CLIFFORDCHANCE

ENERGYTRANSITIONTRENDS2022

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CLIFFORDCHANCE

ENERGYTRANSITIONTRENDS2022

CHANCE

ENERGYTRANSITIONTRENDS2022

-THOUGHTLEADERSHIP

FEBRUARY2022

ENERGYTRANSITIONTRENDS2022

ThereremainsanarrowwindowofopportunityfortimelyactiontoaddresstheclimatecrisisandstillmeettheParisAgreementtargets.Thenecessarytransitionfromfossilfuelstolow-carbonenergysourceswillrequiremassiveandsustainedlevelsofinvestmentinrenewableenergy,increasedelectrification,thedevelopmentofelectrofuelssuchascleanhydrogen,andcarboncaptureandstoragetocaptureemissionsthatcannotbeprevented.Atthesametime,thevulnerabilityofenergysystemshasbeenrecentlyhighlightedwithpricespikes,themorefrequentoccurrenceofsignificantclimateeventsandtheimpactsofheightenedgeopoliticaltensionsonenergysecurity.

Thetrendsthatwehavehighlightedfocusonsomeoftheinnovationsandlegaldevelopmentsthatweareseeinginanumberofsectors.It'salsoimportanttoacknowledgethewidercontext.TheCOP26summitinNovember2021underlinedthatwhileconsiderableprogressisbeingmadeinsomeareas,theenergytransitionwillnotbeastraightline,universalorevensuccessfulinsomeplaces,giventheveryrealcountervailingfactors.Someoftheseincludeconcernsaboutenergysecurity,issuesaroundgreenwashingandalackofcoherentgovernmentpolicieswhicharedesperatelyneededtocreatereliablerevenuestreamsforprojectandotherformsoffinancing.

TheGlasgowClimatePact,agreedatCOP26,alsoemphasisedtheneedforajusttransition,puttingpeopleatitscentre.Particularlyimportantfortheenergytransitionarethechallengesinregionsdependentonfossilfuel.Privatesectorinvestorsandfinancierswillneedtoworkalongsidegovernmentsandpublicsectorinstitutionstounderstandhowenergytransitionprojectsareconsideringtheimpactonvulnerablecommunities,creatingopportunitiestoacceleratethetransitioninamannerthatisjustandcentredonpeopleandresilience.

Sowheredowegofromhere?It'snotalldoomandgloom.Therearemanyopportunitiesinplaceswheregovernmentsupportandmarketconditionscometogethertomakeexcitingandinnovativeprojectspossible.Whilesomefirst-of-a-kindprojectsmightnotbereplicableeverywhere,theywilladvanceourunderstanding,encourageinvestment,enabletheenergylandscapetocontinuetoevolveandprogresstobemadetowardsnetzerogoals.

Smallmodularreactors(SMRs)arechangingthefutureofnuclearpower

TheWorldNuclearAssociationhasestimatedthatthemarketforSMRscouldamounttoUS$300billionperannumby2040.Thesereactorsarenotjustsmallerthantraditionalnuclearplantsandlessexpensivetobuildandoperate,theyalsooffersafetyandsecurityadvantagesandaremuchmoreflexibleintermsofpotentialapplications.Critically,theirscaleandshorterpaybackshouldenable,induecourse,financingoptionswhichhavenotpreviouslybeenaccessiblefornuclearprojects.

Reportedchallengesincludethelackofconsensusonasingletechnologytohelpregulatorydevelopmentandharmonisation,licensingregimes,insurancemarketgapsandfuellimitationsandthelackofasubstantialtrackrecordofprivatedebtfinancingofnuclearprojects.Whatwillbeneededtoencouragedevelopmentandfinancingoftheseprojectsbygovernmentsandtheprivatesector?

Governmentspromotingtheseprojects,suchastheUS,China,theUKandCanadawillbelookingtobridgeanumberofgaps;forexample,supportwhereinsuranceisunavailableand,atleastinitiallyuntilthelevelisedcostofenergy-theaveragenetpresentcostofelectricitygenerationforageneratingplantoveritslifetime-forSMRsreduces,someformofassistanceorsubsidisationtoallowprojectstocompetewithothergenerationtechnologies.

Therearearound70differentSMRdesignsandconceptsglobally.Aconsensusontechnologywillbecriticaltoensuremomentum,bothfromtheperspectiveofregulatoryharmonisationandthepotentialeconomiesofscaleadvantagesofferedbySMRs,forwhichstandardisationwillbeessential.

Complex(anddivergent)nationalregulationistypicallybasedonfull-scale,landbasednuclearplantsandsodoesnotaddressthespecificrequirementsofSMRs.TheInternationalAtomicEnergyAgency'sregulatoryforumforSMRswasestablishedtoshareregulatoryknowledgeandexperience.Itinitiatedthethirdphaseofitsworkin2021andisexpectedtopublishfurtherreportsonlicensingissues,designandsafetyandmanufacturing,commissioningandoperations.Standardisationofdesignwillassistregulatoryalignment.Governmentswill,ofcourse,alsoneedtoensurethatrelevantinternationaltreatieshavebeenratifiedandanydomesticregulatorygapsfilled.Regulationwillneedtobeflexibleandadaptabletothevarietyoflikelytechnologies,whilealsocoveringallpossiblerisks.Theincreaseinfactory-builtelementsofreactorswillalsogiverisetoregulatorychallenges(forexample,overtheappropriatelocationoftesting).

ItwillbeimportantforgovernmentstoensurethatlicensingcostsforSMRdesignsareproperlyadjustedtoreflectthesesmallerprojects,ratherthanmirroringthoserequiredforlargerreactors.

ManySMRdesignsneedafuelthatisnotyetavailableonacommercialscale-high-assaylow-enricheduranium(HALEU).HALEUenablesthesmallerreactordesignstoachievemorepowerperunitofvolume.TheUSDepartmentofEnergyisworkingonanumberofpilotprojects,includingmethodsthatinvolvetherecyclingofusednuclearfuel.Suppliersinothercountries,includingFrance,arealsogearingup,andthereisgrowingconfidencethatthiswillnotcauseabottleneck.

Increasingly,providersofprojectfinanceorinvestmentfundswillprioritiseprojectsseenassustainable,andofficialtaxonomiesarelikelytobeusedtodeterminesustainability.AtthebeginningofJanuary2022,theEuropeanCommissionbeganconsultingonthecriteriatoallownuclearactivitiestoberegardedassustainableundertheEU'ssustainablefinancetaxonomy.Thisproposaliscontroversialandresistancetoinclusionofgasandnuclearappearstobegrowing.However,ifitisadopted,thecriteriawillneedtobesufficientlytailoredand/orflexibletoensurethatpre-andpost-commercialisationSMRactivitiescanqualifyassustainabletomaximisetheavailabilityofcommercialfinance.

Inthedevelopingworld,especiallyAfrica,SMRscouldbeanimportantpartoftheenergytransition.Howeverthereareanumberofissuestoovercomeincludingnavigatinginternationalnuclearnon-proliferationrequirementsandthedisposal

ofwaste.

Noneofthisistosaythatthatwehaveseentheendoflargescalenuclearreactors.Infact,therehasbeenarecentresurgencewithnewprojectsunderdevelopmentin,amongothers,theUK,SaudiArabia,IndiaandEgypt.Asalwaysthekeytothesuccessoftheseprojectswillbesecuringthenecessaryfinancingandweareseeingsomeinterestingnewdevelopmentsinthisarea,inparticulartheproposedapplicationoftheregulatedassetbasemodeltonewnuclearintheUKwiththeNuclearEnergy(Financing)BillcurrentlyundergoingitssecondreadingintheHouseofLords.

CarbonContractsforDifferences(CCfDs)tokickstartcleanhydrogen

Althoughtheelectrolysertechnologyusedtoproducecleanhydrogenisnotnew,developingitonthelargescalecurrentlyenvisagedwillbeground-breaking.Leavingtechnologicalchallengestooneside,thekeychallengefacingthesebigcleanhydrogenprojectsiseconomic-evenatcommercialscale,thefirstgenerationofcleanhydrogenprojectswillnot,bysomemargin,bepricecompetitivewitheither"bluehydrogen"ornaturalgas.Earlyprojectsarethereforelikelytoneedsignificantrevenuesupportandstrongandstablelong-termhydrogenofftakearrangements,forexamplewithaheavyindustryuser.Thiswillbeimportantasinvestorsneedbusinessmodelsthatprovidepredictablereturnstosupportthelevelofcapitalexpenditurethatwillbeneeded.Variousfundingtoolsandsupportschemesarebeinglaunchedinjurisdictionsaroundtheworldtoincentivisetheseearlyprojects,suchastaxcredits,feed-intariffsanddirectfundingtoeligibleprojects.ExamplesofthesearetheEURecoveryandResilienceFacility,HorizonEurope,theJustTransitionFundandtheInnovationFund.

IntheU.S.theBidenadministration'sAmericanjobsplanspecificallyincludescleanhydrogenprojects,buttheadministration'swillingnesstoadvancetaxcreditsandotherfinancialincentives,suchasmasterlimitedpartnershipsusedintheoilandgassector,couldplayasignificantroleinmakingcleanhydrogeneconomicallycompetitive.SupportschemesintheformofCarbonContractsforDifferences(CCfDs)areoneofthemostpromisingoptionstofosterthedeploymentoflow-carbonindustrialtechnologiesandtobridgetheexistingcostgapbetweencleanandfossil-basedhydrogen.Suchschemescouldkickstartthecleanhydrogenmarketandsupportastrongofftake-downstreammarket.Thisfinancialincentivehasbeentoutedacrosstheglobeasapotentialmeanstosupportenergy-intensiveindustriesindevelopinganddeployinglow-carbontechnologiesandtominimisetherevenueuncertaintyattachedtoinvestmentsincleanhydrogen.RegulatorsarealsoexploringCCfDs-initsNewIndustrialStrategy,theEuropeanCommissionrecentlystateditsinterestinaEuropeanapproachforCCfDsinthecontextoftheupcomingrevisionoftheEUETSDirective.Somecountrieshavealreadyrecognisedthisopportunity,andGermanyisafrontrunner-itsFederalMinistryofEnvironmentandNuclearSafetyhaspublishedaWhitePaperinwhichitintendstodevelopapilotprojectforCCfDs.

HowdoCCfDswork?Therearedifferentmethodologies,butinessencetheyaresimilarto"feed-inpremium/tariff"(FIP/FIT)policies,whichmakerenewableenergyprojects"investible".Producersoflow-carbonmaterials,suchascleanhydrogen,areguaranteedafixedcarbonprice("strikeprice").Thebuyercoversthedifferencebetweenthecurrentcarbonprice,which,forexample,maybecalculatedastheyearlyaveragepriceofemissionsallowances(EUAs)andthestrikeprice.ThismechanismwouldhelptoensurethattheCO2pricefacedbyinvestorsinfirst-of-a-kindcommercial-scalecleanhydrogenprojectsbetterreflectsthetruesocialcostofcarbonintheeconomyandwouldreinforcethebankabilityofcleanhydrogenprojectswithveryhighupfrontcapitalcosts.

Tomanagefundingsupportandlimitoverlylongsubsidisation,CCfDswillneedtobestructuredonamarketconformitybasis,asrequiredundertheEUStateAidguidelines,forexample.Thetenderprocesscouldbedesignedinasimilarwaytothecompetitivetenderingprocessforrenewableenergysource(RES)projectsintheEU,wherebygovernmentswouldannouncecallsforcleanhydrogenprojecttenders,includingarequesttobidforaspecificstrikeprice.Ideally,tenderswouldbeorganisedinatechnology-neutralmanner,withdifferentstrikepricesfordifferentsectors(forexample,steel,cement,etc.).

Alloftheforegoingwillneedtotakeintoconsiderationthedevelopmentofamorefluid,lessstructuredcleanhydrogenecosystem,whichwillrequirethearrangementsdescribedabovetoevolveovertime.Thisecosystemwouldconsistofmultiplesellersandbuyersofcleanhydrogen,ina"merchant"atmosphere.Itshoulddevelopinareaswhereacleanhydrogenmidstreamfortransportandstorageemerges,suchasinEuropeviathecurrentinitiativeofEuropeantransmissionsystemoperatorstobuildacleanhydrogenbackbonepipelinesystem.

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Infratech-howenergytransitioncanbeachievedthroughtheintegrationoftechnologywithinfrastructureTheresilienceofcriticalinfrastructureisapriorityforgovernmentsacrosstheworldastheybuildbackfromtheglobalpandemicandpreparestrategiestoachievetheirclimatetargets.Theintegrationoftechnologiessuchasblockchainandotherdistributedledgertechnologies(DLTs)withinfrastructureisseenbymanyashavingakeyroletoplay,althoughitisnotwithoutitschallenges.Digitalisationwillbevitaltoenablecompaniesintheenergysectortomaximiseoperationalefficiencyandfacilitatetheenergytransition.Accesstogood-qualitydataoncarbonemissionswillbeimportant,bothformonitoringprogresstowardsnetzeroandhelpingbusinessesunderstandhowchangecanbeachieved.

Digitalisationalsobringschallenges,particularlyinintegratingadvanceddigitaltechnologiesintoexistinginfrastructure.Cybersecurityisanincreasingriskinmorecomplexsystemswherepersonaldataisattachedtoenergyuseandaproliferationofmicro-generatorswilltestgridsecurity.

Weexpecttosee:

Theincreaseduseofassettokenisation(theconversionofownershipinterestsinhardinfrastructureassetssuchasbuildingsorpowerstationsintodigitalassetsthroughtheuseofDLT-basedtokens),whichmayunlocknewsourcesoffinance,particularlyforprojectsinthedevelopingworld.

Smartinfrastructure(suchassmartgrids,smartcities,roads,portsandpowerdistributionsystems)increasinglybeingusedtoimproveperformanceandefficiencies.Thiswillbetakentothenextlevelthroughthemetaverseascompaniesstarttoreimaginehowtouserobotstoperformtasksfortheminanylocationthroughmetaversetechnology.Forexample,robotavatarsperformingplannedandunplannedmaintenanceinnuclearpowerplantsoratremoteoffshorewindfarms.

Continuedinvestmentinautonomousvehicles,datacentresandtechnologieslike5GandtheCloud,whichhavebecomeanintegralpartofITsystemsworldwide.

Regulationisneededsothattherightframeworkisinplacetoenabletheinfrastructuresectortomakethenecessaryinvestment,includingstructuresthatprovidearevenuestreamtosupportprojectfinancing.Someinitiativesalreadyannouncedinclude:

IntheUS,thenewInfrastructureInvestmentandJobsAct(November2021)includesasignificantinvestmentofUS$21.5billionforthedevelopmentofenergytechnologyprojects,includingenergystorage,carboncaptureprojectsandresearchonsolarenergytechnologies.

TheEU'sroadmaponthedigitalisationoftheEnergySector(July2021)iscurrentlyopenforpublicconsultation.TheareasoffocusincludethedevelopmentofaEuropeandata-sharinginfrastructure,enhancingtheuptakeofdigitaltechnologiesandenhancingthecybersecurityoftheenergysector.

TheUKGovernmentlaunchedanEnergyDigitalisationtaskforcein2021toconsiderthemarketdesign,digitalarchitectureandgovernanceofamoderndigitalisedenergysystem.Itisduetoreportin2022.

WealsoexpecttoseeanincreasedfocusbystakeholdersontheESGimplicationsoftheseInfratechtransactions-forexample,theexcessiveenergyconsumptionofblockchainvalidationprocessesandtheelectronichazardouswastetheyproduce.Therewillalsobegreaterattentionpaidtotheuseofsensitivedataandpersonalinformationthatcanbeatargetforespionage,sabotageandforeigninterference,leadingtoincreasescrutinybygovernmentonforeigninvestmentsinrelationtothesetransactions.Governancearrangementsassociatedwiththedecentralisationofinfrastructuresystemswillalsocomeunderthespotlight,withthecollectiveresponsibilityofparticipantsinsuchsystemsaligningwiththeincreasingawarenessofsustainability.

Developmentsincarbonmarketstructures

COP26inNovember2021sawagreementonkeyelementsoftheParisAgreementArticle6Rulebookforanewglobalcarbonmarketmechanismtoallowcreditsfromcarbonreductionprojectsinonesignatorystatetobeusedtosatisfyanotherstate'scarbonreductioncommitments(orNationallyDeterminedContributions).Afurthermechanismwascreatedtoallowbilateralarrangements(so-calledco-operativeapproaches)toachieveasimilarend.Althoughtheprocessestofinalisetherulescontinue,2022willseesignatorystatesbeginningtoconsiderhowtheywillparticipateintheseArticle6mechanisms.Willdevelopingcountriesallowcreditsfromdomesticcarbonprojectstobetradedinternationally,orwilltheywishtoretainmorecontroltousesuchcreditsforsatisfyingtheirowncommitments?Willtheywishtocontrolvoluntarymarketsmorecloselyanddivertcreditsintotheregulatorymarkets?WilldevelopedcountriesriskclaimsabouttheintegrityoftheirclimatecommitmentsbyacceptinginternationalcreditstohelpsatisfytheirParisagreementcommitmentsorwilltheyrelysolelyondomesticcarbonreductions?

MoreclaritymayalsoemergeovertheextenttowhichtheArticle6Rulebookcouldapplytothevoluntarymarkets-thismayhelpaddresssomeoftheconcernsevidentinthevoluntarycarbonmarketsoverissuessuchasdouble-countingofcredits(oneoftheissuesthenewIntegrityCouncilforthevoluntarycarbonmarketiscurrentlyconsidering).Developmentofcross-bordercarbonmarketsisalsodependentonadditionalclarityastothelegalnatureofcarboncredits,theapplicabilityoffinancialregulationframeworksandtheaccountingtreatmentofcarboncredits,topicsthattheInternationalSwapsandDerivativesAssociation(ISDA)andtheUKVCMForum,amongotherorganisations,areconsidering.FormoreinformationontheArticle6Rulebook,seeourbriefing:

COP26:Article6RulebookForTheNewGlobalCarbon

MarketMechanismAgreed

.

Increasingmarketactivityandcarbonpricepressure

Increasingregulatory,stakeholderandsocietalpressuretoreduceemissionsinallsectorsislikelytocontinuein2022inparticularwiththedeepeningofnations'carbonreductioncommitmentsundertheParisAgreement.Agrowingtrendforcompaniestosetnetzeroandotherclimatereductiontargetsislikelytoleadtoamajorincreaseinactivityinthevoluntarycarbonmarketsandrisesinthepriceofvoluntarycarboncredits,assupplyofcarboncreditsfailstokeepupwithdemandfromcorporateoffsetters.Energycompanieswillincreasinglylooktoestablish,investinto,orfinance,projectstosecureasteadysupplyofreputablecreditswhilstotherswilldeveloptradingplatforms.

InnovationinCarbonCaptureandStorage

Carboncapture,utilisationandstorage(CCUS)technologiesareoneofthefewsolutionstotackleemissionsfromheavyindustryandtoremovecarbonfromtheatmosphere.TheInternationalEnergyAgency(IEA)reportsthatplansformorethan100newfacilitieswereannouncedin2021,butCCUSdevelopmentisnotyetontracktodeliveronNetZeroby2050targets.

Momentumisgrowing,andweexpecttoseeatrendtowardsCCUSnetworks,wherelowercost,less-complexprojectsshareCO2transportandstorageinfrastructureinindustrialclusters.Suchdevelopmentswillenablesmallerprojectstobenefitfromtheeconomiesofscalethatlarge,verticallyintegratedprojectswithdedicateddownstreamtransportsystemshaveenjoyed.

MoreandmorecountriesareincludingCCUSintheirlong-termclimatepolicies,andthereisalsogreaterrangeofprojects.ThreequartersofindustrialCCUScapacitycurrentlyinoperationisnaturalgasprocessing,buthydrogenandbiofuelproductionmakesup50%ofprojectsunderdevelopment(source:IEA).Afurther8%oftheprojectsindevelopmentcompriseCCUSdeploymentiniron,steelandcementfacilities.

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Therearesomeinterestinginnovationsonthehorizon,includingtechnologiesthatdirectlyremoveCO2fromtheatmosphere,socalleddirectaircapture(DAC).DACprojectsareinanearlierstageofdevelopment,butcouldplayanimportantroleinbalancingoutresidualemissionsthataredifficulttoeliminateandincontinuingtoreduceatmosphericCO2inthelongterm.Indeed,theInternationalEnergyAgency(IEA)hasstatedthatDACwillneedtobescaleduptocapturemorethan85MtCO2/yearby2030and?980MtCO2/yearby2050inordertohitthenetzeroby2050target.

SuperchargingRenewableInvestment

Eveninthejurisdictionsthathavebeenmostsuccessfulindevelopingrenewablesatscale,hittingclimatechangetargetswillrequirecontinuedrenewablesinvestmentatamultipleofcurrentlevelsformanyyearstocome.Therenewablessectorhasshownaremarkableabilitytocontinuetoreducecostswithscale,particularlyforPVsolarandwindgenerationtechnologiesandmanyareconfidentthatthiswillcontinueasthesectorgrows.Atthesametime,increasedcommoditypricesareplacingstrainoncapitalexpenditurebudgetsandalowcost,lowinflationworldcannotbetakenforgrantedintothefuture.

Tosupporttherequiredinvestment,anumberofchallengeswillneedtobefaced,including:

Sufficientsuitablesitesfornewprojectswillneedtobefound.Inanumberofjurisdictionsthebestsiteshavealreadybeentakenandopeningupnewareasforinvestmentmayfacesignificantpoliticaloppositionaswellasraisingenvironmentalimpactconcerns.

Repoweringofexistingprojectsattheendoftheirworkingliveswillhaveanimportantparttoplayandahelpfulplanningandregulatoryenvironmentforrepoweredprojectswillbeimportant.Thewindsectorwillhavetofindbettersolutionstodealwitholdturbinebladesthansimplyburyingtheminlandfillsites.

Gridexpansionandgridstrengtheningwillbeneededtosupportasignificantlyincreasedscaleofrenewablegenerationthatisfrequentlysomedistancefromthecentresofdemand.Theimpactofincreasedlevelsofintermittentgenerationonourpowersystemscannotbeignored.Regulationsneedtobefitforpurposetoavoidexcessivepricevolatilityandgridinstabilityandmustsupportparallelinvestmentinelectricitystorageandcleanbaseloadpowercapacitytounderpinthesystem.

Inthenextfewyearsfloatingoffshorewindtechnologyisgoingtobedeployedatcommercialscale.IthasthepotentialtosignificantlyincreasethesizeoftheoffshorewindsectorinexistingjurisdictionsliketheUK(particularlyfollowingtherecentScotwindauctionprocess),aswellaskick-startingoffshorewinddevelopmentinarangeofnewdeeperwaterjurisdictions-includingItalyandSouthKorea.Floatingoffshorewindwillchallengedevelopers,technologyprovidersandsupplychains,portinfrastructureandtheirlendersandinvestorstoquicklydevelopapproachestopermitthemtoreplicatethesuccessoftheexistingfixedfoundationprojects.

Floatingoffshorewind,batteryprojects,gridsolutionsandback-upcapacityarealllikelytorequiregovernmentsupport,includingfit-for-purposeregulations,efficientplanningandconsentingprocessesandfinancialsupportfornewtechnologies(likefloatingoffshorewind)untiltheybecomepricecompetitive.Noneofthiswillbecheapandprotectingthemostvulnerableindividuals,andthehighestenergyusingbusinessesfromadverseimpactsofhigherandmorevolatilepricesisasimportantapoliticalchallengeasencouragingthelevelofinvestmentthatisrequired.

CONTACTS

ENERGYTRANSITIONLEADS

ClareBurgess

Partner

London

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