Is today’s commodity market equipped for the pressures of energy transition?
In recent weeks, major financial firms have announced investments in renewable power producers: BlackRock, for instance, recently acquired organic waste-to-renewable energy producer Vanguard Renewables, while Africa Finance Corporation and Infinity invested in Lekela Power, the largest power producer in Africa. These are only two examples, but such deliberate acquisitions reveal sustained commitment to the transition from fossil fuels to renewable energy.
Part of the impetus for embracing the energy transition is driven by the various regulations set by countries to reduce greenhouse gas emissions. The European Climate Law, for instance, aims to make Europe’s economy climate neutral by 2050. Such initiatives are being supported by the European Emission Trading System (EU ETS), a long-standing mandatory scheme to reduce greenhouse gas emissions. In addition, modern corporates’ net zero commitments are being influenced by consumers and investors alike, causing them to mobilize and participate in voluntary schemes.
One thing is for sure: the industry-wide transition towards cleaner energy is real. It’s here to stay and is happening fast, creating opportunities and pitfalls. But the question remains: how equipped is the commodity market to respond to this swell of interest, pressure, and demand?
A potentially challenging road ahead for the commodity market
The structural shift to a new world order in commodity production, trading, and consumption encompasses a host of new challenges and risks.
New renewable energy products and corresponding value chains have introduced multi-layered complexity to an already fragmented environment. Power generation and production from renewable energy (wind, solar), as well as renewable fuels (like hydrogen), entail processes that depend heavily on robust technological infrastructure.
While hydrogen invites specific operational challenges for scheduling, storage, and transportation, renewable power presents its own set of complexities, such as weather dependency, usage of less established infrastructure, and – in the case of offshore wind production – the possible distance between production and consumption sites. Not to mention that renewable energy products are often accompanied by a wide range of certificates that have their own regional specificity, set of classifications, eligibilities, validities, dedicated registries, and transfer rules, which have to be traded, managed and tracked alongside commodity products.
The nature of thinly traded markets, such as renewables, compounds market challenges. Low volumes and erratic price movements produce a volatile environment for both buy-side and sell-side operators, who are already preoccupied with managing compliance in the face of complex new regulations and planning how best to protect their investments in the future.
In combination with these structural challenges, other unfamiliar effects have to be managed in a world that’s focused on renewables. Many overlook that an influx of sustainable power production can bring about a ‘cannibalization effect,’ whereby a negative correlation between production and price develops. An increase in supply can prompt negative price pressure, due to an inability to efficiently store produced power for later consumption in large quantities. This scenario recently garnered attention in Spain, where wind plants saw strong production correlate with dropping prices.
Flexible technology as the lynchpin of corporate strategy
As the pace of change in the commodity market quickens continually, the attention of economists and analysts will be drawn to assessing the opportunity and the market’s capability to manage added investment and mounting sustainability concerns.
In order to operate and keep up in an environment where market and business needs continuously change, having the right physical infrastructure in place is important, especially as storage capabilities evolve, decentralized asset management becomes more dominant and the adoption of hydrogen increases.
Well-equipped firms — those with the best technology infrastructure — will capitalize on the market and seize the ‘first mover advantage’: something that will differentiate them from their peers, grow their reputation and improve the bottom line with centralized and timely sources of data.
Crucially, while flexible technology is set to be the lynchpin of corporate strategies, it is data that will fuel decision making. This is something I will explore further in the next part of this series, delving deeper into the importance of accurate, timely and accessible data for the commodity market; how businesses can grasp opportunities when they arise and master true risk management in real time.
Corporates all over the world are embarking on a journey to limit climate change, which is in turn having an impact on commodity markets. Traders who embed ESG into their operations and embrace flexible technology to capture and analyze relevant data will be best placed to break away from the pack.
Note: This article was originally published on bobsguide on August 11, 2022.
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