The world is shifting to a low-carbon economy, driven by – and affecting – geopolitics, with major business ramifications.
The bigger picture
As the world attempts to meet the Paris Agreement’s emissions targets over the next two decades, many oil-dependent states will face profound economic and political challenges. Fossil fuel-reliant countries could see a drop of 51 percent in government oil and gas revenues. Of the 23 countries earning at least 60 percent of their export revenues from oil and gas, only one is democratic. Increased fiscal pressures, job losses, a growing need to undertake structural economic reform in countries with weak governancce and few political release valves could lead to domestic political instability in many countries, mostly in Africa, the Middle East and Latin America.
Over time, oil and gas will also become less of a driver of international relations. Major exporters, like Saudi Arabia and Russia, will gradually have less international influence. If net importers successfully diversify energy sources and/or produce more at home, they will become less dependent on petrostates. This will change international power dynamics. For instance, Europe will likely become less dependent on (and less invested in) Russia while the US will have fewer interests in the Middle East, which could lead to less American engagement – for example, how much would the US care about and be deferential to Saudi Arabia in a world where oil is drastically less important for the global economy?
The energy transition will also create new dependencies between states. Hydrogen, which could meet up to 24 percent of the world’s energy needs by 2050, has the potential to create a new class of exporters (e.g. Australia, Chile and New Zealand), reshape the global map of energy trade (with hydrogen pipelines and shipping routes replacing gas pipelines in importance), and reduce the pressure on key maritime chokepoints for oil (e.g. the Strait of Hormuz) and crucial transit countries for natural gas (e.g. Ukraine). And as other resources and technologies critical to the new green economy, such as rare earths and solar photovoltaic cell manufacturing, become more strategic, competition among states for technology leadership will only intensify.
Risks for business will increase in oil-dependent states. As their economic base shifts and revenues decline, petrostates will become less politically and fiscally stable. While it will be a slow burn, in many countries there will be an increase in sovereign default risks as well as chances for political violence, expropriation of assets and other forms of government interference. Countries that successfully increase economic diversification and complexity through reform could open up new investment opportunities, but given most petrostates have poor governance and institutions any such opportunities will nevertheless be at the riskier end of the spectrum. Saudi Arabia, whose vision to diversify the economy by 2030, will be a case study to watch.
Over time, oil will have less impact on the global economy. At present, it is by far the most important commodity: a one percent decline in oil supply typically leads to an increase in oil prices of 10 percent (and vice-versa with demand) while oil price shocks slow economic growth, lead to declines in stock markets returns and significantly move currencies. But as renewable resources become relatively more important, the impact of oil prices changes will likely reduce – and the impact of price shocks in renewables (both resources and underlying technologies) will have greater impacts on the real economy and financial markets. That said, so far, increasing pressure on the oil and gas industry from regulators to transition to low-carbon models has not led to price decreases – prices are actually above pre-Covid levels, which is feeding into inflation. And so any changes in the relative importance of oil and its impact on markets will be long term.
The changing energy mix will also shape the trade and industrial policies governments pursue as they transition to a greener economy. Competition will increase over new valuable commodities (such as rare earths and hydrogen), including both through “carrots” (subsidies and investment) and “sticks” (sanctions, taxes and tariffs). States at the vanguard of the energy transition will more frequently resort to use of trade instruments (like the EU’s new carbon border adjustment mechanism) to create comparative advantages in renewable technologies. And states will increasingly use economic diplomacy measures to promote nascent renewable industries: As JD Rockefeller wrote in his 1909 memoirs, “One of our greatest helpers has been the State Department in Washington. Our ambassadors and ministers and consuls have aided our push into new markets to the utmost corners of the world.” Renewables tycoons of the future will likely write (or tweet, if it’s Elon Musk) along similar lines.
What to do
- Account for greater political risks in petrostates. Sovereign default, political instability, economic recession, dwindling government revenues should all be factored in to risk assessments for long-term investments in states highly dependent on oil and gas.
- Consider the impact of a long-term relative decline in oil on the economy and financial portfolios (including inflation in the short term as oil prices remain high but perhaps lower sensitivity to oil prices changes in the long term). More money will also flood into renewables and metals required for advanced technology, with impacts on prices.
- Look for threats and opportunities in the many forthcoming government interventions in support of a green transition. More direct grants, regulation nudging companies towards low-carbon business models, market access support and restrictive trade measures will likely be a key feature of government actions with direct bottom-line implications.