Global impact of climate risk on the power sector

Meeting global climate goals and achieving climate neutrality requires a fundamental transformation of the global economy and a fundamental change of the way of power production and consumption. Power is essential for the functioning of modern economies, but at the same time, greenhouse gases (hereinafter: GHG) emissions resulting from energy production are by far the largest contributor to global warming. The target of green transition is the de-coupling of global economic growth from GHG emissions. Green transition means a change not only for the real economy, but also for the power sector, exposing power companies to certain risks as well as opportunities, as they are forced to adapt to the new reality. Green transition impacts the power market, which is shifting away from fossil-fuel dominated system and towards renewable energy sources (RES) and carbon-free solutions. These changes pose a huge challenge for power companies, as well as for society, creating an opportunity for new entrants to enter the power sector that become a catalyst in this context. Green transition requires high levels of de-carbonization and electrification of the economy, backed by green fuels, in areas that are difficult to electrify. It creates a high degree of operational complexity, which must be solved by adjustments of the core activities of power companies preparing them for the new challenges generated by technological change, climate-focusing revolution, climate risk, new market participants and societal expectations.

Climate risk in the power sector shall be defined as the impact as well as economic and financial consequences of risk that may arise from climate change or from the efforts to mitigate climate change. The response to climate risk is the de-carbonization of the value chain and “greening” the core activities of power companies. Green transition increases risk in areas of regulatory and market pressure, forcing changes in market strategy or operational techniques. It generates also opportunities for well-prepared organizations that can emerge in the area of changing power production methods (mainly clean technologies, aiming to reduce GHG emissions), a digital revolution on the power market, digitalization of operations, or new elements of the financial market. There is a crucial need to strike a proper balance of the short-term risk of inappropriate activities influencing economies, with the long-term risk of insufficient or overdue actions, preventing the catastrophic economic and social impacts of climate change. Taking this approach into account is essential to the success of both, particular industries and power companies. That is why progressing climate change, and intensive human activity directed at mitigating its effects, has made environmental protection and the need to transform the economy a priority[1]. The de-carbonization of the economy is at the starting point, but one can observe even today the basic shift in the power production mix towards RES, securing the increase of green power utilization by industry and by society.

Power is an essential reaction to climate risk. The use of green power produced by RES supports the creation of a de-carbonized, sustainable energy framework – growing contribution of clean energy sources alongside improvements of energy efficiency. Electricity demand is expected to triple by 2050, due to the electrification of the economy and the increased use of hydrogen produced from green energy (green hydrogen). The development of new, climate neutral power production techniques is essential to ensure the necessary reduction of investments in fossil fuel-based assets in the power sector. The development of new climate neutral technologies is necessary in this context, as well as ensuring competition in supply chains, support for R&D, and instruments financing required investments. RES shall be developed by increasing the capacity of wind and solar farms – it should hold an approximately 90% share in the production of electricity by 2050.

These trends will generate a significant reduction of the use of fossil fuels in the power sector in particular, and in other industries in general. Power companies face a transformation of their business environment, a significant change in competition, and new expectations and needs of customers aiming to de-carbonize their activities. Competition is increased by technological revolution. It is necessary to point out the constant change in the profitability of various power sources, and the uncertainty as to their future profitability (especially return on capital). The need to reduce the usage of fossil fuels will create the risk of demand reduction for fossil fuels-based power, and the deterioration of the competitiveness of the traditional (pre-existing) power industry. However, power companies strive to reduce the emission of GHG per MWh produced, a fact that gives, globally a competitive advantage to RES. Furthermore, RES is usually characterized by a zero marginal production cost – on the wholesale market, RES are immediately more competitive than fossil fuel-based power plants. As a result, many power plants were decommissioned globally in recent years. On the other hand, this situation creates an opportunity for the managers of energy storage systems (batteries, pumped storage power plants, etc.), as the high volatility of prices makes it possible to maximise options provided by such installation. Hence, the pre-existing power industry invests both in RES and systems of a flexible energy supply management. Thus, a paradox arises whereby green transition can be accelerated by traditional power companies as they become “greener” in order to defend their pre-existing market shares and future profitability. The entire system of power production and consumption will have to be transformed in the decades ahead – from fossil fuels to RES – in order to ensure a sustainable future. Hence, power companies have to re-design their core activities in order to secure their future profitability. These changes must involve, at least:

• the available portfolio of products and services that support customers’ needs towards minimizing their carbon footprint and green electrification of production processes, heating and transportation;
• a radical change of production technologies towards a carbon-neutral production portfolio;
• the surplus of renewable production, which needs to be also used by heating systems and green hydrogen production;
• wind, solar, bio-mass and waste surpassing fossil fuels as energy sources;
• rethinking the role of old carbon-neutral technologies in the portfolio of power companies, that is, nuclear, geo-thermal, hydro power; storage of green power and electricity production, based on green hydrogen, operating as peak power producers replacing gas power plants;
• innovation in power trading on customers’ behalf backed by the usage of power storage, connecting the RES production with power storage systems, and the formation of virtual power plants (trading, ancillary services);
• making the power grid ready to accommodate intermittent sources of power from wind, solar, and offshore farms;
• replacing gas power plants by power storage systems as well as demand side management solutions;
• power generation having to be increasingly spread among many suppliers, from large, centralized power plants to individual “prosumers” (consumers that are also producers) making it necessary for the power grid to be ready for bi-directional power transmission – based on the optimization of power supply supported by the digitalization of operations;
• radical digitalization of operations in areas where it creates added value;
• power companies, used to operate in markets characterized by predictable and inflexible demand, needing to adapt to changing demand patterns with respect to the use of RES, electric vehicles, power storage systems and, for example, heat pumps;
• new elements of power systems offering some flexibility in demand-side management – for example, electric vehicle can be treated as elements of power storage systems (vehicle-to-grid).

[1] Climate change shall be perceived as a change in climate over time due to human activity and natural variability. It impacts natural and human systems.