEA, “Net Zero By 2050,”2021, p. 67

[2] Ibid, p. 29

[3] Lesic et al. “Consumers’ perceptions of energy use and energy savings: A literature review”, 2018, p.7

[4] Azevedo. “Consumer End-Use Energy Efficiency and Rebound Effects”, 2014, p. 414

[5] Blazquez et al. “On some economic principles of the energy transition”, 2020, p. 3

[6] Ibid, p. 6

[7] Ibid, p. 7

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