Mar-2022

The cost of energy transition

Energy transition benchmarks have surged in 2021 and prices are expected to remain highly volatile. Transparency is key in this evolving market.

James Burgess & Henry Edwards-Evans
S&P Global Platts

Article Summary

Commodity price benchmarks did not feature prominently at the UN Climate Change Conference, or COP26, in Glasgow in November. But their role in providing transparency about the cost of the energy transition — where price volatility looks set to be an enduring feature — will be vital.
A basket of 10 energy transition-related price benchmarks assessed by S&P Global Platts has more than quadrupled in value between January 1 and November 19 due to a range of drivers.

The increase has been driven by a particularly strong inflation in the value of CORSIA-eligible carbon credits, as well as firm gains in battery metals and European guarantees of origin, recycled plastics and electrolysis- derived hydrogen.

The drivers behind the price gains are a mix of rapidly re-opening economies, booming demand and supply bottlenecks. In wind and solar project development, for instance, S&P Global Platts Analytics expects up to a 10% uptick in capital costs due to bullish raw material demand.

“Due to the magnitude of the required changes to the energy system as nations strive to achieve deep decarbonisation targets, a high degree of volatility in prices is virtually assured,” said Platts Analytics head of scenario planning Dan Klein.

“The intermittent nature of renewables means that the reduction to fossil fuel demand will not always be smooth,” he added.
This has political implications, with some countries starting to query the pace and extent of climate action.

In Europe, Poland, the Czech Republic and Hungary have all called for a revision of the EU’s “Fit for 55” climate package in light of soaring gas prices, which have had knock-on effects on power and carbon costs.

A majority of EU states argue, however, that an accelerated rollout of renewables helps build resilience to global price shocks and will deliver significant economies of scale.

Proving this, via transparency in power purchase agreements and the capture prices that underpin them, will be crucial in building trust that the transition is good for consumers as well as asset owners.

Building trust in VCMs
Nowhere is the need for transparency more relevant than in voluntary carbon markets (VCMs), where a key agreement on accounting and verification rules was reached at the COP26 that is likely to unlock billions of dollars of investment in carbon reduction projects around the world.
Clarity on the Article 6 “Paris rulebook” will help boost confidence in VCMs and drive new sources of demand for carbon credits from sectors covering the 78% of global emissions not covered by compliance markets.

Even ahead of COP26, VCMs were gaining traction in some landmark deals. In early 2021, oil producer Occidental sold the first “carbon neutral” crude cargo, shipping 2 million barrels to Indian refiner Reliance, offsetting the emissions generated across the full life cycle of the cargo with voluntary carbon credits certified by the Verified Carbon Standard.

With a growing number of major global corporate names committing to net-zero emissions by 2050, carbon credit prices have shown a clear rising trend in 2021.

Platts assessed CORSIA-eligible carbon (CEC) credits at $8.50/mt CO2 equivalent November 16, compared with just 80 cents/mt when the assessment was launched on January 4, 2021.

Meanwhile nature-based credits (Platts CNC), linked to projects which reduce emissions from land-use projects, were assessed at $13.25/mt November 16, compared with $4.70/mt when the assessment was launched on July 12, 2021.

Emerging H2 markets
There is the same need for robust market mechanisms and price discovery in emerging low- and zero-carbon hydrogen markets.

In its recent hydrogen business model consultation, the UK government proposed working with price reporting agencies to explore the development of market benchmarks for low-carbon hydrogen.

“A liquid market benchmark price would provide the clearest indication of the market value of hydrogen,” the Department for Business, Energy and Industrial Strategy said in the consultation document.

Ahead of liquidity, price references for early contracts would likely cite other competing fuels, with transparency in the early phases still a key attribute.

Without clear frameworks from regulators, and a broad build-out of new renewables, high and volatile feedstock power and gas prices could send discouraging signals to potential hydrogen project investors.

“Energy markets have already invested in multiple hydrogen projects around the world and are primed to add more,” said Platts Head of Energy Transition Pricing Alan Hayes.

“Clear regulation that can set a path to the deployment of hydrogen across the energy and transport sectors, providing a real boost to further investment,” he said.

Meanwhile, bilateral contracts could help develop international hydrogen and ammonia trade, while commodity traders could bring more liquidity as the market develops, the IEA has said.

Platts hydrogen price assessments show northwest European and Japanese markets as price takers in these negotiations, with Australia one of several lower- cost renewable hydrogen production sources well placed to develop future exports.

The spread between alkaline electrolysis assessments (including capex) November 15 showed European prices (Netherlands, $12.33/kg) over five times those in Australia (Western Australia, $2.24/kg). The comparable assessment for Japan was $9.51/kg.

Now that the initial hard work of hammering out an agreement at COP26 is done, the markets that will deliver the clean transition will come increasingly into focus.