As world energy leaders prepare to kick off a major United Nations conference on climate change on Sunday, the global energy crunch has added a new wrinkle to their ambitions: Nations, to keep their economies on track, are turning back to high-emissions coal as natural gas falls into short supply.
With the energy crunch, countries have been turning to coal to heat homes and keep factories humming.
But as severe as the energy squeeze has become, it is likely to prove little more than temporary as leaders at the UN Climate Change Conference of the Parties, or COP26, in Glasgow convene to discuss goals to reach global net-zero carbon emissions by 2050—the benchmark to stop climate change, according to scientific consensus.
A combination of economic incentives, government mandates and technological developments has already resulted a slowing of carbon emissions, and this push will only continue, even with the current setback.
The term “net zero” refers to the balance between the amount of greenhouse gas produced and the amount removed from the atmosphere. Net zero requires the elimination of coal, which countries have been replacing in favor of natural gas, which produces less carbon.
Yet with the energy crunch resulting in record-breaking gas prices and historically low inventories, countries have been turning to the reliable and cheap—albeit carbon-intensive—substitute of coal to heat homes and keep factories humming.
China, for example, relaxed coal pricing while looking abroad to buy coal in an effort to provide electricity for residential and industrial use. In Europe, utilities have made the switch to coal to generate electricity for the winter, which is projected to be colder than usual. In the United States, coal production is the highest it has been in nearly a decade.
Coal is also partly responsible for natural gas prices leveling off since early October, as some pressure on the limited gas inventory is released.
The middle market
For middle market businesses, there is no way around it: In the short run, high energy prices are inevitable. The perfect storm of pent-up demand amid a global pandemic coupled with low gas inventories have pushed prices into historic highs.
While middle market businesses internationally will feel the impact of the energy crisis, keep in mind that gas price hikes in Canada and the United States, where gas is plentiful, are only a fraction of the increases in countries without a reliable domestic supply.
In the short run, there are few immediate solutions since demand for energy is often inelastic and difficult to adjust. But in the long run, businesses should invest to increase their energy efficiency and explore alternative sources, using government incentives, to hedge against energy price fluctuations.
While coal is the current substitute, its production is unlikely to stay elevated once gas production catches up.
The true cost of coal
To curb carbon emissions, governments in the European Union, Canada, China and elsewhere have implemented carbon pricing programs. Economic incentives to deter the production of carbon by putting a price tag on it are an essential tool to achieve net-zero emissions.
While coal remains cheap, it emits about twice the amount of carbon as natural gas. Once carbon prices are factored in, gas often comes out ahead in cost. As a result, coal use in most European countries decreased for years before the pandemic.
If world leaders stick to their climate commitments, regulations will make it even more expensive to emit carbon. Canada, for example, implemented a federal carbon tax that is set to increase annually until it reaches CA$50 per ton in 2022, and CA$170 per ton in 2030 for industrial use.
The carbon markets mean that once gas supplies increase, driving its price down, gas will most likely be cheaper and the current rush to coal production will not last. In addition, as technological developments make solar and wind energy cheaper to produce, coal and other carbon-intensive energy sources will look less appealing to households and businesses.
Production of natural gas will ramp up
Simple economics led to the global energy crunch: low gas supplies and high demand. Natural gas inventories this past summer reached their lowest level in five years. Producers had already been cutting back, and they doubled down when the pandemic further lessened demand last year.
While gas companies have been caught by surprise this year, production will inevitably ramp up to meet demand. In western Canada, natural gas production is already at the highest level in years and continues to be on the rise.
There is a time lag between when demand increases and when production can catch up, because it takes time to get the infrastructure ready.
So while some producers remain cautious, having been burned by periods of low prices in the past decade, the market will respond when demand is hot enough and money is on the table. And that is already happening.
Pent-up demand is temporary
Helping push inventories to such low levels is the pent-up demand among consumers, which is a direct result of people staying home over much of last year without outlets to spend on while piling up on cash reserves.
This excess of savings, combined with the reopening of the economy, has caused a surge in demand for consumer goods, air travel and in-person events, all of which elevated energy usage. Still, pent-up demand tends to be short-lived and will eventually revert to a manageable level.
The takeaway
Middle market businesses should expect elevated energy prices throughout this winter. Eventually, market forces will work to bring greater balance. Gas production has already increased to address the gap between supply and demand, but in the meantime, coal is helping to fill that gap.
Expect energy prices to remain volatile during such a major, all-encompassing transition to a net-zero future; if anything, the pandemic has only amplified this volatility.
The recent energy crunch—and the return of coal—is just one of the many bumps that will inevitably take place in this energy transition. Businesses that keep their focus on the long term will in the end be in better position to capitalize on a carbon-neutral future.
