The 21st session of the Conference of Parties (COP) at the Paris Climate Change Conference in 2015 culminated in the Paris Agreement. The aim of the Paris Agreement
is to keep global temperature rise this century to well below 2°C, and to pursue efforts to limit the temperature increase further to 1.5°C.
Under the Agreement, signatory nations set their own emissions reduction targets; called Nationally Determined Contributions. Since COP21, 132 out of a total 197 Parties have ratified the Agreement which entered into force on 4 November 2016, 30 days after 55 Parties, covering 55% of global emissions ratified it.
Meeting the 2°C target will be challenging and the 1.5°C target even more so. Aggressive decarbonisation scenarios will be needed to reach these targets. The important things to consider for the energy industry are:
What will demand for coal, oil and gas look like under various scenarios?
What do these demand profiles do for commodity prices?
When will peak demand occur?
The International Energy Agency (IEA), as part of their World Energy Outlook (WEO) each year, provides forecasts of demand for different energy sources in different regions in the world using three key scenarios:
The Current Policies scenario assumes policies that are currently in place remain in place.
The New Policies scenario is the baseline scenario for the WEO, it takes into account country- specific policy commitments, including the current country- based targets which form the basis of Paris Agreement.
The 450 scenario describes limiting global temperature increase to 2°C (the 450 refers to a CO2 concentration of 450 parts per million in the atmosphere).
Given that the intent of the Paris Agreement is to limit temperature rise to well below 2°C, then it is prudent to explore the fossil fuel demand scenarios under the 450 scenario. The WEO considers primary energy demand for oil, natural gas, coal and renewables; secondary energy demand for electricity and the effect of energy efficiency on demand.
The IEA’s projected oil demand under the 450 scenario shows a peak in demand by 2020, followed by a decrease in demand out to 2040, the end of the WEO’s forecast period. This is consistent with an increase in the uptake of electric vehicles and
a corresponding decrease in the amount of oil used in the passenger vehicle sector.
This scenario also assumes fuel switching in the heavy vehicle sector to natural gas and biofuels. In line with this, the price for oil is projected to level out in the medium term
as oil-producing countries reduce output to maintain price levels, but then is projected to reduce out to 2040.
Coal, being the fossil fuel that produces the most emissions per unit of energy when burnt, is projected to have a steep fall in demand under the 450 scenario. The IEA model assumes that peak demand for coal has already happened and that demand will be reducing steeply going forward. This scenario forecasts that only 7% of electricity is produced from coal-fired power by 2040, with the majority of this generation (70%) coming from plants equipped with carbon capture and storage.
Coal use for industrial (non-power generation) purposes is maintained at similar levels to currently under the 450 scenario. This results in a large drop overall in coal demand, particularly thermal coal. The IEA projections show that thermal coal trade may experience a reduction of 60% in the 450 scenario with a reduction in the commodity price as a result.
Natural gas is the only fossil fuel that shows an increase in demand to 2040. The projections from the IEA in the 450 scenario show that gas demand grows through the 2020s but then levels off.
Average growth in natural gas demand is 0.5% per year to 2040. This is a rosier picture than the demand scenarios for oil and coal but demand is still curtailed under the 450 scenario when compared to other IEA scenarios. The growth in gas comes from increased gas usage in the power generation sector and the use of natural gas in the transport sector.
Net zero emissions
It is clear that the IEA’s 450 scenario does not reduce emissions to zero over the forecast period. Figure 1, taken from the WEO, shows projected emissions reductions by technology type and still has just over 18 gigatonnes per year of CO2 equivalent being emitted in 2040.
During the latter half of this century, there will be requirement to reach net zero emissions in order to limit temperature increase to “well below 2°C”. A pathway to net zero emissions, and even net negative emissions, has been developed by Shell. This
pathway is reliant on biomass for removing CO2 from the atmosphere and also a process known as Bio Energy Carbon Capture and Storage (BECCS) as a way to combust biomass and capture/sequester the emissions. Shell’s balance between sources and sinks of emissions is shown in Figure 2.
The net zero emissions pathway as above shows that net zero emissions, whilst continuing to maintain some fossil fuel demand, is possible. It is worth noting, however, that BECCS has not yet been deployed successfully at scale. The above scenario is also reliant on signi cant uptake of CCS for fossil fuel combustion, which is also not yet deployed widely and continues to be relatively expensive.
As assets – particularly electricity generation assets – are aging and reaching end of life, decisions are being made as to what should replace them. Given the longevity of new assets, these decisions generate inertia in the system. That is, a decision to employ higher emitting assets now will lock in those emissions for decades to come. There is a balanced decision to be made that looks at national and international greenhouse gas reduction targets, energy security, cost and risk.
A risk management approach
The most appropriate course of action for energy companies is to complete scenario analysis using a credible source of demand scenarios and analysing the impact of e orts to achieve the Paris Agreement goals on business. These demand scenarios will reflect commodity prices so the impact of changes in forecast commodity prices should be explored.
Stakeholders and shareholders in energy companies have recently been questioning how robust their investments are under different climate change action scenarios and often, emphasis is placed on the IEA 450 scenario – particularly as this is in line with the Paris Agreement targets.
It is prudent to employ a risk management approach to explore the risk to the business from this scenario. Namely, the likelihood of this scenario being realised and the consequence to income and profitability. Then, opportunities to minimise this risk exposure can be explored.