Chapter 4. The Energy Transition in an Era of Low Fossil Fuel Prices
- Rabah Arezki, and Akito Matsumoto
- Published Date:
- December 2017
The human influence on the climate system is clear and is evident from the increasing greenhouse gas concentrations in the atmosphere, positive radiative forcing, observed warming, and understanding of the climate system.
The international response to climate change began in 1992 with the Rio Earth Summit and adoption of the Rio Convention that sets out the UN Framework on Climate Change (UNFCCC). The Rio Convention came into force in 1994 and has near-universal membership of 190 countries, and a Conference of Parties (COP) is held annually to review its implementation. One result of the 2015 Paris Climate Conference (COP21) was the Paris Agreement, which commits signatories to work toward limiting global temperature rise. Each country commits to reduce its greenhouse gas emissions by an amount referred to as its Intended Nationally Determined Contribution (INDC). The post-COP21 agenda focuses on implementation of these INDCs, at the heart of which is the so-called energy transition—the move away from using fossil fuels (petroleum products, natural gas, and coal) and toward using clean energies.
While the energy transition is arguably at an early stage, with important differences in goals and achievements across countries, what is not in question is that we are at a critical juncture. Indeed, to avoid the irreversible consequences of climate change induced by greenhouse gas emissions, the energy transition must take firm root while fossil fuel prices are low and likely to stay that way for some time. Solidifying the move from fossil fuels toward clean energy involves both significant opportunities and significant risks, which energy policies will need to address.
This chapter answers four key questions about the energy transition:
What forces now affect fossil fuels?
What is the state of clean energy?
What are the opportunities and risks associated with the energy transition?
What is the way forward?
What Market Forces Now Affect Fossil Fuels?
Oil prices have dropped by more than half since June 2014 and are expected to remain low for a long time owing to a variety of factors (see Arezki and Obstfeld 2015). Important supply-side factors include the advent and relative resilience of shale oil production and increased oil production by members of the Organization of Petroleum Exporting Countries (OPEC). On the demand side, slower economic growth in emerging markets has tended to reduce oil demand growth reinforcing the effect from the secular increase in global oil efficiency (Figure 4.1), which is expected to continue. That said, the expansion of the middle class in giant emerging market economies is expected to increase dramatically the demand for transportation services and the level of car ownership and, in turn, to support oil demand growth (Figure 4.2). The balance among these forces will determine the growth of demand for oil.
Figure 4.1.World Energy Efficiency
Sources: US Energy Information Administration; World Bank, World Development Indicators; and IMF staff calculations. Updated September 16, 2016.
Figure 4.2.Car Ownership, 2013
Sources: IMF, World Economic Outlook database; International Road Federation, World Road Statistics; and IMF staff calculations.
Note: Cars per 1,000 people for India is from 2012 (most recently available).
Prices for natural gas and coal have also experienced declines that look likely to be long lived. The North American shale gas boom has resulted in record low prices in the region. Recent discoveries of extensive gas fields in some developing economies add to the pool of available reserves.1 The resumption of nuclear-powered electricity generation in Japan permanently contributes to lower natural gas prices in Asia. Coal prices also are low, owing to oversupply and the scaling down of demand because of environmental concerns and slower economic activity, especially from China, which burns half the world’s coal.
The share of oil in global primary energy consumption has declined rapidly, from 50 percent in 1970 to about 30 percent today (Figure 4.3). The share of coal, now about 30 percent of global energy consumption, has actually risen since the early 2000s, mostly due to rising demand from China and recently also from India. In contrast with oil, more coal is burned for each unit of global GDP than in the early 2000s (Figure 4.1). Natural gas consumption has increased steadily since the 1970s and now accounts for nearly 25 percent of global primary energy consumption. Global demand for natural gas is projected to increase strongly over the medium term (IEA 2015), with emerging market and developing economies accounting for most of this growth. The projected growth in oil and coal demand falls short of that for total energy demand, partly because, unlike emerging markets, advanced economies are expected to drastically reduce their demand. According to the International Energy Agency, the shares of oil and coal in total energy consumption are expected to drop from 36 percent and 19 percent, respectively, in 2013, to 26 percent and 12 percent, respectively, in 2040.
Figure 4.3.World Energy Consumption Share by Fuel Type
Source: BP Statistical Review of World Energy 2016.
Note: Consumption of renewables is based on gross primary hydroelectric generation and gross generation from other renewable sources, including wind, geothermal, solar, biomass, and waste.
Oil is used mostly to fuel transportation, whereas coal and natural gas are used mainly as inputs into the power sector (electricity and heat generation), which accounts for more than one-third of total primary energy consumption (Table 4.1). Coal is the biggest source of energy for electricity generation, followed by renewables (including hydropower) and then natural gas.2 Roughly equal, and substantial, amounts of energy are also consumed in industry, transport, and building construction, including as inputs to the electricity and heat that these sectors consume. The transport sector accounts for roughly two-thirds of global oil use.
|Energy Source||Power Generation (electricity and heat)||Final Consumption||Total Primary Energy Demand|
|Electricity and Heat||−||842||26||1040||…|
In terms of carbon dioxide emissions, the cleanest energy source among fossil fuels is natural gas, and oil is second. Coal is the dirtiest, especially when used by older, low-efficiency plants, which also tend to emit more air pollutants such as nitrogen oxides and sulfur oxides (Figure 4.4, panel 1). Despite the increased use of renewables and the decreased use of oil as fuel, total greenhouse gas emissions have increased because of the increase in demand for coal (Figure 4.4, panel 2). In fact, global carbon intensity per unit of energy has increased since the beginning of the 1990s owing to the rising consumption of coal, especially in Asia (see Steckel, Edenhofer, and Jakob 2015). Even while China, the world’s largest coal consumer, shifts toward renewable energy resources, coal intensity is expected to increase in other fast-growing emerging market economies, especially India, especially if coal prices stay low (Figure 4.5, panel 1).
Figure 4.4.Carbon Emission for Various Fuels
Sources: International Energy Agency; and IMF staff calculations.
Figure 4.5.Electricity Generation
Sources: International Energy Agency; and IMF staff calculations.
Note: These shares relate to electricity generation only and exclude the heating sector. OECD = Organisation for Economic Co-operation and Development.
If the energy intensity of economic activity does not fall or if developing economies do not adopt state-of-the-art technology for coal-powered plants to lower the carbon intensity of electricity generation, economic development in most regions of the world will continue to drive global emissions upward. Emissions will reach dramatic levels and, in turn, accelerate global warming. Poorly designed regulations for the use of coal in developing economies could also discourage technological innovation in the electricity sector. As a result, the world might not benefit, in terms of lower global emissions, from the downward trend in coal use in advanced economies.
Given its relative cleanliness and abundance, natural gas can play a key role in the transition from coal to renewables. Growth in U.S. shale gas production is expected to make natural gas the energy of choice in the United States. There is also potential for growth in the use of shale gas and conventional natural gas in China and many other places around the globe (see Chakravorty, Fischer, and Hubert 2015).
What is the State of Clean Energy?
One of the most notable trends in energy consumption is the increased use of renewable energy resources (Figure 4.5, panel 2), which has been supported by a formidable reduction in the costs of various renewables, including solar and wind (Figure 4.6, panel 1). These cost reductions are the result of research and development (R&D) efforts to promote clean energy and energy efficiency (“grey” technology) (Figure 4.6, panel 2). This R&D investment dates to the 1970s, an era of record-high fossil fuel prices, and was mostly government financed. This is no surprise: the private sector typically does not internalize the positive externalities associated with an increase in R&D. Public R&D spending early on, however, paved the way for corporate R&D spending during the 2000s, another period of high fossil fuel prices. The result has been a flow of technological innovations across sectors, including the development of electric and natural-gas-powered vehicles. The outlook for alternative fuel vehicles is somewhat mixed. There has been an increase in use of compressed natural gas for transportation, particularly commercial fleets and buses. But sales of electric cars, notably plug-in hybrid vehicles, still have a low penetration rate, accounting for less than 1 percent of car sales in the United States. Unsurprisingly, electric car sales decreased with the recent drop in gasoline prices (Figure 4.7).
Figure 4.6.Cost of Renewables and Research and Development Efforts
Sources: International Energy Agency, Energy Technology Research Development and Demonstration 2015; and US Department of Energy.
Figure 4.7.US Sales of Electric Vehicles and Gasoline Price
Sources: IMF, Primary Commodity Price System; and Electric Drive Transportation Association.
Note: Total electric drive market share includes hybrid vehicles.
Among primary energy sources, renewables (including hydropower) are the least carbon intensive. The International Energy Agency forecasts that the share of renewables in global total primary energy consumption will increase from 14 percent in 2013 to 19 percent in 2040 as a result of expected energy policy changes. Electricity generation is set to change dramatically: the share of renewables is projected to increase from 22 percent to 34 percent over this period.
One obstacle to increased use of renewable energy in power generation is intermittency and hence reliability. Unstable supplies of wind, sun, and rainfall can trigger a mismatch between supply and demand. Addressing this will require ramping up of supply during daily peaks to achieve load balancing.3 In other words, the intermittencies associated with the increased usage of renewables trigger spikes in demand for “controllable” power, for example power generated from natural gas (Figure 4.8). To overcome this problem, the power sector needs to develop economical battery backup technology and foster electricity exchange. Battery technology has shown steady progress, suggesting that electricity storage technology eventually will facilitate a more widespread reliance on renewables.
Figure 4.8.Duck Curve: Illustrative Change in Projections of Net Load Curve
Source: California Energy Commission staff, Energy Assessments Division.
Note: Projections are based on load shapes and production profiles from actual data of the California Independent System Operator on March 22, 2013.
Bioenergy has long played a role in electricity generation. Biosolids are relatively cheap sources of energy because they are residuals from other processes or are simply waste materials. Power plants fired by biomass can also compensate for generation lapses associated with other renewables because they can operate at any time of the day. Both advanced and developing economies are expected to develop more bioenergy-based facilities. For use in transportation, biofuels are usually blended with conventional gasoline or diesel, sometimes in response to governmental mandates. As a result, the share of biofuels in transportation fuels has doubled over the past decade. Biofuels can reduce carbon emissions, but they also put pressure on food markets and have been blamed for food price increases (see Chakravorty and others 2015).
Nuclear power makes up only a small share of global energy consumption. Carbon emissions associated with nuclear energy generation are limited, but in the aftermath of the March 2011 Fukushima disaster, several countries imposed moratoriums on nuclear energy use to address environmental liabilities and safety concerns. The human health risks associated with potential exposure to radiation are fairly well known, but nuclear energy’s overall impact on the environment is hard to judge because waste management of used nuclear fuel is still at an early stage. There are also concerns about the potential for radioactive materials involved in nuclear power generation to be diverted to military use. There are, however, important benefits to nuclear energy. For example, unlike renewable energy, nuclear power has no problems of intermittency. Also, immediate fatalities associated with power plant accidents—as opposed to long-term health consequences related to radiation and pollution exposure—are historically much lower for nuclear plants than for any other type of power plant, including coal-fired plants (Table 4.2). Finally, nuclear power is seen as a source of relatively clean energy. Some countries, including China and the United States, view use of nuclear energy as a way to curb greenhouse gas emissions. Despite the serious issues to be solved in terms of safety and waste management, many scientists argue that it will be hard for many countries to achieve their INDC targets without greater use of nuclear energy.
|Energy Chain||OECD||EU 27||non-OECD|
What are the Opportunities and Risks Associated with the Energy Transition?
The persistence of low fossil fuel prices complicates the energy transition by slowing or threatening progress in developing renewables (see Arezki and Obstfeld 2015).4 Renewables account for only a small share of global primary energy consumption, but they will need to displace fossil fuels to a much greater extent to forestall further significant climate risks. Evidence indicates that higher fossil fuel prices strongly encourage both innovation and adoption of cleaner technology (see Aghion and others 2012; Busse, Knittel, and Zettelmeyer 2013). Not only do the current low prices for oil, gas, and coal eliminate many of the economic incentives for research into fossil fuel substitutes, they have already raised demand for fossil fuels in some countries. In Germany, for example, the use of coal (the dirtiest fossil fuel) has risen at the expense of natural gas (the cleanest).5 Lower gasoline prices also reduce the incentive to purchase fuel-efficient or electric cars (Figure 4.7). Similarly, the number of clean- or grey-energy patents correlates positively with the price of fossil fuels (Figure 4.9). Finally, low prices for energy in general may hamper overall economic growth and overall energy consumption if consumers substitute the purchase of more energy for other commodities.
Figure 4.9.Number of Energy Patents in the World
Source: Aghion and others 2012.
Note: “Dirty” indicates automobile technologies affecting internal combustion engines, “clean” indicates automobile technologies in electric vehicles, hybrid vehicles, fuel cells for hydrogen vehicles, and so forth; and “gray” indicates innovations in fuel efficiency.
Because coal is currently relatively cheap, it is tempting for countries to use coal for power generation. This is true even for those countries that have committed to reducing their reliance on coal and especially if they cannot afford cleaner alternatives, which are typically more expensive. As mentioned, even advanced economies in Europe increased their use of coal when the shale revolution in the United States displaced coal there and international coal prices dropped.6
In addition to these short-term demand effects, low coal prices may have longer-term consequences by boosting capacity investment in coal power plants and simultaneously reducing efforts to develop more efficient technology. Specifically, the prospect that environmental concerns would decrease demand for coal power provided an incentive to power plant manufacturers to improve plant efficiency and reduced emissions; with lower coal prices and increased demand, they might moderate these development efforts. This could leave emerging market economies that have fewer energy options with less efficient and more pollution-intensive coal power plants.
Another key technology under development that could be slowed by low coal prices is carbon capture and storage, which can significantly reduce carbon emissions not only for power plants but also for other carbon-emitting industries such as steel production. At this point, carbon capture and storage and clean coal technologies are not considered to be primary global-warming mitigation tools, but pursuing these technologies may still be important for coal and oil producers Without carbon capture and storage, in the long term, if and when the energy transition is achieved, fossil fuels could become “stranded assets”—assets that either lose their value unexpectedly or prematurely or become liabilities. In the case of fossil fuel industries, the stranded assets might include “stranded reserves”—fossil fuel reserves that are no longer recoverable—and “stranded or underutilized capital”—sunk capital investments that become obsolete (for example, oil platforms that are never used). Because it remains to be seen how rapidly the energy transition might take place, however, there is significant uncertainty regarding the time horizon over which fossil fuel assets become stranded.
One important lesson from earlier energy transitions is that these transitions take time to complete—witness the transition from wood and biomass to coal in the eighteenth and nineteenth centuries and the transition from coal to oil in the nineteenth and twentieth centuries. History may not be repeated in this case, however, because the technological forces unleashed by the public and private response to climate change appear to be more potent than the factors that drove earlier energy transitions and may speed up this transition, notwithstanding the potential delays from the current environment of persistently low fossil fuel prices. Considering the industry’s carbon emissions intensity, coal-related assets are more exposed to the risk of becoming stranded than oil and natural gas assets.
Stranded assets could cause heavy losses for coal and oil companies and for countries that rely heavily on fossil fuel exports, many of which have attempted to diversify to mitigate these risks. Many major oil companies have long diversified among fossil fuels by investing more heavily in the production of natural gas and also in so-called breakthrough renewable technologies. Oil-exporting countries have also attempted to diversify their economies away from oil, but this has proven challenging. Nevertheless, opportunities exist. For example, the United Arab Emirates has endorsed an ambitious target of drawing 24 percent of its primary energy consumption from renewable sources by 2021.
Solar power concentration is highest in the Middle East and Africa and parts of Asia and the United States, according to the U.S. National Aeronautics and Space Administration (Figure 4.10). Interestingly, Morocco, host of the 2016 United Nations Conference on Climate Change (COP22), unveiled the first phase of a massive solar power plant in the Sahara Desert that is expected to have a combined capacity of two gigawatts by 2020, which would make it the single largest solar power production facility in the world.
Figure 4.10.Direct Normal Irradiation
Source: US National Aeronautics and Space Administration; and The Institute of Engineering Thermodynamics at the German Aerospace Center.
What is the Way Forward?
Large economies tend to be the biggest emitters of greenhouse gases, and the 10 largest emitters are responsible for more than 60 percent of the global total (Table 4.3). Any effort to address global warming should therefore encompass all the largest economies (see Arezki and Matsumoto 2016). Although high-income countries are big greenhouse gas emitters in per capita terms, energy efficiency has been improving rapidly in these countries, and many are therefore already reducing greenhouse gas emissions, with some committed to doing more. As a result, consumption of fossil fuels in advanced economies can therefore be expected to continue to decrease. As a result, even though advanced economies account for the bulk of current emissions, emerging market and developing economies will drive the growth of future emissions. These economies remain heavily reliant on coal, and their consumption of coal and other fossil fuels will continue to rise.
(CO2 emissions from fuel combustion, 2013)
|Country||Share (of global)||CO2/Population (tons of CO2 per capita)||CO2/GDP PPP (kilograms of CO2 per current international dollar)||GDP Per Capita (current PPP)|
|Total share (top 10 countries)||67.3|
There are important variations in countries’ efforts to shift their energy mixes at least partly toward renewables and away from fossil fuels, especially coal and oil. In 1991 Sweden became the first country to adopt a carbon tax, and it now gets more than 38 percent of its energy from renewables. The European Union as a whole gets 13 percent its energy from renewables. In an effort to reduce its very high pollution levels, China has an ambitious plan to meet a significant portion of its future energy needs with renewables.
As noted, the 2015 Paris Climate Conference (COP21) was by all accounts a success, with nearly every country committing to reduce its greenhouse gas emissions through the INDCs (Table 4.4). The first internationally coordinated attempt to reduce carbon emissions occurred well before the 2015 Paris Agreement, in 1997 with the Kyoto Protocol agreed at COP3, but a few major countries, including China, India, and the United States, did not accept its legally binding targets. The 2009 Copenhagen conference (COP15) failed to yield an agreement, and no real progress occurred until the 2015 Paris conference. Again, the challenge following COP21 is implementation, and setting the right incentives for achieving the INDCs will be essential. This is complicated by the Trump Administration’s decision in 2017 to begin the process of withdrawing the United States from the Paris Agreement.
|United States1||Between 26 percent and 28 percent below 2005 levels by 2025|
|European Union1||40 percent below 1990 levels by 2030|
|Japan1||26 percent below 2013 levels by 2030|
|Canada1||30 percent below 2005 levels by 2030|
|China1||60 percent to 65 percent below 2005 levels by 2030 (CO2 emissions intensity)|
|India2||33 percent to 35 percent below 2005 levels by 2030 (CO2 emissions intensity)|
|Russia1||25 percent to 30 percent below 1990 levels by 2030|
|Brazil1||37 percent below national baseline scenario by 2025|
|South Africa2||Between 398 and 614 million tons of CO2 emissions by 2025 and 2030|
The International Energy Agency and most scientists agree that the INDCs, in their current form, are insufficient to avoid the worst effects of climate change (IEA 2015). In addition to implementing mitigation efforts, countries will also need to undertake adaptation initiatives to adjust to the realities of a warmer planet. These may include population shifts from exposed areas or new infrastructure and housing better suited to withstand new climate risks.
But mitigation and adaption—alone or in tandem—will be neither fully acceptable nor sufficient, given that climate change will be irreversible. For instance, some ecosystems will be unable to adapt to rising temperatures and the result will be substantially reduced biodiversity. Short of pervasive and economically viable carbon capture and storage technologies, the planet will be exposed to potentially catastrophic climate risks (see Meehl and others 2007) unless renewables become cheap enough to guarantee that substantial fossil fuel deposits remain underground for a very long time, if not forever. In economic terms, the price of fossil fuels should reflect the negative externalities that their consumption inflicts. That means the price of carbon should equal the social cost of carbon, which is the present discounted value of marginal global warming damage from burning one ton of carbon today.7 In other words, the best way to meet the challenge of implementing the INDCs would be a global carbon tax, which is the most efficient way to reduce emissions.
Politically, low fossil fuel prices may provide an opportunity to eliminate energy subsidies and introduce carbon prices at a politically acceptable, even if not optimal, level. Global carbon pricing will have important redistributive implications, both across and within countries, and so the best approach is gradual implementation, complemented by mitigating and adaptive measures that shield the most vulnerable.8 A low initial carbon price could rise gradually over time toward efficient levels, perhaps through future international agreements. Agreement on an international carbon price floor would be a good starting point in such a process and would definitely be preferable to a failure to address comprehensively the problem of greenhouse gas emissions, which would expose this and future generations to incalculable risks (Stern 2015).9
Developing economies, in particular, may need aid to facilitate the clean technology imports necessary to enable them to participate in the energy transition.10 Such aid would help offset the transitional costs associated with removing carbon subsidies and levying positive carbon taxes. The Green Climate Fund was established within the framework of the United Nations to help developing economies put in place adaptation and mitigation practices. It is intended to be the centerpiece of efforts to raise climate finance to $100 billion a year by 2020. The IMF is also supporting its member countries in dealing with the macroeconomic challenges of climate change.11
Shifting away from fossil fuels to clean, renewable energy resources or to nuclear energy can help reduce greenhouse gas emissions. And moving from coal to natural gas for electricity generation can also contribute significantly to reducing carbon emissions. For each country, developing and expanding its renewable energy sector will require an overhaul of the existing energy infrastructure and involve training and retooling the labor force. These transformations will eventually be a source of jobs and cleaner, more sustainable growth, but the process also involves transitions and disruptions that must be addressed. Indeed, with global energy prices at historically low levels and with prospects for such low prices to persist, with interest rates are at historic lows, and with countries around the world looking to infrastructure spending both to support demand and to spur future potential growth, the time may be right to undertake the investment needed to jumpstart the energy transition.
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Prepared by Rabah Arezki (team leader), Christian Bogmans, Rachel Yuting Fan, and Akito Matsumoto, with research assistance from Vanessa Diaz Montelongo.
The recent discovery of the giant Zohr gas field of the Egyptian coast and, more recently, the discovery of natural gas of the coast of Senegal will eventually have repercussions for prices in Europe, the Mediterranean region, and west Africa. In addition, many other locales, especially in developing economies, are opening up for resource exploration and offer significant potential (see Arezki, Toscani, and van der Ploeg 2016).
The share of natural gas in total primary energy demand is expected to rise, but it faces competition from substitutes for gas in many sectors, especially from renewables and coal in power generation—in part because of subsidies and gas-pricing regimes. In particular, natural gas use is expected to increase in the transport sector, where its use is now very limited. This development, along with the eventual use of liquefied natural gas as a shipping fuel, will contribute to the dis-placement of oil as the primary fossil fuel energy source.
The net load curve represents the variable portion of the load that integrated system operators must meet in real time. The net load is calculated by taking the forecast load and subtracting the forecast of electricity generation from variable generation resources, wind, and solar (see California ISO 2016).
Low oil prices may in part reflect, in addition to the factors discussed earlier in the chapter, an independent process of structural transformation that is taking place in China and is diminishing (or slowing down the growth of) the oil intensity of GDP (see Stefanski 2014).
As the relative price of coal to natural gas in Europe declined in recent years, the share of coal in electricity generation increased in Germany, from 43.1 percent in 2010 to 46.3 percent in 2013. Over the same period, the share of natural gas fell from 14.3 percent to 10.9 percent.
The share of coal as an input in power plants among European members of the Organisation for Economic Co-operation and Development increased from 23.7 percent in 2010 to 26.0 percent in 2012 (with the increase in coal use largely arising from displacement of natural gas use), although the share of renewable energy increased as well. Japan increased its share of natural gas and coal significantly after it stopped nuclear power production following the Fukushima accident.
Farid and others (2016) discuss macro and financial policies to address climate change.
Li, Narajabad, and Temzelides (2014) show that, even when some degree of uncertainty is accounted for, taking into account the damage from climate change can cause a significant drop in optimal energy extraction.
Collier and Venables (2012) discuss Africa’s needs to achieve its potential in hydro and solar power.
See “The Managing Director’s Statement on the Role of the Fund in Addressing Climate Change” (IMF 2015).