2022 represents a critical inflection point in the way we think about energy and the global systems needed to source, produce, deliver, and decarbonise it.

Era-defining events are shaping both short- and long-term structural considerations around energy security, affordability, and sustainability. The emergence of this urgent, once-in-a-generation trilemma makes it vital for industries to adapt fast.

This year, in our annual global survey of over 4,000 C-suite executives from across sectors, including energy, the top five boardroom concerns were surging energy prices, inflation reaching damaging levels, rising unemployment, global energy shortages, and economies failing to tackle climate change quickly. All five elements are interconnected and have major ripple effects across entire economies. The energy sector, which fuels our economies globally, is victim to current volatile geo-politics and energy independence is becoming an omnipresent national security issue – driving increased impetus for faster energy transitions.

Lenders and investors are challenging the robustness of business strategies to deal with market events and supply side shocks, now and in the future. The very relevance of business models to address rapidly changing consumer, societal, and economic needs is under review.

Global sanctions are impacting profitability and liquidity, and in some cases, lenders and regulators are requiring a clear roadmap for transitioning away from certain energy operations, for example those linked to Russia. Decisionmakers are demanding enhanced visibility and documentation on specific milestones for “de-risking” events as well as future plans for greater resilience.

With diminishing investor appetite for the traditional energy sector, businesses will need to start preparing contingency plans alongside their refinancing strategies to maintain optionality and protect value for stakeholders.

of Energy companies in the US expect to require refinancing in the next year

in Turkey

in India

Data from our most recent global Resilience Barometer highlights that over the next 12 months 45% of energy companies surveyed believe that they will face increased pressure to improve on ESG / Sustainability, compared to 36% of companies in other sectors.

This pressure ranked highest on CEO’s agendas and even outstripped concerns about improving operating performance and or increasing market share. The reason for this is three-fold:

  • Compared to other sectors, energy companies reported having the most outdated business models.

  • Comparatively, our analysis shows that more energy companies lost revenue last year due to an inability to keep pace with climate change regulations and expectations.
     
  • Energy companies are now facing tough scrutiny from investors, regulators, activists and the media from a financial, environmental and sustainability standpoint.

From an investors point of view, it appears that investors are putting their money where their mouth is: our Resilience Barometer data shows that more energy companies struggled to secure finance in the last 12 months as compared to other sectors. This reflects the increasing pressures that companies in the energy sector are facing around financing.

The energy sector is highly capital intensive and has multi-year investment cycles at the very minimum. Energy companies typically rely on a range of funding mechanisms, some of which are now finding themselves constrained due to concerns around sustainability

A confluence of climate-related factors is exacerbating this risk:
 

  • On a cost basis, the downward trajectory of renewable energy costs may render fossil fuels uncompetitive earlier than expected.
     
  • Physically, assets may become inoperable due to changing climactic conditions.
     
  • Regulations may change such that energy projects that are large emitters are forced to stop operating ahead of schedule.

Whilst energy companies are under increasing scrutiny to improve ESG / Sustainability, governments and regulators are also increasingly under pressure from a vocal set of environmental groups and concerned citizens concerned about the slow march of progress, or lack thereof, when it comes to climate action.

The activism is not just confined to environmental groups and concerned citizens but also extends to investors and shareholders. Shareholder activism is a key driver of climate action in the energy sector, for example, last year, investors filed hundreds of climate-related resolutions.

The courts have also proven to be a route for activism: Shell was ordered to cut emissions faster than it planned to following a lawsuit by environmentalist groups. As such, it should be clear that the climate imperative could quickly close the door on investment into new fossil fuel projects.

From a demand-side perspective, energy companies are facing immense pressure due to the not-always-complementary needs to transition from fossil fuels to more renewable sources whilst simultaneously maintaining and in some cases increasing overall energy supply.

Transport

Emissions from road vehicles, contributes approximately 20% of global carbon emissions. As a result, decarbonising the transport sector remains a key hurdle on the path to net zero.

Beyond road vehicles, air transport and shipping are also undergoing major changes driven by decarbonisation. While air transport is a significant contributor to climate change, there are currently limited technological solutions to replace its role in long-haul travel.

The immediate need for change in transportation and mobility is clear.

Policy incentives

Governments and regulatory bodies are driving this change through the implementation of favourable subsidy schemes and punitive legislation. For example, cities in Spain are providing municipal road tax discounts up to 75% for electric vehicles.

Key challenges

With this growth there are many new challenges and opportunities:

  • Electricity demand will rise further, and there is growing acknowledgment that the EV revolution is only as green as the grid from which electricity is supplied
  • Battery development faces significant reputational and commercial risks from its supply chain.
  • As minerals needed for battery development increases, securing supply for countries and companies will become increasingly important.
  • Organisations will therefore need to be more cognisant of supply chain risks.

Our research highlights that the impact of ESG / Sustainability is among the top three threats for companies in heavy industry over the next 12 months. As such, enabling decarbonisation in heavy industry is another major challenge in the energy transition as these sectors have traditionally relied heavily on conventional fuels.

Hydrogen as a potential solution

The production of steel, cement and chemicals, for example, is carbon intensive as processing requires significant amounts of heat that cannot be generated by direct electricity. One possible solution is to scale up the production of ‘green’ hydrogen as a very efficient fuel for high-temperature industrial processes.

Key challenges need to be addressed before hydrogen is a viable option:

The green hydrogen buildout will require substantial investment.

It will also require a large buildout of renewable electricity infrastructure dedicated to green hydrogen production.

Competing demands for renewable power generation could threaten the development of the industry overall, especially given that using electricity for green hydrogen production is a less efficient use of the power than supplying it directly to the grid.

The energy transition will not just require the building of new power generation resources, it will also require the creation of an entirely new ecosystem of industries and companies dedicated to supporting it. This includes seismic changes to the metals and mining sector, primary industry, grid infrastructure, and consumer technology.

As such, it is clear that the entire supply chain will become a source of opportunity and risk. In fact, results from our data reveal that 49% of energy companies surveyed plan to conduct reviews of supply chain and suppliers in the next 12-months in response to anticipated consumer activism.

Grid flexibility

Western European governments have established plans for retirements of coal and nuclear assets across the region over the next 5 years. This will result in a flexibility deficit across multiple markets of 20 GW by 2030.

Growth in intermittent generation will create much greater demand for grid flexibility solutions than what has historically been required. Grid flexibility has historically focused on servicing relatively mild fluctuations in peak / off-peak load. Wind seasonally balances solar, but the two are uncorrelated within during the day, i.e., wind and solar can spike/fall together.

Price volatility will continue to grow in significance throughout the next decade as the change in generation mix accelerates. For renewable generators with exposure to wholesale prices, this will impact the risk profile of their assets with potential implications for financing and portfolio value. Incorporating effective measures (which could be a mix of financial and non-financial solutions) will become an increasingly important consideration when seeking to maximise economic value.

The growing importance of grid flexibility will also create opportunities. Energy storage companies will be able to benefit from higher values placed on balancing the grid; such benefits could even extend to the average consumer of electricity, with vehicle-to-grid trials allowing drivers to use their electric vehicles as batteries that can automatically send electricity to the grid. A more connected electricity system reliant on demand-side response technology could help stabilise portions of the grid.

With a larger, more interconnected supply chain, energy companies are going to have to monitor supply chain risks. Supplier risks can be seen in many contexts: there are reputational risks, chiefly linked to the potential for supplier conduct to have negative ramifications for the customer; commercial risks due to security of supply and pricing concerns; and security risks from cybersecurity breaches that can cascade further to the business.

The fast integration of ESG / Sustainability considerations into investment decision-making and regulations carries with it a new set of considerations around supplier behaviour.

The UK, for example, is planning to institute mandatory disclosure in line with TCFD across the economy. Additionally, human rights, labour issues, and climate performance of suppliers is coming under heavier scrutiny.

As such, vetting suppliers will become more important in the short-term, but in the long-term it will be necessary to ensure greater engagement with key suppliers to ensure that there is a collaborative effort to move forward on key issues like emissions: for example, without greener feedstock, companies will be unable to reduce their own emissions.

Commercial challenges

Supply chain failures across industries have been widely publicised, take for example the shortage of microchips has had knock-on effects across industries. For the energy sector, there will be increased strain on the supply of vital commodities, from basic resources like copper and rare earth materials to processed goods like steel and cements.

Ensuring continuous supply of affordable feedstock will become more critical, and price rises have already created financial hurdles for renewable energy OEMs and, by extension, developers and utilities.

Security challenges

Cybersecurity is a growing concern in the energy sector as electricity systems and grid infrastructure become more digital and the energy transition towards renewables advances. In fact, our data revealed cyber attacks and threats are the element that energy companies believe will harm them the most over the next 12 months.

The reason for this is simple: as energy systems become distributed as more wind and solar come online and electrification expands (i.e., electric vehicles, energy storage, smart meters) there is more opportunity for cyber attacks. As such, adversaries may choose to target a nation’s energy infrastructure as this has the potential to cause massive disruptions.

Third-party cyber risk is a unique issue in that while most organisations are aware of the significant threat it poses, many fail to implement an adequate risk mitigation strategy. Energy companies in particular will need to ensure that they create risk mitigation frameworks to avoid third-party risk due to the existential threat cyber attacks can pose to businesses and the energy system as a whole.

Resilience Barometer® - Energy Sector report

The realities of climate change are in greater evidence than ever before. As the world emerges from the COVID-19 pandemic, governments and businesses are facing crucial questions about how to best maintain and expand energy access in all corners of the globe in a manner that is sustainable and equitable. Meanwhile, the threats from rising temperatures and a failure to adequately address climate change have intensified. New policy frameworks are emerging that challenge the status quo, creating both risks and opportunities for companies across all industries.

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Navigating the Energy Crisis

Rising energy prices are a key concern for energy companies, as they add a new layer of risk to energy trading activities. The most significant risk brought about by the surge in prices is that of market contagion.

Responding to energy supply chain disruption

Caroline Das-Monfrais talks about the ongoing disruptions to the energy supply chain due to the recent sanctions imposed against Russia, and the need for operational and financial resilience in business strategy. Viktor Pomichal also explores how businesses can respond effectively to the energy crisis.

Resilience Barometer® - Energy Sector report

Building a path towards corporate resilience in the ESG era

ESG has become one of, if not the, greatest area of disruption, and transition - but also opportunity - for G20 businesses today.

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