Looking for the silver lining

While the Ukraine conflict may set decarbonisation goals back in the short term, it may boost net zero action in the long term, writes Rick Lacaille, global head of ESG, State Street.

Nation states are grappling with two energy problems as a result of the conflict in Ukraine. First, how to minimise long-term energy costs while reducing the concentration risk of supply, especially from nations that may be hostile. Second, how to reduce carbon emissions from all activity to meet national commitments at an acceptable economic cost.

Unfortunately, there are no easy answers. In the short term there may be a trade-off between energy security and sustainability as the European Union does whatever it takes to reduce reliance on Russian gas, including burning more coal.

Yet in the medium to longer term, there’s good reason to expect convergence between energy security and decarbonisation priorities. In the case of the EU, diversification of the region’s energy supply is critical to achieving energy security. And diversification can only be achieved with renewable energy. That means investments in lower-carbon intensity energy are consistent with investments in energy security.

Diversity of energy may soon extend to consideration of energy supply chains as some renewables are dominated by key players. For example, China dominates the solar industry and the manufacture of solar infrastructure.

While the volatility of fossil fuel prices has made comparisons with renewables difficult over the last three years, the lifetime cost of renewables continues to decline.

In some regions, the optimal solution might be to build renewables more quickly, but there will remain a time gap between planning, financing and building. On top of that, intermittent generation rates mean that storage needs to be built into the cost. In regions like Europe a more sophisticated grid is needed to yield the benefits of northern wind and southern sun. These considerations reinforce the long-term nature of investments in renewables.

Then there are other low-carbon energy sources like nuclear. While nuclear solves both decarbonisation and diversification objectives, it comes at a higher economic and environmental cost and remains a divisive issue.

Debate hinges on several issues: the safety and lifetime cost of nuclear, including operating, waste and de-commissioning risks; the ability of gas to provide a much lower-carbon alternative to coal as a base-load power source, but with a multi-decade investment horizon (and therefore delays to reaching net zero); and whether renewables in combination with substantial storage capacity could replace both coal and gas within a reasonable time horizon. Technology arguments also come into play because in all cases it is likely that we will see improvements in the future.

The EU proposed including nuclear as a green activity earlier this year, validating it as part of a decarbonisation strategy. And now that energy security has come to the fore, pressure on Europe has only increased to maintain and even expand its nuclear generating capacity as part of its strategy to wean itself off Russian energy supplies.

In March 2022, the International Energy Agency outlined its 10-point plan for Europe to reduce its reliance on Russian gas and proposed that Europe maximise generation from existing nuclear power sources. The EU also confirmed its intention to extend the life of existing nuclear plants as part of its plan for significantly bolstering energy security by 2027.

The need to decarbonise and secure energy will require action by policy-makers and the private sector. While this may raise the spectre of a planned economy, it would be a mistake to assume private markets can solve these long-horizon problems alone. At the same time, it will be important to ensure that governments are focused on providing a framework for the private sector and not replacing it.

So while in the short term, the EU’s decarbonisation plans may suffer a setback as a result of Russia’s invasion of Ukraine, over the longer term those plans may get a significant boost. And that may be a silver lining in an otherwise horrendous situation.