War and the green transition

2022-08-30 at 11:40 Timo Löyttyniemi

A lot of things have changed as a result of Russia’s war of aggression. Energy is in short supply and its price has risen sky-high, all in addition to the destruction caused by the war. Moreover, increasing oil and gas prices have pushed inflation to new heights. What about the green transition? Will it move ahead and accelerate and who stands to gain?


Green transition

Green transition means a transition to a low-carbon society. Accordingly, global warming should be limited to +1.5oC as foreseen in the Paris climate agreement. Fossil fuel consumption should decrease and renewable energy production increase. As part of the huge transformation, countries have pledged to achieve zero net emissions. Some have set the target for 2050. A number of countries expect to proceed more briskly than others.

Nations and companies continue to generate more and more GDP or revenue at greater efficiency and lower carbon emissions relative to earnings or production volumes. But as output and revenue grow, efficiency is not always enough, because absolute CO2 emissions are not falling fast enough. Many governments, companies and investors are grappling with this dilemma. What to do to reduce absolute emissions? While there is still time to think it over, it is running out year by year.


Impact of war on the green transition

The underlying assumption with the green transition was that it would increase the cost of fossil energy. This is exactly what has happened as a result of the war and the “energy policy” pursued by Russia. However, the proponents of the green transition had assumed that the price of fossil fuels would increase as a result of emission trading or import taxes or other such developments, which in turn would lead to a fall in consumption. Now, the war has made the prices skyrocket surprisingly fast, but the beneficiaries are not the same as in an authentic green transition.

Had things been normal, the green transition would have benefitted governments and the companies leading the way. They would earn more revenues and be unaffected by price increases. With the war-driven green transition, the beneficiaries are energy producers and exporters at the expense of other countries and companies, at least in the short term.


Windfall profits to producers

Investors have been urged to reduce the percentage of energy inefficient companies or at least fossil fuel producers in their portfolios. Yet in the war-driven transition, these companies have emerged as winners, depending on the nature of their dependency on Russia. Oil and energy producers have been the winners and energy purchasers have lost.

The one-off windfall profits will inure to the benefit of countries and companies producing and exporting fossil fuels. However, they will lose in the long term. Before long, the price mechanism will restore the situation to what it would have been like under a normal green transition. However, many governments and businesses will miss out on the revenue streams of the transition years, which will now be irrevocably lost. Nevertheless, in a sustainable transition, the best companies and investors tend to gain the upper hand in their respective sectors, unless they have gleaned fossil businesses from their portfolios.


Acceleration of the derivates market

The actions of investors and the market often accelerate the ongoing change. Now it appears that this acceleration is underway in the energy market. Belief in rising energy prices for the coming winter causes strong anticipation among investors, and the rise in market prices has already been realized in recent weeks. This has confused the European energy market. It remains to be seen whether the market, and especially the derivatives market, will face major reforms so that the market and market forces do not cause unreasonable problems for producers and consumers. However, the derivative market accelerates the green transition.


Conclusions

The increase in the price of energy should reduce demand. As the price rises, it becomes increasingly important to reduce consumption and improve energy efficiency. Recent promises and calls for compensating consumers for price increases sit ill with the indispensable price mechanism. Moreover, compensation may prove costly for governments if energy prices remain high for long.

Rising fossil fuel prices have diverted the revenue stream to those who were not supposed to benefit from the green transition. However, the price mechanism will fix it with time, which will hopefully not be too long.

The writer is VER's CEO Timo Löyttyniemi.

TLö blogi 2020

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