Corporations must prepare for a greener energy mix. The transition starts now
When it comes to energy, organizations are faced with a potentially explosive set of circumstances. In the second half of 2021, oil prices hit a three-year high; natural gas prices hit record levels too, amid ‘energy crisis’ headlines (in Europe at least). With an increasing global political focus on climate change, there is a spotlight on the role of renewables in meeting our future energy needs in the ‘net zero’ era – and the challenges of transition.
Our energy challenges require both action from individual organizations, and collective, co-ordinated steps. Firms must act now by aligning their strategic objectives and operational structures with efforts to mitigate the negative impact of climate change. And collective action must be taken to better manage the fundamental forces distorting the supply and demand equilibrium.
The need for electricity was curbed by the pandemic, as it was by the 2008 financial crash – yet demand still exceeds the current capacity of renewable energy sources (RES). Despite notable improvements since 2008, the capacity of RES as a proportion of total demand is stuck at the levels of the early 1990s. Furthermore, new technologies designed to curb carbon emissions, such as electric cars, are creating even greater asymmetry of supply and demand. This distorted equilibrium results in macroeconomic conditions – such as inflated energy and commodity prices, lack of resources and disrupted supply chains – that are highly unpredictable, and pose significant challenges to all facets of economic activity.
There are two primary reasons why renewables still fall short of meeting the world’s needs. The first is that the technology for renewable energy generation is not yet cost-efficient. However, it is improving rapidly. Some small-scale ventures show great promise. For instance, the Greek island of Tilos is the first energy self-sufficient island in the Mediterranean, thanks to its investment in renewables. Other regions are likely to follow its example.
The second key factor is that while energy consumption patterns are predictable, energy generation from RES is not. There is regularly either a deficit or surplus – which makes storage essential. Efficient options are still a way off, although private entities like Tesla, as well as national governments, are making significant investments in improving storage capacity.
These factors contributed to the supply chain disruptions witnessed in 2021 – the result of inelastic energy demand, compounded by constraints resulting from the pandemic, leading to unrealistically high prices for the most popular transition fuel, liquefied natural gas. The episode exposes our collective inability to disengage from conventional fuel and rely more on RES, and presents corporations with a rapidly shifting and challenging environment. Yet given the damage done by carbon emissions, there is no doubt that RES needs to rapidly become a bigger part of our energy supply.
The agenda for business
How can organizations prepare for this transition? Corporations should already be focusing on five important areas.
1 Adjust to new regulation We will see the arrival of new regulations to curb resource use and limit corporations’ environmental impact. Businesses should plan for this and integrate the notion of ‘responsibility’ into their strategy. Corporate social responsibility (CSR) may sometimes look counter-productive and cost-inefficient, but in the longer term, firms that do not comply with ever-stricter regulations around the world will become cost-ineffective anyway. CSR should be seen as a protective mechanism against adverse incoming regulation.
2 Finance their decarbonization projects At the corporate level, the decarbonization process will need funding – not always straightforward when the financial world seeks fast returns. Environmentally-friendly approaches like paper straws or recyclable packaging may be easy to implement, and even create competitive advantage and higher profitability. However, reducing a carbon footprint might be cost-inefficient in some industries, such as transportation, aviation, manufacturing and so on, where energy consumption and waste management are sizeable.
A shift towards a lower carbon operational level would be a capital-intensive strategic move; conventional financing tools would be prohibitively expensive. Therefore, corporations must act swiftly to find alternative ways to finance decarbonization. Energy subsidies, green bonds, crowdfunding and other methods are promising, but they each require certain conditions to be met. This must be done internally, with full leadership commitment to achieving change.
3 Insurance Climate change and energy dependency risks will become ever more prominent. Financial innovation will lead to financial products that are specifically designed to finance energy transition, but also offer the necessary insurance covenants to mitigate energy-related adverse effects. In Europe, the summer of 2021 was the hottest on record: the fires that followed made it clear that environmental risk is a reality that has to be addressed. Coordinated governmental action is likely, but firms must also act individually to mitigate their risks with specific insurance products that aim to protect their operations. The financial services sector is responding to this – albeit slowly – by providing custom-made insurance products. Expect these to become more mainstream.
4 Adjust quickly to demographic shifts Younger generations are strongly aware of environmental and energy issues. As a result, aggregated consumption is expected to shift rapidly, and corporations must re-design their strategies to target younger market groups. Firms that offer goods and services with elastic demand might find it easier to adjust by re-branding their products in a more environmental context, but other sectors such as the car industry will need intensive investment in research and development. It would not be surprising to see big ‘brown’ players replaced very rapidly by new ‘green’ competitors.
5 Dependency on the grid Corporations, like individuals, are end users of energy, and will need to adjust their energy consumption habits in light of new trends. Because of their size and inelastic demand, corporations will be major players and should design their operational structures accordingly. It is not unrealistic to expect that, when smart meters have 100% penetration, utilities will offer dynamic pricing. Consequently, companies will have to optimize for energy costs across their production, storage, and delivery activities. This will be a challenge for large and small businesses alike; many small and medium enterprises might need the help of energy consultants, a profession that is likely to become increasingly important.
The economic impact of climate change is undeniable. The rather hectic responses of the past, at micro- and macro-economic levels, are set to change drastically. Governments have already started reacting. Now is the time for firms to start building a future around renewable energy – or prepare to face some fierce green competition.