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COP26 and the European Energy Crisis - Lessons and Implications for the Australian Energy Transition

You can date the change in the politics of climate change in Australia to the bushfires that swept the country in the summer of 2019/2020. In the wake of fires larger than medium-sized European countries burning for weeks, the Australian public decided that it was ready to act on climate change. The rain came. We got lucky this time.

Surveys of businesses across the country consistently reflect the importance of this issue. They show that everyone from Board members down to the employees want to change.

 This month the Australian Retailers Association has released research indicating that 63% of their members agree that urgent action is needed to mitigate the impacts of climate change. This strength of this finding prompted ARA CEO Paul Zahra to call on the government to heed the message and get serious about climate action.

The ARA research is corroborated by research from Energy Action, an energy management business that has been helping Australian businesses simplify, clean and lower the cost of their energy spending for more than 20 years. Energy Action released research in August this year revealing that 85% of employees of Australian businesses believe that regardless of what the government does, businesses need to act on climate change.

As we hurtle towards the last chance saloon of COP26 in Glasgow in November, we are watching the spectacle of the minority coalition party hold sway over the Federal Government as our Prime Minister belatedly fixes a binding - but not legislated- target of net zero emissions by 2050.

Based on reports from the National Party room this week, it appears that a strengthening of the existing 2030 commitment of a 26-28% reduction on 2005 emission levels has been taken off the table. This will be problematic for the Australian delegation in Glasgow. It conflicts with the widely accepted projections that Australia will deliver a 35% reduction by 2030. It also conflicts with the emerging consensus across business leaders that the next 10 years will shape Australia's opportunity to become a renewable energy powerhouse.

To be fair, however, the past 14 years of federal politics in Australia leaves us with no doubt that selling the vision of a cleaner world with a clear pathway to get there, is more difficult than you might think.

The politics are contentious: big changes create uncertainty, which amounts to uneven distribution of costs and benefits. The proposed changes mean new engineering solutions are required, as are social and demographic changes.

The sweep of changes is immense, from closing mines and generation assets that bring benefit to communities and the nation, threatening both regional towns and the GDP, to driving change in the skills mix that powers the workforce. The stakes are high: the process of change in our 21st-century economy inevitably creates winners and losers, which may take years or generations to unwind.

Looking beyond the politics, we have the science. Scientists have anticipated the possible increase in temperatures that carbon emissions will cause. It's been articulated time after time that these temperature changes will and are impacting people’s lives. The 2019 bushfires that wreaked havoc in Australia came from years of drought and poor forestry management. This was predictable; however, the scale and ferocity of the fires were not.

Meanwhile, in Europe and across Asia this week, economies are bracing for severe winter and a real prospect of energy shortages. Short term wholesale LNG prices in London, Amsterdam and Tokyo are tipping $AUD 40/GJ. Windfarms are failing as weather patterns change. There are predictions of people dying and factories halting production. If shortages in energy supply eventuate, they will magnify frustration, fuel inflation and cause decision-makers to turn back to emission-intensive fossil fuels to generate electricity. The politics that have allowed progress to date, may change.

In short, engineering a path of significant social and technological change against a volatile change in climate is more difficult than we all expected. In the next breath, it is obvious that delaying the change is not going to make it easier.

So, with the political and climate stakes so high, what can Australians expect out of COP26?

Australian businesses are well integrated to the global economy. We have our significant supply chain and market exposure to the US, Asia and Europe. This integration, coupled with local exposure to energy costs mean, COP26 is looming for all businesses, and many are not prepared.

The two biggest issues likely to arise from COP26 are:

1. the increased pressure on Australia to announce a plan towards net zero in 2050 (or earlier)

2. the beginning of the establishment of an international Cross Border Adjustment Mechanism (a carbon tariff).

Let’s take a moment to look at what each of these means for Australian businesses:

Pressure to adopt an aggressive trajectory towards net zero.

COP26 comes five years after the 2015 Paris Agreement, at which 190 members of the 197 original signatories to the 1994 United Nations Framework Convention on Climate Change (UNFCCC), agreed to do 2 things:

1. work together to limit global warming to well below 2 degrees and to aim for 1.5 degrees, to adapt to the impacts of a changing climate

2. meet every 5 years to review their commitment to this goal and update their plan to reflect their highest possible ambition at that time.

A recurring issue in Australian politics since the ratification of the Paris Agreement in 2016, is whether our commitment to a reduction in greenhouse gas emissions of 26- 28% below 2005 levels by 2030 is enough to limit global warming to less than a 1.5 degree increase on pre-industrial levels.

As we can see playing out in federal politics in Australia this month, pressure will be required at COP26 to push leaders to do today what can be put off to tomorrow. Collectively setting the bar at the lowest common denominator will not deliver the outcome that the planet needs.

Significant and continuous investment will be required over the coming decades to get us there. The IEA estimates the phenomenal sum of $USD 5 trillion per year will be required by 2030, and ongoing to 2050, to convert global energy systems to low emission systems.

The good news is that IEA thinks that energy systems globally can do this without carbon offsets. The bad news is that this will translate into higher energy input costs globally, and replacement costs for end-use equipment as well. Expect to hear a lot more of the buzz phrase “electrify everything” (and then combust hydrogen for what’s left).

In Australia, there are fewer constraints than some nations to supporting an entirely renewable and zero-emission energy system.. The key question is what is the pace of change that the system (including consumers) can support? On the eastern side of the country, State Governments have initiated renewable energy zones to target upgrades in transmission and distribution systems required to support intermittent power and storage. But gas is likely to be a transition fuel, even if we can wean ourselves off coal faster than predicted. As new energy storage comes online (including Snowy 2.0 in 2026 onwards), and the pace of investment ebbs and flows with access to rare earth minerals and engineering skills

We can expect one constant: international LNG prices will set the price for the firming of electricity supply for at least the next decade.

In the background, we can also see as an outcome of pressure to do more sooner at COP26 that the trade-in carbon offsets will increase in value, as will obligations on businesses to purchase them to acquit their emissions. COP26 is seeking to engage finance and develop carbon markets to further support a transition to a zero-emission global economy. The contentions around the claims of what does and does not constitute a high-quality carbon offset will also increase. This development will go hand in hand with an increase in reporting obligations to increase transparency in carbon reporting globally.

Carbon Pricing: the EU proposal for a Cross Border Adjustment Tariff

A significant proposal that will be discussed in detail at COP26 is the European Union’s proposal to implement a Cross Border Adjustment Mechanism (CBAM): a carbon tariff.

The intent of the CBAM is to reduce carbon leakage by equalising the direct carbon costs embedded in products that are produced in jurisdictions that have implemented a carbon price, with products that are exported from a jurisdiction that has no such cost impost applied.

This issues a threat to all Australian exports. The fact that Australia does not have a mandatory carbon price will leave Australian exports at a price disadvantage in those markets. As an obvious, Australian coal exports are vulnerable. If coal buying countries are required to account for the carbon embodied in the products they produce, this puts Australian coal at a price disadvantage compared to the less emissions-intensive energy generation sources.

It is also an opportunity for consideration for all Australian manufacturers. Where previously high energy costs have hampered Australia’s onshore manufacturing industry, a CBAM offers the prospect that energy costs will be equalised around the world, providing Australia with a natural advantage if we can make the leap to a low cost, reliable and renewable energy system.

The matter of carbon leakage is one that COP26 will seek to implement new rules on. However, it is unlikely that the EU CBAM will be accepted at COP26. This is partly because its principle of discriminating between products based on their input costs is at odds with a number of the key principles of the World Trade Organisation (WTO), regardless of how they may have been produced. Indeed, it is unlikely that the EU has proposed the complex set of rules with an expectation that they would be accepted at COP26.

More likely is that the EU has proposed the CBAM system, replete with blank schedules on carbon pricing methods and exempted countries in order to spur negotiation on the issue. Whether this can be achieved over 10 days in Glasgow, remains to be seen.

Find out more as it happens

Join us for an early wrap of COP26 on the 11th of November, as we discuss with Alfa Energy, our partners in the UK, the up-close view of COP26, and also European energy pricing. We will try and dig into the news from Glasgow, and the lessons we can draw from the UK energy transition.  You can register for our free webinar by clicking here.

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