Pathways and obstacles to a
low-carbon economy
The
energy transition is happening. But the pace of change depends on a range of
technical, business, and societal factors.
Technological advances and falling
prices are driving the momentum toward low-carbon
energy production across the globe. In this episode McKinsey partner Arnout de Pee and Lord Adair
Turner, chair of the Energy Transitions Commission and the Institute for New
Economic Thinking, speak with McKinsey Publishing’s Cait Murphy about the shift
toward renewable resources and the future of sustainable development.
Pathways and obstacles to a low-carbon economy
Cait Murphy: How can the world produce the energy it needs to
broaden prosperity without damaging the environment beyond repair? The Energy
Transitions Commission, whose members comprise leaders from the public,
private, and social sectors, is dedicated to answering that question.
Speaking with us today is Lord Adair
Turner, head of the Energy Transitions Commission, and Arnout de Pee, a partner
at McKinsey’s Sustainability and Resource Productivity group. I’m Cait Murphy
of McKinsey Publishing.
Let’s start with the broad question. Lord
Turner, what is meant by the term “the energy transition,” and why is such a
transition necessary?
Lord Adair Turner: The term “energy transition” describes the fact
that over the next several decades, we are going to have to achieve a really
dramatic transition in the world away from reliance on fossil fuels. Fossil
fuels have been absolutely essential to the original industrial revolution, to
the growth of prosperity that we’ve achieved in an increasing number of
countries over the last 200 years.
In order to limit global warming to below
two degrees centigrade above preindustrial levels, we will have to really very
significantly move away from fossil fuels, while still delivering in many
countries even more energy use than there is today.
And that’s what we mean by the energy
transition; how do we build economies using enough energy to deliver prosperity
for everybody, but with much reduced carbon emissions.
Arnout de Pee: One word to stress here is also the economic
implication. So, for many nations, it is no longer only an energy transition,
but also an industrial or an economic transition away from the activities and
the way energy is being produced, the way goods are being produced, the way
goods are being transported, and people are being transported to new forms and
ways of that.
Cait Murphy: How will the energy transition look across
different regions such as Asia, Africa, Europe, and North and South America?
Lord Adair Turner: Probably to have a reasonable standard of living,
you need to consume maybe 80 to 100 of what are called gigajoules of energy per
capita per annum. The European Union’s average is now about 130. We could get
more efficient and still have our standard of living.
America uses about 200. They could get
much more efficient. A country like India is still only consuming about 25
gigajoules per capita, so even if it gets much, much more efficient, if it’s
going to have a prosperous lifestyle, they’re going to consume a lot more
energy. So, first of all, we have some countries where the challenge is
actually reducing energy use, others where it is growing, but not growing
energy use as much as you grow in prosperity. That’s one big difference.
Arnout de Pee: I think the dimension to add is also the
composition of the economy. There is a large difference between being a service
economy versus being heavily industrialized. Given that, for instance, China is
moving more and more to a service economy, their pathway toward decarbonization
is going to be very different from those countries that are going to be
building up industrial activity. So, I think that that’s another angle to the
problem that makes China different from India, makes it different from
Malaysia.
Cait Murphy: If the goal then is to change the way that goods
are moved and produced and how people get around, how do we get there?
Lord Adair Turner: So, we’ve just got to get much more efficient at
how we get prosperity out of the energy we use. But whatever the energy we use,
we’ve got to increase the extent to which that comes from zero-carbon sources.
And it’s those two things, use energy more
efficiently and decarbonize, as we call it, the sources of energy; put those
two together and we can drive CO2emissions down to the level which
is required to stay well below two degrees. It is, however, a very big
challenge upon both of those dimensions.
Cait Murphy: How do we get there in terms of specific technologies?
Lord Adair Turner: We know how to take the carbon out of electricity
production.
We know that there is a collapsing price
now of renewable energy from solar photovoltaics or from wind. And that means
that if you combine that with batteries, which are also collapsing in cost, or
with gas turbines as backup, we are very confident that we will be able within
15 years to build energy systems—electricity production systems which rely
almost entirely on renewables and which produce all the electricity that we
eventually need—at a price of only seven US cents per kilowatt-hour.
And that’s completely competitive with
fossil-fuel production. We can start having cars or automobiles which run on
electricity. We can get more domestic heat from electricity. We can electrify
more of the economy, and that’s a very, very attractive thing also in terms of
local air pollution. The challenge then becomes that there’s a whole set of
functions in the economy, things like producing steel, producing cement, making
airplanes fly, where it’s not clear that we can electrify it, so that even if
we’ve got low-carbon electricity, we don’t have the solution.
Arnout de Pee: We’re now moving to looking more at the demand
side of the energy system, just like Adair said. What do you do with industry?
What do you do with heavy-duty transport? What do you do with building heating,
where electrification is not the economic solution?
Plus, these are systems with very long
lifetimes of over 30 and 40 years. So, even if you would have a greenfield,
new-build solution that will be able to produce steel or chemicals at zero
carbon, then you would still be left with an enormous amount of brownfield
capacity, where changing the process, moving to an electric furnace or a
hydrogen furnace, comes at additional capex cost.
Lord Adair Turner: One of the things that we should be looking at in
these industrial-materials areas is how we recycle much more, how we get more of a circular economy so
that we don’t need to produce as much new raw steel. One vision is that the
steel industry eventually will be essentially recycling steel that we’ve
already made.
Now, recycling steel that you’ve already
made, you can electrify with electric arc furnaces, whereas producing more
steel in the first place is pretty difficult to electrify, and we may have to
find other routes. We need to be thinking about how we move to a more recycled
economy where we’re not adding to the stock of these materials in future.
So, the different dimensions tend to
overlap in practice, but the key message is the bit which we think unsolvable
is solvable here, and that is: Are you going to be able to heat and light your
house from clean energy? Yes, because there’s going to be clean electricity.
Are we going to be able to produce steel, cement in a clean way? We’ve really
got to work out the details of how we do that.
Cait Murphy: What about the business and investment community?
What can they be doing to be part of this transition? And why would they want
to?
Lord Adair Turner: Some businesses absolutely want to be part of it. I mean, there are
now huge businesses in the solar space, the wind space,
the electric-car space, the
battery space. These are huge businesses making very, very big investment
commitments. I think for investors the challenge is they’ve got to think
through how much they want to be invested in these new technology sectors and
what is their approach to investment in the fossil-fuel sectors.
We will need fossil fuels for some time.
Some of them have got to go into decline very quickly. I would say coal,
particularly in the developed economies. Oil will reach a peak and come down.
Gas has to flatten out. But if oil reaches a peak and comes down, there is
still a need for investment in some of the existing fields to meet even a
declining level of total oil production. So, you can’t have a simplistic point
of view that says, “All oil investment has got to stop tomorrow.”
On the other hand, investors in oil and
gas and certainly coal companies have got to make sure that they don’t end up
investing in assets which are too high cost to make sense in the world where
the total demand for fossil fuels is going to come down.
Arnout de Pee: I think for a lot of companies, it is also getting
a better understanding of what an orderly transition could look like, instead
of having an unorderly transition. What I mean by that is regardless of almost
in which industry you are in, as long as you have a sensible outlook of how
policy will develop, what’s going happen to commodity prices and therefore the
state of your industry, the easier it is to make your decisions.
Most of the energy companies I talk to,
what they need is a longer-term outlook of how policy will develop in order for
them to make the investment choices that meet that future outlook. As long as
we don’t have that, it becomes very challenging for energy companies to make
proper investment decisions here.
As Adair puts it, the energy transition is not a radical shift to only renewables and no
more fossil fuels. There is going be a
long period ahead of us where these two will have to go hand-in-hand, where we
will be still reliant on the ramp-up of fossil fuels in some sectors to allow
for economic prosperity. So, the two will have to go hand-in-hand.
Cait Murphy: What are the biggest challenges in technical,
political, and social terms?
Lord Adair Turner: These are difficult transitions economically;
they’re difficult transitions to get people to agree with. So, yeah, that’s a
challenge. There’s also a challenge, I think, about timing, and about speed at
which we progress.
Am I confident that the world can have an
economy with the prosperity levels of the rich developed world for everybody in
the world on a low-carbon economy, eventually? I am absolutely, 100 percent
confident.
Am I confident that we can get there fast
enough to avoid putting so much stock of CO2 into the
atmosphere that we have excessive warming? I believe we can do it, but we have
to try hard to meet that challenge. So, the challenge is not is the end point
possible; it’s the pace at which we’ve got to get there.
Arnout de Pee: One big challenge is we’ve talked a lot about
electricity. Electricity is currently less than a fifth of the total amount of
energy that we’re consuming, and also the way that our energy infrastructure is
set up, the way energy flows between nations, the way energy is stored in
countries is all on the basis typically of fossil fuels.
That entire energy system, the backbone,
will have to change alongside everything that we’ve already been mentioning on
energy demand and supply. But also between seasons, there will be flows of
energy that will be very different than we have today. I think there is still
an enormous challenge. I see it as a positive challenge for technology
innovation to solve the energy-systems issues of the future.
Lord Adair Turner: We need to get some changes in behaviors, and we
need to incentivize them and encourage them. But here’s the interesting point
about the electric car, which in theory it enables us to shift electricity use
around the day. But unless we work out how to make that happen with price
incentives and software and mechanisms of management that make it easy for
people to leave their car, their automobile on the driveway and have it switch
on the charger at 2 in the morning, unless we do that, electric cars could make
some of the problems of electricity management systems worse.
If everybody who drives an electric car
comes back home at 6:30 in the evening and all plug it in simultaneously, then
we’ve got a bigger problem of managing electricity supply and demand than we
have at the moment.
It’s very technologically exciting. It’s
an area where the application of information and communications technology can
achieve some wonderful things for the world. But there’s a lot of new business
ideas, implementation, and in some cases, appropriate regulation has got to be
got right to unleash that potential.
Cait Murphy: What are some policies and approaches that
governments have used that you find interesting and useful? Either to
decarbonize or to increase efficiency?
Lord Adair Turner: Well, we know two things that work, one on the
decarbonizing side and one on the sort of energy-efficiency side. On the
decarbonizing electricity, we began with a set of experiments about how to
encourage renewable-energy takeoff, direct subsidies, et cetera.
And increasingly, what we’ve migrated to
is a system of fixed-price auctions, which simply says to the solar farm or the
wind farm, “How cheap can you get the delivery of kilowatt-hours of
electricity?” What the contract’s essentially saying is, “If you get it really
cheap, the system will take that electricity whenever you produce it, and then
we’ll sort out the backup problems,” sometimes called a “take or pay” contract.
These are very efficient ways of
derisking, and they’re what have driven these dramatic reductions that we’ve
seen recently in the prices at auction for renewable-energy provision.
And then when I think you switch around to
the energy productivity side, the appliance regulation, the process of saying
that regulators are going go through a series of generations—with light bulbs,
for instance—you’re creating an environment where there’s a year beyond which
you can’t use an incandescent light bulb, and then a year beyond which you
can’t use, you know, a halogen light bulb, and a year beyond which you can’t
use compact fluorescent.
And you drive a certainty for the LED
producers, that there’s going to be a big market for them, and because of that
certainty, they invest at scale, and because of that certainty, by the time you
get to that regulatory date, the price has come thumping down. Those sort of
pull-through regulations, they work well.
Arnout de Pee: Yeah, I think another one too is the emission
standards that have been set for cars, for industries, for insulation of homes.
Especially when they are given a longer-term trajectory, they’re going get a clarity for investment,
and it gives clarity for producers or the OEMs of the equipment and the
appliances to start investing in this supply chain in a way that they will
understand how they can make a return in five or ten years from now.
If I talk to players, for instance, in the
wind industry, what they’re also asking for is, “Give us a longer-term ambition
that we can work toward,” because whether we’re moving in a market that is 5 or
50 gigawatts in size for a certain region has enormous implication on the type
of supply chain that you ramp up.
The better you are in at least
understanding what that risk is, the easier it gets to get proper financing and
also to place that risk there in the value chain where it can be best managed.
Lord Adair Turner: I think that’s absolutely
right. So it’s a very sort of self-reinforcing circular process that scale
commitment drives cost reduction, which makes the scale commitment cheap when
you actually get it. I think actually the Netherlands has been doing this pretty well recently, with its offshore
developments, where we’ve seen the latest in the course of the last year; we've
seen some incredibly aggressive bids offshore of the Netherlands, for offshore
wind, coming down to $54 per megawatt hour.
Cait Murphy: Two big ideas are getting a lot of attention: cap
and trade and a carbon tax. Do you think these are useful ways of addressing
the decarbonization side of the equation?
Lord Adair Turner: Look, on the carbon tax idea, it’s absolutely
clear that it would be extremely useful in different segments of the economy,
if we had significant carbon prices and commitments to rising carbon prices.
What I would be very wary of, and you
sometimes get this with a sort of an ideology, which is, “Well, a carbon price
can be an answer to everything. And if we had a good carbon price, you could
just get rid of all other regulation.”
Carbon prices work best where you’ve got
business managers making decisions, looking at future costs. Ask yourself this:
Would you persuade the ordinary householder to switch from an incandescent
light bulb to an LED light bulb by the expectation of a future carbon price?
Most normal, sensible human beings just don’t run their life like that. And
given that they don’t run their life like that, that is an area where
regulation is more powerful than price.
Switch over to some of the industrial
sectors and the need to search out precisely how we’re going decarbonize
chemicals, refining. There, a carbon price would be important, and I think it’s
actually essential to help drive some of the change that we want.
Arnout de Pee: What’s important to look at in that regard,
especially for those industrial sectors that act on a global market, is that
you need to have a global price-setting mechanism. Take refining, take
chemicals, where many of the producing assets only produce maybe for 10 or 20
percent, for their regional market.
Then the rest is all traded on an
international market, where the price difference can be as small as a few
percentage points. So, penalizing a region with a CO2 price
might stifle a certain part of the industry that’s acting in the global
marketplace.
Lord Adair Turner: The other thing just to comment on is the
difference between a tax and a cap-and-trade system. I mean, in absolute
theory, you set the total amount of emissions and you have that on a declining
path, as there is within the emissions trading scheme. And then the price
process with the market decides the price, and that’s an efficient way to do
it.
It depends crucially on having a tight
enough set of emissions, permits that are in the auction. And the problem that
the flagship emission-trading scheme of the world has had, which is the
European emissions-trading scheme, is due to a set of political decisions,
frankly; there were just far too many emission permits out there. Tons of
emissions allowed, and that meant that the price was very low and also very
fluctuating, and really wasn’t a powerful indicator. I think we sort of
realized that there may be advantages in progressing through a tax side.
Cait Murphy: Most people are familiar with
major renewables, such as wind, solar, and biomass. What are some other
technologies that you find interesting or promising?
Lord Adair Turner: The whole technology suite of
batteries and other forms of energy storage is hugely
important. We have these amazingly strong and plentiful energy sources, in
particular solar. Every day, the sun radiates on earth about five thousand
times as much energy as the entire human race needs to support a prosperous
lifestyle.
But one of the big
problems is storage. Now, batteries are a very important technology, and it is going to go through a
whole series of waves. And it’s not just a matter of the cost. It’s also a
matter of the weight; how many kilowatt-hours of energy can you get in a
kilogram of batteries?
I think that’s going to be a hugely
important technological development, but there are also other ways of storing
energy. You can store energy by pumping water uphill, by compressing air. One
of the biggest problems we have in the world is not where does energy come
from, but the ability to generate it at one hour and use it at another. And
anything that solves that is hugely valuable.
Arnout de Pee: For me, number two is everything around
hybridization, and this is more technology deployment rather than development.
Can you imagine what would happen if you
would be able to switch on and switch off or hybridize 30 or 40 percent of
energy demand for an industry, because you have a system of electric boilers
combined with hydrogen or gas boilers? I find that hugely stimulating also
because there’s a high-tech component to it.
The third thing I would mention is carbon
capture and storage and then also usage. When you look at the
difficult-to-abate sectors in industry, there is still a wealth of opportunity
to capture that CO2, and to either store it or use it in products,
either through circularity or through another process, which for now are still
expensive.
Cait Murphy: You have both been engaged in the climate-change
and energy debate for many years. What’s changed?
Lord Adair Turner: Well, I have been interested in the whole issue of
climate change for 20 years, but I first got sort of significantly involved in
it, in terms of commitment of my time, when in early 2008, I was made the first
chair of the UK Climate
Change Committee, which is charged with driving UK emissions down by our legal commitment to 80 percent below 1990 levels by 2050.
I suspect if I was to dig out the reports
that we produced in the first year of my committee about what we thought was
going to happen to the price of wind, the price of solar, or the price of
batteries, I would just be embarrassed by how we failed to see the pace at
which the costs were going to come down.
And that is hugely optimistic and one of
the things that should make us feel that public policy sometimes gets things
right by driving the early development of a technology in a way that it then
gets onto a self-reinforcing path, where the private sector takes over and
drives the price down.
Arnout de Pee: The way I would say it, ten years
ago, we were still thinking in linear terms, when we looked at
price projections and the speed at which things could change. I think we’ve
grown a little bit more used to it, that some of these cost curves actually
follow a very different path [from a linear one] that is, being exponential.
And for me, that’s hugely exciting,
because that also tells us that there might be lots of different areas where
we’re also applying a linear way of projecting how quickly costs can go down or
how quickly the penetration can increase. Well, actually, we have it all wrong.
It can go a lot quicker.
Cait Murphy: Thank you both very much for a fascinating
conversation.
Lord Adair Turner: Thanks very much. It’s been a great discussion.
Arnout de Pee: Thanks for a good discussion.
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