ESG Insights

Energy is fast becoming an important global policy area. Factors ranging from supply disruptions, geopolitics, inflation and climate objectives are all at play, triggering short – as well as long-term – energy considerations. A burning question will be, especially for economies with set climate goals, is how they can balance those goals with urgent needs to secure short-term energy needs.

In this issue of #WhyESGMatters, we explore why regions such as Europe, arguably one of the most hard-hit from Russian supplies, could see the energy crunch as a potential catalyst to radical shifts in policy priority. We also look at the different ways in which Europe can diversify its dependency, in both the short and long term, and enable investors to understand how the landscape is evolving towards a more sustainable energy transition.

The Russia-Ukraine war has jolted Europe into a radical shift in its energy policy. The continent will likely reduce its dependency on Russian oil and gas, while we are seemingly witnessing the start of energy security soaring up the priority list within the region’s governments.

This shock has come at a time when the world is already experiencing energy-induced inflation, only months after Europe led the way with ambitious energy transition goals at the UN climate change conference (COP 26) last November. The International Energy Agency (IEA), European Commission, and UK government have also issued plans depicting the scale of challenges to move away from Russian oil and gas after decades of dependence. Figure 1 illustrates the levels of energy consumption across the region:

Figure 1: Europe is still heavily reliant on oil and gas for primary energy consumption

Not all economies in Europe face the energy crunch with the same severity. In fact, aside from the varying levels of exposure to Russian oil and gas, there are also different options on how the dependency can be reduced. The sun does not shine and the wind does not blow at the same rate across Europe, and politics also plays an important role. France, for example, has for decades relied on nuclear energy and will continue to do so. Germany, on the hand, has been clear that nuclear will not play a role in its energy transition.

As the geopolitical crisis escalates, it becomes increasingly difficult for Europe as a whole to justify Russian energy imports; indeed, the EU recently agreed a ban on 90% of oil imports from Russia by the end of this year. On the flip side, Russia may look to shut off gas deliveries, as evident with Poland and Bulgaria in April, due to their refusal to pay in Russian rubles. Yet if gas deliveries to the region were cut off at scale, Germany would suffer the most severe economic impact, given its dependency on gas as primary energy (26%) and its reliance on industrial output. Figure 2 shows other economies are who rely on Russian piped gas supplies.

Figure 2: Many economies are very reliant on Russian piped gas supplies

Climate change and the need to decarbonise the energy system has been a dominant global narrative, particularly in Europe, in recent years. However, with security of supply and geopolitical risk now becoming the primary – and crucially most urgent – energy issue, this has the potential to cause radical shifts in policy priority. 

The region is faced with an unenviable task – tackling the wide use of a rigid and deeply embedded energy source, at short notice. Europe will want to ensure that its actions achieve two aims: firstly to reduce the draw on Russian natural gas, and secondly to ensure this does not compromise the progress on long-term emission reductions targets.

Over time, the broad deployment of renewables can enhance energy security, as well as reduce import dependency. This can help work toward the goals of decarbonisation and enhancing energy security in the medium-to-long term.

The Russia-Ukraine conflict could be a catalyst that propels the energy transition in Europe forward, and faster than previously, even if some undesirable short-term measures need to be taken. The long-term goal of removing risks from fossil fuel exposure – such as price volatility, supply uncertainty and geopolitical counterparty risk – shall be consistent with the overarching European goal to reach ‘net zero’ emission by 2050. 

There are several options available for Europe to reduce reliance on Russian natural gas. Some measures are more short-term orientated, e.g. diversifying natural gas supply, increasing storage levels and demand management. Others are medium-to-long term and more structural in nature, e.g. electrifying end-uses of natural gas, building out of renewables and accelerating energy efficiency efforts. Some broad avenues of action include:

Accelerating the deployment of renewable energy in Europe, such as solar and wind, is a way to reduce the role of natural gas for electricity. It can also benefit other electricity-based substitutes for fossil fuels, e.g. electric vehicles. 

Reducing Europe’s primary energy consumption (in coal, natural gas and oil) without having to drastically alter end-energy use for heating homes, powering industry, etc. is key. The cumulative impact of energy efficiency measures across the system could be more impactful in driving down emissions to 2050, versus the build-out of renewables.

Nuclear energy can provide zero-carbon electricity, at scale, and limit potentially high levels of intermittency to energy systems, e.g. from high wind/solar use. However, this fuel source could still be less accepted within Europe. New reactors may also take years to plan and develop. 

Green hydrogen, produced via renewable energy sources, resembles more like natural gas, with the exception that it is domestically produced and emits no CO2. However, green hydrogen production and transport see significant costs and scale issues.

In lieu of pipeline-supplied natural gas from Russia, importing LNG from other economies (e.g. the US, Qatar) will require transport via seaborne cargoes. This raises the need for new receiving terminals to be built.

The European Union cannot replace all of its Russian natural gas without significant disruption – natural gas alone currently represents approximately 40% of European consumption (over other energy supplies). Diversifying supply is an option, reducing consumption is also an approach – advocated recently by the IEA. Renewables, hydrogen, nuclear energy, energy storage and efficiency measures can all help to wean Europe off natural gas but are not overnight, reflecting the structural rigidities in the European energy complex.

Governments, corporates and individuals are increasingly advocating for significant steps to slow the pace of climate change and adjusting the energy mix to result in lower carbon emissions. As environmental, social and governance (ESG) trends continue to rise, so will the interest in sustainable investing opportunities by investors. Investors may be approaching sustainable investing from different angles: some may be values-driven to exclude certain sectors, while others will want to invest in companies in the transition to net-zero. Embedding ESG metrics into one’s portfolio may also be an effective way to manage risk, enhance the potential for resilience and tap into green innovation to generate long-term capital growth.