South Africa’s proposed electricity industry reform: lost in translation?
By Stephen Labson, Consulting Economist; and Senior Research Fellow, University of Johannesburg,
South Africa’s ruling party recently proposed establishing a second state-owned power company. The purpose is to offset the “grave strategic risk” of relying on Eskom, the country’s monolithic state-owned utility.
Some 15 years of poor operational and financial performance, and disruptions to the nation’s electricity supply, led President Cyril Ramaphosa to speak of a “spectacular calamity” facing the nation should Eskom fail as a corporate entity. In his July address to the 15th National Congress of the South African Communist Party he said Eskom had been operating according to a model that is no longer suited to the technology or the economic conditions of the present.
Ramaphosa then reportedly held up China’s power sector as an example South Africa could learn from.
China’s experience is that supply shortages and a lack of investment in the sector during the 1980s led to the unbundling of the State Power Company in 2003. It was separated into five power generation companies and two transmission companies. The full legal separation from the State Power Company was critical because China wanted the private sector to invest in power generation. Investors had to be protected from the financial legacy of the State Power Company and allowed to compete.
Ramaphosa did not mention Australia’s experience of industry restructuring, but there are lessons to be learned there too.
In a nutshell, over roughly three years the Australian State of Victoria unbundled its State Electricity Commission. Brown coal, gas and hydro power stations were established as legally separate state-owned companies. Transmission was formed as a proprietary company. System Operations was established as an independent not-for-profit company with shareholder oversight. Grid rules were developed, an economic regulator was established to oversee network charges, and short-term bulk power supply agreements were vested with generators.
South Africa’s energy roadmap
South Africa’s government published its own reform options as a “roadmap” in 2019. It envisaged Eskom Holdings being unbundled into several state-owned power generation companies, transmission, and system and market operations.
The roadmap anticipated the reform process to take place over several years. Eskom would emerge with optimised operations, restructured finances and a sustainable business model. It would have “appropriate controls to ensure that the recent incidences of irregular, fruitless and wasteful expenditure are a thing of the past.”
Three years have already passed and these outcomes will not be achieved in the time frame given.
Transmission was to be established as a subsidiary of Eskom Holdings by the end of 2021. Generation and Distribution would be established by 31 December 2022. Generation, transmission and distribution divisions have already been formed. But this has been a condition of licence since 2005 and was part of Eskom’s corporate structure until 2010.
Why then is it taking so long to complete the task?
One line of reasoning is that it is impractical to restructure while the system is in such distress.
But the case of Victoria provides some perspective. The initial reforms undertaken in Victoria were driven by a group of perhaps 20 professionals in the Department of Finance, alongside a small number of senior officials of government. From this resource base, the necessary operational, commercial, legal, legislative, governance and employment structures were created to restructure Victoria’s electricity industry.
Certainly South Africa can source a similar level of domestic and international experts to avert the calamity feared by President Ramaphosa.
Last mover advantage
But it doesn’t have to end in calamity. Some solace can be found in South Africa being a “last mover”. Wholesale power trading arrangements such as those found in Australia and across Europe are now having to integrate new power generating technologies into legacy market structures. This has led to shortfalls in investment, supply constraints, and exorbitant increases in prices.
This recent experience may suggest that South Africa should focus on a relatively simple task. That is, separating Eskom Holdings into legally separate power generation companies, a transmission company and an independent system operator. It could leave market operations and commercial arrangements within Eskom Holdings.
Two points arising from international experience are worth expanding on.
The first point is that bundling transmission with system and market operations, as proposed in the 2019 Roadmap, funnels transactions and default risk through the transmission business. Market participants might require government guarantees, which would add to the national treasury’s burden. It would complicate and delay the establishment of the transmission company – the least complex element of electricity industry reform.
The second insight is about the impact of new generating technologies. Nowadays, relatively simple wholesale trading arrangements (perhaps based on bulk supply tariffs) are likely to outperform the more sophisticated real time wholesale markets established during the 1990s. The latter are now proving to be unworkable in systems that source a large proportion of power supply from renewables.
The simple unbundling of South Africa’s power sector alluded to by the president could herald a new era in South Africa’s energy future. It could allow well-run state-owned entities to flourish, and leave uncompetitive ones to be reshaped by market forces.
For example, underperforming or ageing power stations might be let under concession arrangements with private operators. Roughly speaking, long term leases containing a set of defined operational requirements would be agreed with the operator. The power station would remain under state ownership. This would provide a cash inflow to government and a reliable stream of power from the concessionaire.
Importantly, this new energy future does not imply a callous disregard for workers who might be made redundant in restructuring the industry. Any well planned reform starts with the consideration of those who have built the industry. Consider the R25 billion (about US$1.5 billion) of irregular expenditure that Eskom is reported to have accrued during the past two years. If the efficiencies expected from unbundling Eskom Holdings reduce this loss by even half, those funds could do much to address the needs of those displaced as a consequence of transitioning to an efficient and reliable energy future.
Electricity sector reform is really not that complex – it simply takes the will to do better.
What a new world order might mean for the global economy
Russia’s invasion of Ukraine has opened fault lines between nations which will affect trade relations and investment for years to come.
Keith Wade – Chief Economist & Strategist at Schroders
The war in Ukraine is already having a significant effect on inflation and activity in the world economy as commodity prices have soared and supply chains have been disrupted. Inflation in the G7 was running at more than 7% in April, its highest for 40 years, and will reach double digits in some countries such as the UK later this year. The conflict also marks a watershed moment as it challenges established assumptions about the balance of geopolitical power in the world economy. This has implications for future alliances, trade and investment.
In our view, the consequences of Russia’s invasion of Ukraine will reverberate for many years and will act as a further disruptive force on the world economy. In this note, we look at how the war could lead to a realignment of global powers, and a more regionalised world economy with implications for global supply chains and inflation.
Beyond Russia’s invasion of Ukraine: a new world order?
We start by looking at how the war may alter geo-politics and then ask how future trade and investment flows will be affected through changes to supply chains.
Although clearly important in energy markets Russia accounts for only a small part (2%) of global trade. It plays a relatively minor role in international investment and global supply chains or value chains (GVCs). At face value the impact of the war and sanctions would not seem to be a threat to overall globalisation.
However, the invasion of Ukraine has demonstrated the power of sanctions. It’s also opened up a divide between those nations who oppose the war and support Ukraine, and others who are with Russia. There is also a large group of countries which are taking a more neutral position and may at some point be pressurised into choosing sides.
In effect, the war has opened up a fault line between nations and will influence behaviour and investment going forward. Companies are now more aware of the political risks and costs associated with trade and foreign direct investment (FDI).
One of the first lessons from the Ukraine conflict has been the power of sanctions to isolate an economy from the global financial system. Russia thought it was well prepared, but found its war chest of $600-billion foreign exchange reserves ineffective. Access to them has been stymied in the face of sanctions such as exclusion from the SWIFT system, which is integral to making international payments.
Alongside the outcry from public opinion, such sanctions have meant Western companies have had to write off significant investment in Russia since the war began. Estimates from the United Nations Conference on Trade and Development suggest that two-thirds of the Russian FDI stock is held by companies domiciled in developed market (DM) countries opposed to the war. The top 10 holdings by multi-national companies amount to $105-billion, much of which has been written off.
Ignoring political risks can be expensive, but identifying them in advance is never straightforward. One approach is to look at how countries vote in international forums. For example, the recent United Nations (UN) vote to expel Russia from the Human Rights Council provides some clues as to where future alignments may lie.
The necessary two-thirds majority to expel Russia was achieved, with strong backing from the West, particularly the 30 NATO countries. However, there were some notable abstentions such as India, Brazil, South Africa, Indonesia, Mexico, Saudi Arabia and other nations from the Middle East. Meanwhile, Russia, China, Cuba, North Korea, Iran, Syria and Vietnam were among the 24 countries who voted against.
China and the risks of broader sanctions
Clearly, China stands out amongst the dissenters. The world’s second largest economy, it accounted for 18% of global merchandise exports  in 2021, the highest for a single country according to the World Trade Organization (WTO). China has also attracted considerable FDI as companies seek direct exposure to the Chinese market. In 2021 it was the second largest recipient and the fourth largest source of FDI.
United by a mistrust of Western institutions and particularly NATO, Russia and China have formed an alliance which has “no limits”, indicating scope for broad-based co-operation. From an economic perspective, the two are complementary as Russia seeks more sophisticated technology and China is very commodity-dependent. It may also be possible to trade the Chinese yuan against the Russian ruble outside of SWIFT and free of Western sanctions.
So far China has been careful in what it says about the Ukraine crisis and at this stage there has been no acceleration in trade with Russia. As the friendship develops, however, there is a risk that support for, or even a lack of opposition to Russia will be interpreted in a hostile way and ultimately attract sanctions from the West.
One potential flash-point is in energy markets, where sales of gas and oil have been critical in funding the Russian military. As a consequence of sanctions there is a significant discount on Russian oil, currently $25/barrel (see chart 1, below) which offers a substantial saving on energy costs and a competitive advantage for those economies who are prepared to buy it.
Some of that discount is eroded by refining and insurance costs, but with the EU and US set to embargo Russian oil, the saving on Urals crude is expected to persist. The discount has certainly already proved sufficiently attractive for India. It has become a significant importer of Russian oil, increasing its share of the country’s exports to 18% from 1% before the conflict in Ukraine. India and China now account for about half of Russia’s marine bound oil exports.
Consequently, we can expect tensions to build and it will not be long before we hear a call for tariffs or other measures on those supporting Russia through trade. Such action could be seen as being in the same vein as the EU plan to impose carbon tariffs on imported goods which are heavily reliant on burning fossil fuels. Russian aggression rather than climate change would be the target, but the measures would be the same.
China’s relations with the West: a balancing act
Before we go too far along this path though, we should remember that China will try to strike a balance. China’s prosperity is based on international trade, mostly with the West. The US-China trade route is still the busiest in the world and increased trade with Russia cannot compensate for the potential loss of US or EU business.
Meanwhile, the West is well aware that the growth in China trade has been one of the major drivers of globalisation. The increased supply of low cost Chinese goods has played a key part in suppressing inflation (see chart 2, below, for the link with US retail sales) and, by raising global labour supply, putting downward pressure on wage costs in the developed markets.
Should the West extend sanctions to those nations seen as supporting Russia and prolonging the conflict in Ukraine, global growth would be weaker as international trade slows. China would be badly affected and would struggle to counter the loss of US and European trade. However, the impact would also be felt in the West through faster global inflation and an even greater cost of living crisis.
Such a stagflationary outcome means that mutual interests in the global trade system are likely to prevail and both sides will tread carefully to avoid an escalation in tensions over Russia.
Another blow to globalisation
Nonetheless, the conflict in Ukraine clearly sets the stage for an increase in geopolitical tension as a new world order emerges. In this respect the risks have risen and hence deal another blow to the globalised model of extended supply chains. When making decisions over where to locate production, multi-national companies will be weighing the risk of adverse political outcomes against the benefits of more efficient operations.
That model has, of course, already come under strain from Brexit, US trade wars with China and the Covid-19 pandemic.
The latter exposed the weakness of far-flung supply chains and remains an issue as China’s zero-Covid policy continues to delay deliveries. The trade war between the US and China has also injected a degree of caution. Tariffs and restrictions on technology have increased such that FDI into China has slowed.
For the UK, Brexit has caused major disruption in supply chains as international firms grapple with the complexities of producing goods across different trade jurisdictions.
Meanwhile, climate change acts as a continuing threat in the background with the potential to disrupt supply routes and production facilities.
Not surprisingly, “just in case”, is replacing “just in time” as the guiding principle for firms seeking to make their supply chains more resilient.
Options for future trade
This presents several options. We may see increasing capital flows into other “friendly” lower risk countries as alternative locations for FDI. Companies may hold more inventory, there may be more onshoring of overseas production, or simply less output as the extra risks deter expansion.
Increased FDI to lower risk countries
Companies holding more inventory
More onshoring of overseas production
Less investment, less output
The first of these options would be preferred from an economic perspective as it would sustain global trade, albeit on a more regional basis. Estimates from the McKinsey Global Institute suggest that 15-25% of global goods trade could shift to different countries over the next five years. The result would be that a broader set of countries will participate in GVCs in the years ahead. Our earlier analysis on US-China decoupling also provides some scenarios.
Alongside this we are likely to see a simplification of production processes as has been apparent in the reduction in semi-conductor chips in the auto industry and greater standardisation, such that inputs can be sourced from a wider group of suppliers.
The result may be a departure from the optimal allocation of capital, but efficiency losses would be minimised. In effect, supply chains could become simpler and more diversified, an outcome acceptable to economists and risk managers alike.
Increasing inventory – the second potential option – is probably the most obvious: building buffer stocks into the supply chain. This would be a reversal of the more efficient just in time model which helped drive significant declines in the inventory-sales ratio in the first decade of the century. These declines occurred between China’s ascension to the WTO and the global financial crisis (GFC).
However judging from recent trends in the US there has already been some increase in inventory-sales ratios in recent years and prior to Covid (see chart 3, below). This may not reflect the broader international picture, but could be attributed to low interest rates after the GFC which reduces the cost of funding inventory.
Going forward, inventory is likely to rise given its low cyclical position and as firms choose to hold greater stocks in the long run to guard against disruption, but higher interest rates may temper this move.
The third option of more on-shoring through bringing supply chains home would boost domestic activity, but clearly represents a retreat from globalisation. The supply chain may become more robust and resilient to global shocks, but security comes at a price. For example, moving production from Asia back to Europe can be expensive. Although the ratio of workers’ wages in the US compared to China has fallen from over 30 in 2000, it was still five times in 2018 (the latest figures available).
The increase in transport costs (shipping and fuel) helps offset this, but higher labour costs mean that increased onshoring will come alongside greater investment in robotics and artificial intelligence (AI). Higher productivity will be needed to stay competitive. One of our longer run themes or Inescapable Truths – accelerated technological change – will be strengthened by the search for more resilient supply chains.
The fourth outcome, less investment, is the worst outcome as it would simply mean less trade, weaker growth and lower income.
In practice we will probably see a mix of all four options: diversification of supply chains to “safer“ countries, more inventory and onshoring and some withdrawal from international trade.
Stagflation as the risk premium on globalisation rises
What does this mean for investors? The reverberations from Russia’s war with Ukraine point to a new alignment of nations. Tensions over the war are likely to lead to a more fragmented or regionalised world economy.
In macro terms this means less efficiency, higher costs and slower growth i.e. more stagflation. Global supply will be more disrupted and in this respect inflation will be harder to control. The challenge for central banks in keeping inflation to target will be greater, making interest rates higher and more volatile.
There will be bright spots as the search for greater security of supply should encourage greater adoption of technology. Firms will need to counter higher costs through higher productivity. Wages should be stronger as a result, although overall global employment would be lower particularly in the emerging markets.
The war in Ukraine will intensify the focus on the risks of globalisation and raises geopolitics up the agenda for business and investors. Trade and investment help bind countries together, but when they unravel the costs are significant.
 China plus HK, China (WTO)
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The global electric vehicle (EV) demand is surging
Today there are roughly 16 million active EVs majority of which are Chinese
The last decade has witnessed tremendous growth in global electric vehicle (EV) sales. From about 130K EV units sold in 2012, today, up to 16M of these are in active service worldwide. Part of that growth is due to declining prices of lithium-ion battery packs that are crucial to powering them. Additionally, there’s been an increase in global consciousness on sustainable transport means.
BanklessTimes has been researching the global EV sales trends. In a recent data projection, the site indicates that the global EV sales hit the 6.6M mark in 2021. That figure represents roughly 9% of global car sales in that year. Additionally, it’s double the 3M EVs sold in 2020 and triple the 2.2M units sold in 2019.
Further, BanklessTimes reckons that the annual electricity consumption of the 16M EVs plying our roads is about 30 terawatt-hours (TWh). That’s equal to Ireland’s electricity generation yearly. These are an important ally in the fight against CO2 emissions as they have cut down consumption of fossil fuels.
China Leads in EV adoption
BanklessTimes’ compilation shows December as the month that attracted the most EV sales. Across the three leading EV markets, December’s sales more than doubled January’s. Again, 2021 monthly EV retails outdid 2020’s corresponding months’ figures by at least 50%.
The data shows that China is the largest EV market in the world. In 2021, it retailed 3.4M units. That was more than the combined total from the rest of the world in 2020. To get there, it had nearly tripled that year’s sales.
China has been at the fore of EV adoption for a while now. From 2015, it has had the fastest yearly increases in that space. Its EV market is on course to meet the government-set target of 20% share of yearly motor vehicle production by 2025.
Why’s the Chinese market booming?
Several reasons explain China’s thriving EV market. First, Beijing extended subsidies to the sector up to this year. The chances are that many Chinese EV customers rushed to acquire their vehicles using 2021’s subsidy levels that are way higher than this year’s.
Secondly, there’s a wide variety of EVs for the Chinese market. Like the Wuling Hongguang Mini, some provide an affordable entry-level vehicle for first-time owners. All in all, China’s e-car industry will boom in 2022.
EU EV sales outpaced diesel vehicles
Europe, the second most significant EV market, also posted impressive returns. According to BanklessTimes’ presentation, its 2021 electric vehicle sales amounted to 2.3M cars. However, the annual increase lagged compared to 2020’s.
In 2020 the European EV market doubled its 2019 sales. Strict emissions limits that the region adopted partly account for this surge. Again, most of the region enhanced their incentives for purchasing EVs.
Consequently, their sales peaked in Q4 2021, attaining a 21% market share in December that year, outpacing diesel-powered vehicles for the first time.
Tesla dominates the U.S EV market
The U.S electric vehicle market also posted encouraging results. It sold over 500K units, more than doubling 2019 results. That saw the U.S EV market grow to 4.5%.
Tesla remains the undisputed market leader here. It controls more than 50% of all electronic vehicles sold here. That, however, is a decline from the 65% market share it held in 2020. Increased competition in this space partly contributed to the decline.
Global EV sales have, however, been lagging. Today, electric cars account for under 2% of their total sales in markets outside the three dominant ones. This is in part due to the expensiveness of EVs and them having an inadequate charging infrastructure.
By Old Mutual Wealth Investment Strategists Izak Odendaal and Dave Mohr
These strange times have become even more unusual. Despite the enormous efforts to reduce the demand for carbon-emitting fossil fuels, their prices have shot up in recent weeks.
The upcoming COP26 Glasgow Climate Summit could ironically take place against the backdrop of coal and natural gas prices at record levels and oil at multi-year highs even though the share of renewables in the global energy mix has thankfully risen steadily.
Chart 1: Futures prices for coal, gas and oil, US$
A perfect storm
It is a perfect storm of events that got us here. On a positive note, demand for energy has increased from the lockdown-induced lows. For instance, IATA estimates a 26% growth in airline passenger numbers between 2020 and 2021, though they are still more than 40% below 2019 levels. However, this improvement in demand has not been met by rising supply. On the contrary, several factors have constrained supply.
One is simply the weather. Northern Europe relies heavily on electricity from wind, but it has been less windy than usual. Droughts in Brazil, China and the US mean hydro-electrical production has also been lower than normal. This has led to increased demand for natural gas and coal. However, natural gas inventory levels have been lower than usual at storage depots across Europe. This has created an opportunity for Russia, Europe’s main gas provider, to flex its geopolitical muscles and go slow on deliveries, although it has indicated a willingness to stabilise the market recently. With winter looming, natural gas prices in Europe have gone stratospheric, pulling up prices in other parts of the world.
In China, flooding has disrupted domestic coal production. China is already the biggest consumer of coal in the world, but demand has increased recently, and with it, its price. Geopolitics play a role here too. China blocked Australian coal imports, about a tenth of its total last year, after Australia questioned the origins of the coronavirus. Imports from Mongolia have also been disrupted by Covid.
Chinese electricity prices are heavily regulated, and utilities cannot freely pass on the cost of higher coal prices to customers. Many have opted to cut back on production, rather than sell at a loss. Beijing has now announced that selling prices will be allowed to rise somewhat. All this has happened at a time when local governments were already reducing electricity production from coal to curb air pollution and carbon emissions. The net result is something South Africans know well: widespread load-shedding.
Finally, in terms of oil, OPEC (along with Russia) has largely maintained the production cuts it put in place last year to prop up the oil price. In other words, there is no fundamental shortage of oil. Supply is being deliberately held back. OPEC can increase supply if it worries that high prices will choke off demand, but for now, its members seem comfortable with the revenues flowing in. Importantly, the price increase has not yet led to the associated increases in American shale oil production as has been the case over the past decade. Shale producers have largely abandoned the old production-at-all-costs mindset in favour of maintaining profitability and shareholder returns.
Chart 2: US oil prices and production
An associated factor is that these companies and their peers face increased difficulty in accessing the funding needed to increase short-term (in the case of shale) and long-term production (in the case of the oil majors). Banks and asset managers across the world are phasing out exposure to fossil fuels and some have already cut all ties. This has contributed to steep declines in capital expenditure by fossil fuel producers.
In other words, the big move among global investors towards embracing environmental, social and governance (ESG) principles might have the unintended consequences of higher fossil fuel prices until such time as renewable sources reach critical mass.
Chart 3: Capital expenditure by listed oil, gas and coal companies
The good news is that elevated fossil fuel prices do create a strong incentive to increase investment in alternatives. This is where ESG can play a big role to make sure the alternatives are green, not brown. Economists have long argued that the best way to tackle climate change is to put a tax on carbon emissions. This is because the price we pay for a tank of petrol, for instance, covers the cost of production and distribution but not the cost of the associated air pollution. Since the cost of this externality is not included, petrol is too cheap. This leads to excessive demand. A carbon tax raises the price to its “correct” level and lower demand. The recent price increases could therefore achieve a similar effect.
A tax on your houses
Increased energy prices act as a tax for most consumers. Most of us have no choice but to fill up our car. If you live in the snowy Northern Hemisphere, you have little choice but to heat your home with gas.
In other words, this will be a drag on global consumer spending, the question is just for how long will prices remain elevated. It is somewhat compensated for by the excess savings that households in the rich world have built up, but it also appears that most of the excess savings are concentrated in the hands of more affluent households. Meanwhile, it is lower-income households that are most exposed to increases in energy prices and associated rises in food prices. Nonetheless, it is worth pointing out that at around $80/barrel, the oil price is nowhere near the $150/barrel record set in 2008 on the eve of the global financial crisis, or the $100+ levels that prevailed between 2011 and 2014, especially adjusted for inflation or growth in incomes.
The other complication is that these price increases come at a time when inflation rates are already elevated. The global production and delivery of goods are already severely constrained by Covid-related disruptions, shortages of inputs and labour, and logistical bottlenecks. But now production in China, the world’s factory, has to contend with electricity blackouts. This is likely to worsen the supply chain problems already besetting the world economy.
People often confuse higher fuel prices with inflation. Fuel prices are very visible since most motorists have to fill up at least once a month. But inflation refers to sustained price increases in a broad range of consumer goods and services. Energy is a component in consumer price indices and therefore higher energy prices do have a direct short-term impact. But the big question is whether firms can raise their selling prices to compensate for higher input costs. In this way, higher energy costs ripple through the economy. If workers then demand higher wages to compensate, we have the beginnings of a wage-price spiral. This clearly requires pricing power on the part of firms and bargaining power on the part of workers that have been absent for many years. However, in the current Covid-distorted global economy, there have been signs of both.
Winners and losers
There are clear winners from this energy crunch. Net exporters of coal, gas and oil are clearly smiling, particularly countries such as Nigeria that have really struggled until recently.
In contrast, many countries are energy importers and face not only higher inflation rates, but also potentially balance of payments problems as they need to cough up more of their scarce dollars for each barrel of oil. Compounding matters, this comes at a time when the US Federal Reserve is planning to scale back its monetary stimulus, which has put upward pressure on the dollar. Some developing countries, therefore, face a triple whammy of higher energy costs, a weaker currency, and domestic central bank interest rate hikes aimed at stabilising exchange rates and inflation.
South Africa has one leg in this camp as an importer of petroleum products. The rand has been on the back foot in recent weeks, and this means a big petrol price increase is on the cards for next month.
However, we are also the world’s fifth-largest coal exporter (behind Australia, Indonesia, Russia and the US) and the rising export revenues limit downward pressure on the rand. Coal exports would be even higher if not for the capacity constraints on the Transnet rail corridor from the Highveld to the coal terminal at Richards Bay.
It also helps that inflation has been relatively stable in South Africa, with price increases excluding food and energy costs running at only around 3%. The SA Reserve Bank’s latest forecasts suggest that inflation should stay close to the 4.5% midpoint of the target range over the next two years. However, the risks are clearly to the upside. A gradual interest rate hiking cycle is therefore likely to commence in the next few months. How gradual will depend on where energy prices settle and how the rand responds. The Reserve Bank will also keep a close eye on what other central banks are doing, particularly the US Fed.
Oils well that ends well?
In summary, it is a delicate moment for the global economy, and could end up being a long, cold winter for people in the Northern Hemisphere. The big risks are a slowdown in consumer spending, further disruptions to production and persistent inflation that forces central banks to tighten monetary policy sooner than they’d like. None of this is good for markets.
However, it is worth repeating that the underlying cause is the strong recovery in demand as the world gradually puts the pandemic behind it. This is good. Moreover, energy prices are notoriously volatile. In April last year, a key oil futures contract briefly traded at a negative price. Traders were willing to pay to get rid of the oil rather than take delivery. The most recent price moves in gas and coal also have all the hallmarks of panic-driven trading, and therefore are unlikely to be sustained over time. Investors in diversified portfolios should similarly avoid making panicky moves in response to the recent dramatic headlines. The current situation is the result of a nasty confluence of events, and some of the contributing factors on the supply side could ease.
Finally, in the current context, it might be worth remembering that 13 years or so ago, “Peak Oil” was a dominant investment narrative. It was believed that the global supply of oil would peak and this justified prices surging to $150/barrel and beyond. The opposite turned out to be the case. Today, we’ve probably already passed the point of peak oil demand due to the rise of electric vehicles. Demand for coal could prove stickier, while natural gas could increase in importance as a “bridging fuel” while the world transitions to renewable sources. However, short-term price movements are clearly going to remain unpredictable.
This is relevant when thinking about investments more broadly. Dominant narratives can lead you astray. Just because you read about a “megatrend” or “structural change”, whether it is ESG, clean energy, blockchain, biotechnology, or demographic shifts, doesn’t mean that there is easy money to be made. It could be priced on already, or simply overhyped. You could be way too soon or too late already. Maintaining appropriate diversification across different asset classes and within each asset class remains the best way of investing, even if it sounds boring.
China finances most coal plants built today – it’s a climate problem and why US-China talks are essential
As nations gear up for a critical year for climate negotiations, it’s become increasingly clear that success may hinge on one question: How soon will China end its reliance on coal and its financing of overseas coal-fired power plants?
Jeff Nesbit Research Affiliate, Yale Program on Climate Change Communications, Yale University
China represents more than a quarter of all global carbon emissions, and it has spent tens of billions of dollars to build coal power facilities in 152 countries over the past decade through its Belt and Road Initiative. Roughly 70% of the coal plants built globally now rely on Chinese funding. That’s a problem for the climate. The International Energy Agency warns in a new analysis that if the world hopes to reach net zero emissions by 2050, widely seen as necessary to meet the Paris climate agreement goals, there should be no investment in new fossil fuel supply projects or in new coal-fired power plants that don’t capture their carbon emissions. Shortly after that report came out, the G7 group of leading industrialized democracies called for an end to international financing of unabated coal projects on May 21, 2021.
US presidential special climate envoy John Kerry was asked pointedly about China’s progress on climate change when he testified before the House Foreign Affairs Committee in mid-May.
Chinese President Xi Jinping had called climate change a “crisis” during a world leaders’ summit on climate change a few weeks earlier, but Kerry said talks between the two countries grew “very heated” over China’s continued insistence on financing coal-fired power plants around the world.
While he stopped short of saying it explicitly, Kerry made the US position clear: China’s climate pledges won’t be credible or legitimate until it stops overseas coal financing. “We’ve got five more months left to get them to embrace something we hope you will view as legitimate,” he said. “We’re not there yet.”
China has been the world’s largest carbon emitter for 20 years. It’s been responsible for 28% of the world’s carbon emissions for the past decade. That number hasn’t budged, despite rapid growth of China’s renewable energy and clean tech industries. One of the central reasons is coal, the most carbon-intensive fossil fuel. Coal accounted for 58% of China’s total primary energy consumption as recently as 2019 – even as coal use was collapsing elsewhere. China currently operates 1,058 coal plants, roughly half of all coal plants worldwide. To meet even its modest climate goals, it will have to shut down more than half of them, according to a recent analysis by TransitionZero, a U.S.-based thinktank.
It has also made a strategic decision to export its industrial and manufacturing might across the globe under its Belt and Road Initiative. Japan and South Korea, which traditionally financed overseas coal projects, have started to abandon them, and China sees opportunity. Nearly all of the 60 new coal plants planned across Eurasia, South America and Africa –70 gigawatts of coal power in all – are financed almost exclusively by Chinese banks.
It’s clear that China is juggling energy security and economic growth concerns. That’s why analysts were surprised when Xi announced in late 2020 that China would be carbon neutral by 2060, a decade earlier than planned, and make sure its carbon emissions peaked before 2030.
Seasoned climate negotiators are watching what China does with coal today – not just the pledges it makes that are 10 or even 20 years in the future.
The U.S.-China climate relationship was central to reaching the Paris climate agreement, Todd Stern, former U.S. climate negotiator, has said. Failure to revive such engagement “would have grave national security consequences in the United States and around the world.”
But talk isn’t action. The world will expect both to commit to measurable actions ahead of the United Nations climate summit in November. Countries are expected to strengthen their pledges this year – hopefully enough to keep global warming in check. I worked in both the George W. Bush and Barack Obama administrations and have been involved in climate change issues for several years. It’s clear that if China and the US don’t lead the way, the world won’t get on track to meet the Paris climate goals.
China has reason to cooperate on climate change
China is already planning for a world in which fundamental natural resources like water and food grow scarce because of climate change. For example, when China saw a looming threat to its ability to grow enough soybeans, due in part to climate change, it went from importing virtually no soybeans to importing more than half the soybeans sold on Earth. I outline the reasons for this tectonic shift in my book “This is the Way the World Ends.”
China also sees economic opportunity in solving the climate crisis. It is mining raw materials essential to battery storage solutions at the heart of a global renewable energy industry; building cheap electric vehicles as fast as it can for domestic and foreign consumers; and aggressively subsidizing solar panel manufacturing and exporting those panels worldwide.
China lost the tech revolution race that defined the global economy of the 20th century. It does not intend to lose the renewable energy and clean tech revolution that will define the 21st. But even that imperative has not kept China from financing the world’s reliance on coal-fired power. Which is why climate negotiators hope China does more than make promises for the future. Ending coal financing overseas would be a serious first step in that direction.
Courtesy: The Conversation
Jeff Nesbit is affiliated with Climate Nexus, a not-for-profit communications group dedicated to highlighting the impacts of climate change and clean energy solutions in the United States.