Accelerating the journey to net zero

As the energy transition gathers pace, it will be further enabled by continued growth in green technologies.

Compendium December 2023

Contents

Chapter 3: Generation 98 What will it take for nuclear power to meet the climate challenge?

Introduction

Chapter 1: Energy Transition 2

Chapter 4: Trading 109 How traders can capture value in sustainable fuels

The role of natural gas in the move to cleaner more reliable power

Toward a more orderly US energy transition: Six key action areas

Chapter 5: Grid 123 Smart scheduling for utilities:

Four themes shaping the future of the stormy European power market

A fast solution for today’s priorities

Five key action areas to put Europe’s energy transition on a more orderly path

131 Winner takes all? Digital in the utility industry

67 Decarbonize and create value: How incumbents can tackle the steep challenge

Chapter 6: CAPEX 141 Europe’s €10 billion savings

opportunity to deliver onshore wind and solar

Chapter 2: Renewables 78 Enabling renewable energy with battery energy storage systems

147 Capital projects are critical for a green future

86 Build together: Rethinking solar project delivery

Accelerating the journey to net zero

Introduction Many of the articles we published in 2023 show that, although there has been a strong increase in low-carbon technologies such as

hydrogen—can grow fast enough to meet net-zero targets and projected increasing electricity demand. Recent developments show that nuclear power is emerging as a key component of decarbonization plans. — The sustainable-fuel market is still mostly nascent, characterized by complex regulations and interdependencies across sectors. With such complex market fundamentals, sustainable-fuel traders are seeking to understand which markets will increase in liquidity, which arbitrage plays to explore across products, which storage hubs to invest in, and which offtakes to secure to gain access to supply. — Natural gas can play a critical role in decarbonizing the US power supply by providing a backup energy supply for renewables. In the following decades, a fully “dispatchable” backup energy supply will be required to ensure the reliability of the power grid for multiday swings. However, infrastructure upgrades and new market mechanisms will likely be required to position mainstream gas operators to provide the natural gas that consumers will need. We hope this compendium offers new insights that can help energy executives remain competitive as the transition continues apace.

This compendium includes a representative selection of articles with findings that help illustrate the evolving net-zero landscape, including the following: — The number and scale of capital projects crucial to the energy transition will not suffice. When the Inflation Reduction Act was signed in 2022, the US federal government released $370 billion in funding to provide tax credits for clean-energy projects. Today, the challenge is securing the right people, resources, and physical space while overcoming supply chain constraints and financing for nonestablished players. — More than $5 billion was invested in battery energy storage systems (BESS) in 2022—almost a threefold increase from the previous year. By 2030, the global BESS market could reach between $120 billion and $150 billion, more than double its size today. Yet the fragmented nature of the market means many providers are wondering where and how to compete.

solar, wind, and electric heat pumps, more-urgent global momentum and collaborationacross

the energy value chain is needed.

As the world strives to limit temperature increases to 1.5°C, in line with the Paris Agreement, investment in a broad and balanced portfolio of low-carbon solutions is one of the most critical levers for accelerating the transition. According to McKinsey’s Global Energy Perspective 2023, total annual investments in the energy sector overall are projected to grow by 2 to 4 percent per annum, roughly in line with global GDP growth, to reach between $2.0 trillion and $3.2 trillion by 2040. 1 Furthermore, decarbonization technologies demonstrate the highest levels of investment growth at 6 to 11 percent per annum, driven predominantly by the strong uptake of electric-vehicle charging infrastructure and carbon capture, utilization, and storage.

— Nuclear power is a proven

technology that can be called upon to play a bigger role in decarbonization. As rapidly as renewables have scaled up in recent years, it’s unclear whether wind and solar—along with other emerging solutions, such as carbon capture, long-duration energy storage, and

1 “Global Energy Perspective 2023,” McKinsey, October 18, 2023.

Accelerating the journey to net zero

1 Energy

Transition

Accelerating the journey to net zero

The role of natural gas in the move to cleaner, more reliable power Natural gas can play a critical role in decarbonizing US power supply by providing a backup energy supply for renewables—but infrastructure investments and market mechanisms will be needed.

by Jamie Brick, Dumitru Dediu, and Jesse Noffsinger

Accelerating the journey to net zero

Across the United States , renewable energy sources are impacting natural gas generation. The growth of renewables in the grid, compounded by the increased electrification of energy demand, will expose the grid to the risks of an intermittent renewables supply to meet growing power demand. As a result, in the coming decades, a fully “dispatchable” backup energy supply will be required to ensure the reliability of the power grid for multiday swings. In the absence of breakthroughs in long- duration energy storage, natural gas—which can be implemented at scale—could be the cheapest and lowest-carbon candidate for this role. Demand for gas is expected to be more volatile going forward—lower on average, but potentially much higher on peak-demand days when intermittent renewables are at low generation levels. However, today’s gas system was not designed and sized to deliver the high gas volumes that will be needed on these peak-demand days in the future. Infrastructure upgrades and new market mechanisms will likely be required to position mainstream gas operators to provide the natural gas that consumers will need. Natural gas’ track record in decarbonizing the power sector over the past decade Since 2005, the United States has reduced its energy-related CO2 emissions by about 18 percent.¹ A switch from coal to natural gas accounts for a significant portion of this reduction. According to the US Energy Information Administration (EIA), the use of natural gas in the electric power sector increased by more than 100 percent between 2005 and 2022, while coal use declined by about 55 percent.²

532 million metric tons in CO2 emissions over the same period.³ This has been the most significant decarbonization lever, mitigating the equivalent of more than 10 percent of 2021 US greenhouse gas (GHG) emissions. This is more than double the mitigation of approximately 248 million metric tons of CO2e (carbon dioxide equivalent), which can be attributed to the increase in renewable generation.⁴ Moving forward, the United States has the opportunity to increase the decarbonization impact through natural gas, alongside other power supplies, by continuing coal-to-gas switching, implementing carbon capture and storage (CCS) solutions on existing and future gas-fired power installations, supporting blue hydrogen production, and accelerating the rollout of intermittent renewables beyond the level of 13 percent of power generation in 2021.⁵ In addition, natural gas exports from the United States can support energy supply security and decarbonization efforts overseas—for example, in Europe through coal-to-gas switching and enabling the accelerated rollout of renewables and new energies (such as the hydrogen economy).⁶ The electrification of energy demand and the growth in renewables A major trend in the energy transition is the electrification of energy demand. The greater the electrification of end-use energy needs, the higher the importance of the energy supply reliability to meet growing power demand. To illustrate, the electrification of road-based transportation is currently taking place by replacing internal combustion engine (ICE) vehicles with electric vehicles (EVs), the electrification of household heating is occurring through heat- pump adoption, and the electrification of industrial processes is happening through the electrification of low-temperature heat.

This shift from coal to natural gas for power generation resulted in an estimated reduction of

1 US energy-related carbon dioxide emissions, 2021 , US Energy Information Administration, December 2022. 2 “Electricity data browser,” US Energy Information Administration, June 6, 2023. 3 “Electric power sector CO2 emissions drop as generation mix shifts from coal to natural gas,” Energy Information Administration, June 9, 2021; metric tons: 1 metric ton = 2,205 pounds. 4 Global energy review 2021 , US Energy Information Administration, April 2021. 5 “Electricity data browser table 1.1. Net generation by energy source: Total (all sectors), 2013–March 2023,” US Energy Information Administration, 2023. 6 “How climate action can help deliver EU energy security,” McKinsey, August 12, 2022.

Accelerating the journey to net zero

densely populated areas—to provide the land required for renewables. Solar requires roughly 10 to 20 times more land than gas, and onshore wind up to 200 times more, to generate the same amount of electricity.⁹ Overall, significantly larger investments will have to be made in the power grid to support the rollout of renewables. This could amount to an increase in investment of five to ten times historical levels.1 In addition, supply chain constraints and other factors, like the availability of craft labor, may lead to cost increases and delays in renewables projects. Depending on the degree to which the renewables industry manages to address these challenges, the share of renewables in power generation may range from very low (15 percent solar and wind by 2040 in the “current trajectory” scenario as laid out in the Global Energy Perspective 2022 ) to very high (70 percent solar and wind by 2040 in the “achieved commitments” scenario) (Exhibit 1). Across all scenarios, however, gas-fired power generation will play an important role: in a “less- renewables” scenario, gas-fired generation will be needed to meet higher electricity demand as renewables scale up; in a “more-renewables” scenario, gas-fired power generation can provide affordable and dispatchable power supply to balance out the intermittency of renewables.

To meet US decarbonization goals, this higher electricity demand must be met with a clean power supply. Power supply decarbonization can be achieved with a higher share of renewables in the grid (for example, solar and wind), alongside other low-emitting energy sources—such as nuclear, hydroelectric power, or gas-fired power generation with CCS. In virtually every decarbonization scenario and each independent system operator (ISO) in the United States, the share of renewable generation is expected to increase and coal generation is expected to decrease. Renewable growth is supported by federal policy and state-level decarbonization goals. At the federal level, the Inflation Reduction Act of 2022 directs roughly $400 billion in federal funding to renewables, also lowering carbon emissions by providing decarbonization incentives for operators throughout the energy value chain.⁷ Parallel to this, individual US states have set ambitious targets to achieve substantial decarbonization, with 22 states (representing around 45 percent of the US population) already having deep decarbonization targets of 80 to 100 percent by 2040 or 2050.⁸ There is no doubt that many challenges will need to be resolved to substantially increase renewables supply. For example, regulations around land access will need to be updated—especially around

Renewable growth is supported by federal policy and state-level decarbonization goals.

7 “The Inflation Reduction Act: Here’s what’s in it,” McKinsey, October 24, 2022. 8 McKinsey analysis based on industry figures.

9 Hannah Ritchie, “How does the land use of different electricity sources compare?” Our World in Data, June 16, 2022. 1 Life cycle assessment of electricity generation options , United Nations Economic Commission for Europe, 2021.

Accelerating the journey to net zero

Decarbonizing the grid with a large share of renewables comes with reliability challenges Decarbonizing the US power supply with solar and wind generation entails the challenge of an intermittent supply that cannot reliably match power demand, especially the multiday variability of this demand.¹¹ The higher share of electrified energy demand implied by decarbonization will make reliability in the grid even more important, as electricity will be needed for residential heating and critical industrial processes.

There are several options for securing a reliable and dispatchable power supply in a decarbonized grid to address multiday variability (Exhibit 2). While various long-duration energy storage (LDES) solutions may be economic in some geographies to provide electricity during multiday periods of low renewable generation, natural gas is consistently the most reliable and cost competitive—even after accounting for carbon costs. Natural gas generation is known as a “dispatchable” energy source, meaning that the facilities for natural gas generation can be switched on or off depending on need—demonstrating its suitability as a security supply for the grid.

Exhibit 1 The share of renewables in the grid has a direct bearing on US decarbonization goals. US power generation mix, thousand terawatt-hours decarbonization goals. Gas Wind and solar

Hydro and nuclear

Other¹

7.5

0.8 6.9

0.2

0.9

0.2

1.9 0.8 5.8

0.2

1.1 5.1

4.6

0.1

4.3

0.9 4.3

1.7 0.6 1.0 0.9 4.3

0.4

3.8

0.4

1.2 1.1

5.8

1.6 1.2 1.1

2022 2030 2040 1.7 0.6 1.0 2.9

2.2

1.8

1.6

0.6

2022 2030 2040

Scenario Current trajectory (CT)

Further acceleration (FA)

Achieved commitments (AC)

Description • Decline in cost of renewables continues and existing enacted targets are met, but no new policies are put into law

• Presupposes that most ambitious publicly discussed ambitions are met • In the US, this includes net-zero power by 2035 on a path to a net- zero economy by 2050 • Largely ignores supply chain issues and other constraints

• Driven by increased commitments, though financial and technological restraints remain

Slower

Faster

Speed of energy transition

1 Includes coal and dispatchable renewables like hydrogen and bioenergy.

McKinsey & Company

11 “Toward a more orderly US energy transition: Six key action areas,” McKinsey, January 12, 2023.

Accelerating the journey to net zero

Exhibit 2 Gas generation is less expensive than hydrogen turbines or other long-duration energy storage solutions to address multiday power supply variability. 2030 electricity costs,¹ $/megawatt-hour energy storage solutions to address multiday power supply variability.

Gas levelized cost of electricity (LCOE)

Carbon capture, utilization, and storage (CCUS) Long-duration energy storage (LDES)

Implied cost of CO₂ emissions

Combined cycle gas turbine with CCUS

Hydrogen

Direct air capture (DAC)

New gas peaker with carbon tax

156

131

New gas peaker with DAC offset

131

125

256

LDES

175–300

New H₂ peaker (H₂ delivered at $2–$3/kg)

254–330

Note: Metric tons: 1 metric ton = 2,205 pounds. 1 Key assumptions: Gas CCGT w/CCUS—LCOE $35/MWh; CCUS costs of $85/ton; emissions 0.45 tCO₂e/MWh; 90% CO₂ capture; 85% utilization; new gas peaker—LCOE $131/MWh; gas price $3/mmbtu, utilization 10% pa, emissions 0.5 tCO₂e/MWh; social cost of carbon $51/ton, as per current US federal guid ance; DAC cost $250/ton; 100% of emissions offset; LDES approximate costs across multiple technologies including: iron air/flow, Li-ion, modular CAES and gravity assuming 24-hour discharge; 90 cycles per year; new H₂ peaker, utilization 10% pa; hydrogen costs delivered to peaker. - Source: EIA

McKinsey & Company

The natural gas system needs to be built out to deliver on peak-demand days when renewables cannot generate at full capacity To ensure that dispatchable gas-fired power generation can be used to complement renewables, the supply of natural gas to power plants must be robust enough to meet demand on peak days— occurring when solar and wind generation are low for multiple consecutive days. In deeper decarbonization scenarios, this will lead to a lower average annual gas demand volume, with higher peak-day gas demand. The need for dispatchable power will likely vary by region—with some regions relying much more on gas-fired power generation than others depending on the availability of attractive renewable generation, such as solar and wind (Exhibit 3) (See sidebar, “The need for natural gas in a transition to renewables: A case study”).

New market mechanisms and gas infrastructure investments will be needed to bridge the gap The natural gas infrastructure in North America— pipelines and storage facilities—has grown over decades to transport gas based primarily on long- term, take-or-pay contracts between pipeline operators and customers (typically gas marketers or large buyers, like utilities or industrial companies) that pay a reservation charge (or tariff) for capacity. In the coming decades, the capacity of the natural gas system will have to be increased to allow it to deliver on peak-demand days when renewables cannot generate at full capacity, even in areas currently not impacted by insufficient pipeline capacity. However, expanding this gas infrastructure capacity and maintaining the existing gas infrastructure will require new investments, though the capacity will be utilized at a much lower

Accelerating the journey to net zero

The need for natural gas in a transition to renewables: A case study

To meet decarbonization goals, New York (NY) and New England (NE) ISOs are starting to replace natural gas with renewable generation as a power source. From 2021 to 2040, gas generation is expected to decrease with a CAGR of 6 percent, while renewable generation grows with a 1 percent CAGR. Although gas accounted for over half of NY’s and NE’s power generation in 2021, by 2040, renewables would contribute the bulk— around 75 percent (exhibit). Despite this shift from gas to renewables and the ultimate drop in annual gas

rest of the country. This poses a challenge for natural gas providers and consumers— how best to organize and regulate access to an emergency supply of natural gas? To ensure grid reliability, access to gas will be needed. And this, in turn, will require new infrastructure to be developed (such as pipelines and gas storage). Providing— and paying for— this infrastructure requires a change in how the gas and power market currently operates; new market mechanisms will have to be introduced to allow full access to the natural gas market.

generation, demand for gas on peak days—when renewables generate below full capacity—could increase, especially in the absence of other dispatchable energy supplies that can be ramped up to meet power demand. In 2021, peak-day gas demand in NE and NY reached up to 6.6 billion cubic feet per day (bcfd) above the average annual gas demand. By 2040, peak-day demand in NE and NY could quadruple the annual demand, with an 11.5 bcfd difference. Natural gas, therefore, will remain essential to the grid in NY and NE, as in the

Exhibit In New York and New England, average gas demand will decline, and peak-day demand will increase.

NY and NE annual generation to meet decarbonization targets, terawatt-hours

2040 NY, MA, CT, and RI demand,¹ billion cubic feet per day

Power

Gas local distribution company (LDC)²

Industrial

CAGR

401

2021–2040, %

15.2

0.8

–1

Other

12.3

–6

Gas

0.7

5.9

+11.6

235

+6.6

6.4

5.7 0.7 2.1

304

Renewables

8.5

3.6 0.8

134

5.2

2.0

2.8

0.9

2021

2040³

2021 annual demand

2040 annual demand

2040 peak day demand

2021 peak day demand

Note: Assuming IRA and current state carbon policy. 1 Excludes Maine, New Hampshire, and Vermont. 2 Based on modeled gas LDC consumption for 2040 and the average winter peak day demand of ~3× higher. 3 Assuming a constant demand for industry. Source: ISO New England; Power forecast data; McKinsey Energy Insights; McKinsey Global Energy Perspectives

McKinsey & Company

Accelerating the journey to net zero

Exhibit 3 Gas demand for power will decrease on average and increase on peak days. Gas demand for power will decrease on average and increase on peak days.

Gas-fired power generation, average and peak, terawatt-hour of gas-fired generation per day

Average Peak

Midcontinent Independent System Operator and Southwest Power Pool

California Independent System Operator

Electric Reliability Council of Texas

4.4

+86%

2.4

+60%

1.5

0.8

1.7

0.5

+44%

1.3

0.9

0.6

0.3

0.1

2021

2040

2021

2040

2021

2040

Southeast and Florida Reliability Coordinating Council

Pennsylvania-New Jersey- Maryland Interconnection

Western Electricity Coordinating Council

7.0

+167%

4.3

+37%

3.1

2.6

+63%

1.6

2.3

1.8

1.5

1.2

1.0

2021

2040

2021

2040

2021

2040

McKinsey & Company

needs to balance out the three imperatives of decarbonization, affordability, and reliability.

rate. The regulatory and market mechanisms that will support such investments are the key unlocks in this regard. Addressing this challenge requires collaboration across the entire value chain—gas producers, pipeline operators, utilities or power producers (PPs), ISOs or regional transition organizations (RTOs), and policy makers—and a recognition that the solution

Pipeline and storage operators: These operators in particular will be affected by this. Together, lower average gas demand and the costs of increasing gas infrastructure capacity pose a unique challenge for pricing the delivery of midstream gas services to customers.

Accelerating the journey to net zero

importance of reliability will increase. For example, during the winter storm Elliott in December 2022, plant equipment outages accounted for a large share of power supply shortages, followed by securing gas supply.12 As outlined in a previous McKinsey article, “The future of natural gas in North America,” decarbonization policies will likely drive gas-fired generation to average loads of 10 to 20 percent by 2040. This increase may create a need for capacity markets or other mechanisms to remunerate dispatchable gas-fired (peaker) capacity supporting renewables unless more attractive solutions emerge for dispatchable generation and storage. Upstream gas producers: Over the last decade, upstream gas producers have provided US customers with affordable energy and ensured energy supply security both domestically and overseas through LNG exports. If gas is to remain a core pillar of the power generation system, the importance of the reliability of gas supply will only increase. For example, winter storm Uri that hit in February 2021 (which impacted 30 percent of nationwide production mainly in Texas and the Southwest), and winter storm Elliott that hit in December 2022 (which affected 20 percent of nationwide production mainly in Appalachia), have emphasized the need for investments, solutions, and mechanisms to ensure a reliable gas supply, especially during extreme weather conditions. Policy makers and regulators: The role of policy makers and regulators will be critical in establishing the pace of decarbonization and the appropriate market incentives to shape the role of gas to support renewables penetration—such as the provision of flexible dispatch in power generation to compensate for intermittency in solar and wind power. If the power system relies on gas for flexibility, then capacity markets or other mechanisms will be required to ensure that necessary investments are made in the gas system.

Current patterns of compensation for gas assets (such as storage facilities and transport pipelines built for predictable demand at moderate volumes) are not designed for this volatile demand. If these patterns persist, end users will likely be forced to pay for year-round access to a gas supply they may only need a few times a year. Additionally, pipeline operators have proposed peaking services to address some of these issues, which require investments (for example, flexible storage assets or new pipeline connections). However, in the current regulatory environment, investment costs often are not allowed to be passed onto customers. Participants in the natural gas market will need to choose carefully how they approach the conundrum to justify gas infrastructure investments. One option is to continue to offer connection tariffs. The weakness here, however, is that customers will have to pay for infrequently used gas infrastructure capacity. For example, gas infrastructure capacity could be booked on a monthly basis with a fixed reservation charge. Peaking power plants would often not know whether they will dispatched and therefore may find it uneconomic to pay a monthly reservation charge. Another option is to offer customers hourly, pay-as-you-go payment plans, which may require regulatory support and customers’ willingness—such as power generation utilities—to pay high hourly rates for short periods during peak gas demand days (Exhibit 4). Without market mechanisms (and regulatory support) to justify infrastructure investments (for example, secure funding and engineering, procurement, and construction [EPC] contracts), the current challenges of pipeline constraints may become exacerbated with a higher share of intermittent renewables and electrification of energy demand. Power-generation utilities: Gas-fired power generation will be exposed to far greater volatility in seasonal, daily, and intraday load—while the

1 “Winter storm Elliott,” PJM Interconnection, December 2022; PJM Interconnection coordinates the movement of electricity through all or parts of Delaware, the District of Columbia, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, and West Virginia.

Accelerating the journey to net zero

Exhibit 4 New market mechanisms will be needed to allow gas suppliers to meet peak-day demand.

Power market change Gas market change

Change to gas and power market

Minimal change

Substantial change

Require firm transportation (FT) for gas generators

Maintain current G&P contracting structure • Continue operating gas and power markets under current standard contracting practices

Hourly gas prices

Option based pricing

Potential option

• Offer gas supply on a dynamic hourly basis

• Require generators to have FT to participate in power capacity markets

• Variable cost gas supply that changes based on market conditions (for example, pay less during normal conditions but pay a premium during a price fly-up) • Getting power and gas players to agree to terms when higher prices are permitted may be difficult • More variable revenue (pipeline) and costs (power)

Additional considerations

• Pipeline revenue becomes highly volatile • Power generators and regulators may be cautious to pay potentially thousands $/mmbtu for a few hours of gas access

• May increase power costs • Power generators and regulators may be unwilling to pay for year-round gas access when it is required infrequently

• Power generators may be unwilling to pay for year-round gas access when it is required infrequently

Note: To meet higher peak-day gas demand in a renewable-dominant power grid, additional infrastructure (such as pipelines and underground storage) will be required.

McKinsey & Company

through affordable and reliable grid balancing. To do this, the gas system must be ready to deliver high volume on peak-demand days when renewables cannot generate at full capacity—this will require the introduction of market mechanisms and infrastructure not in place today.

With the right regulatory and infrastructural changes, natural gas can play a key role in decarbonizing the US power supply in the coming decades, supporting the accelerated rollout of intermittent renewables

Jamie Brick is a consultant in McKinsey’s Houston office, Dumitru Dediu is a partner in the Boston office, and Jesse Noffsinger is a partner in the Seattle office. The authors wish to thank Adam Barth, Anton Derkach, Yuliya Olsen, Micah Smith, and Humayun Tai for their contributions to this article.

Accelerating the journey to net zero

Toward a more orderly energy transition: Six key action areas The US drive to decarbonize is at an inflection point. Critical actions could accelerate the transition while enhancing energy affordability and supporting inclusive economic growth. This article is a collaborative effort by Gracie Brown, Blake Houghton, Jesse Noffsinger, Hamid Samandari, and Humayun Tai, representing views from McKinsey’s Global Energy and Materials and Sustainability Practices.

A combination of federal legislation, state targets, corporate commitments, investor pressure, and advances in clean technologies is giving new momentum to public- and private-sector efforts in the United States to moderate the effects of climate change. 1 This forward movement improves the country’s chances of significantly reducing its emissions by 2030 and coming closer to meeting its climate commitments. At the same time, powerful headwinds are present. The war in Ukraine has shattered lives and liveli hoods, disrupted energy security and affordability, and deepened geopolitical tensions. It has also exacerbated the supply chain issues and inflationary trends that arose with the pandemic and increased the threat of a global recession. An increase in US natural-gas prices of more than 50 percent in September from a year earlier led to the announce ment of delays in the retirement of some coal plants. - - 2 Supply chain challenges in the United States

have also increased the price of renewables, with reduced access to solar panels from Asia raising prices by 30 percent and causing project delays. Indeed, it seems that over the past three years, the United States, and the world, have been witnessing a confluence and mutual reinforcement of the four main systemic risks facing humanity: global-health, macroeconomic, geopolitical, and environmental risks. Yet that same confluence makes the case for action even stronger as the relationship between the risks becomes clearer. Where do we go from here? The energy transition, as it is often called, includes not only the decarbonization of the electric sector— which accounts for about 25 percent of US greenhouse-gas (GHG) emissions today 3 —but also three additional elements: the development of new

The requirements of the transition must be carefully balanced with the need to ensure a reliable, resilient, and affordable energy supply all along. The United States does not seem to have found this balance.

1 The passage of the Inflation Reduction Act (IRA), and the government’s commitments to cut greenhouse-gas (GHG) emissions by 50 to 52 percent by 2030 and to achieve a net-zero grid by 2035, represent the most ambitious climate actions by the federal government to date. For more information, see “Fact sheet: President Biden sets 2030 greenhouse gas pollution reduction target aimed at creating good-paying union jobs and securing U.S. leadership on clean energy technologies,” White House, April 22, 2021. (See sidebar “The potential impact of the Inflation Reduction Act.”) At the same time, policies put in place by the 25 states that have set economy-wide emissions-reduction targets continue to accelerate decarbonization (“U.S. state greenhouse gas emissions targets,” Center for Climate and Energy Solutions, updated August 2022). In addition, more than $30 billion in climate-focused assets are under management in the United States (“Climate funds dig deeper roots,” Morningstar, April 13, 2022), while more than 1,500 businesses have committed to setting net-zero targets (Science Based Targets home page, accessed December 18, 2022). 2 Timothy Gardner, “U.S. coal plants delay closures in hurdle for clean energy transition,” Reuters, August 10, 2022. 3 “Sources of greenhouse gas emissions,” US Environmental Protection Agency, August 5, 2022.

Accelerating the journey to net zero

The potential impact of the Inflation Reduction Act

The Inflation Reduction Act (IRA) of 2022 will likely have a significant impact on enabling the United States to achieve climate commitments. The law directs an estimated $393 billion in climate spending to six key categories: energy, climate and environmental justice, manufacturing, land and agriculture, transportation, and water. Funding is channeled through tax investment and production credits, federal grants, and loan programs. Many of the tax credits are uncapped, meaning no limit is written into the law that restricts how much they are used. Moreover, the $40 billion in funding for loans covers subsidy costs exceeding $400 million for direct loans or loan guarantees for innovative clean energy, energy infrastructure reinvestment, and upgrading transmission lines, among others. The true magnitude of the public- sector investment could reach $1 trillion if implemented effectively.

The IRA has the potential to support a more orderly energy transition but also could introduce further risks and challenges. Key implications of the legislation for the power sector include the following: 1. accelerating the transition of the US power mix toward renewables 2. expanding the distributed solar market, with different customer segments, such as low-income customers, taking on more prominence 3. unleashing of a new stand-alone storage market for developers and asset owners 4. unprecedented expansion of US cleantech manufacturing and supply chains 5. directing investment to energy- producing regions and communities

that may be most affected by industry changes 6. accelerating of electrification and energy-efficiency opportunities, increasing the importance of serving low-income customers 7. jump-starting the hydrogen market, with a relatively higher emphasis on lower-carbon supply 8. creating a CO2 economy driven by expanded credit options 9. kick-starting production of sustainable aviation fuels, including novel power- to-liquids pathways

net-zero energy supplies (for example, scaling up production of low-carbon hydrogen); the electrification of demand, such as transportation and buildings; and the transition of the gas system to being primarily a capacity provider. These will require new policies, markets, business models, and technologies to be rapidly developed and deployed at scale. At the same time, the requirements of the transition must be carefully balanced with the need to ensure a reliable, resilient, and affordable energy supply. On its current trajectory, the United States does not seem to have found this balance. Resilience investments, where they are being made, appear

set to radically increase bills. Where they are not made, customers would face expensive and dangerous outages. The speed of the deployment of renewables remains insufficient. There appears to be little agreement on the extent to which new fossil-fuel investments would be required to ensure resilience, or how to make them as low-carbon as possible and without long-tail stranded assets. Moreover, the transition could exacerbate consumer inflation, which is already historically high. In other words, the energy transition is currently on a disorderly path.

Persisting on this path could mean that achieving the same cumulative net emissions by 2050 4 would

4 Delay in taking action could require an estimated $5.7 trillion in generation investment alone through 2050, compared with about $4 trillion for a more orderly energy transition—a 42.5 percent increase.

Accelerating the journey to net zero

cost at least 40 percent more (Exhibit 1). This would also likely entail much greater environmental damage than a more orderly energy transition, in which emissions reductions in the near term rapidly put the United States on a path closer to a 1.5°C global warming scenario while balancing affordability, reliability, resilience, and security. (See sidebar “Modeled scenarios underlying our analyses.”) An even more dramatic scenario, in which no abatement action is taken and US emissions are aligned with a 4.8°C warming pathway, would be drastically more costly. McKinsey’s 2022 report on the transition highlights nine critical requirements to reach net-zero emissions. 5 From these, we have identified six action areas that we believe are critical at this point to enable a more orderly energy transition in the United States. Although the following actions will probably not be sufficient in themselves, we believe they constitute the necessary bedrock for this transformation and take priority at this stage:

1. designing and deploying a capital-efficient and affordable system

2. strengthening supply chains to provide stable access to raw materials, components, and skilled labor 3. securing access to adequate land with high load factors for the deployment of renewables while taking into account the needs of local communities 4. reforming transmission development to include proactive planning, fast-track permitting, and systematic consideration of transmission alternatives 5. creating market mechanisms for expanding firm capacity to ensure reliable and adequate clean energy supply

6. accelerating technological innovation to ensure timely deployment of new clean technologies

Exhibit 1 Energy transition investments could increase power sector capital by approximately 40 percent through 2030.

Projected total power sector costs, 2022–30, $ billions

Generation Transmission Distribution

500

1,000

1,500

2,000

Current Trajectory scenario

Incremental costs

Achieved Commitments scenario

Incremental cost

Source: McKinsey Energy Insights Global Energy Perspective 2022; McKinsey Power Model; McKinsey Transmission Model

McKinsey & Company

5 The nine critical requirements to reach net zero are: physical building blocks , encompassing (1) technological innovation, (2) ability to create at-scale supply chains and support infrastructure, and (3) availability of necessary natural resources; economic and societal adjustments , comprising (4) effective capital reallocation and financing structures, (5) management of demand shifts and near-term unit cost increases, and (6) compensating mechanisms to address socioeconomic impacts; and governance, institutions, and commitment , consisting of (7) governing standards, tracking and market mechanisms, and effective institutions, (8) commitment by, and collaboration among, public-, private-, and social-sector leaders globally; and (9) support from citizens and consumers. See “The net-zero transition: What it would cost, what it could bring,” McKinsey Global Institute, January 2022.

Accelerating the journey to net zero

these net new investments could help avoid the even more costly consequences of delayed action and reduce ongoing fuel costs, resulting in a system that could be less expensive to operate in the long term. Spending on the energy transition, coupled with the significant grid investment needed for reliability and resilience under any scenario, could increase the cost of the energy system for households and businesses in the coming decades. If these cost increases aren’t carefully managed and mitigated to the extent possible, they could hamper economic activity and create customer backlash. This, in turn, would delay needed action and result in a less orderly energy transition. Businesses and policy makers will thus need to target capital expenses to mitigate the affordability challenges that customers will face. (For more detailed context, see sidebar “Investments and affordability.”) KEY PRIORITIES To enable a capital-efficient system, business leaders and policy makers need to consider three key priorities now: planning investments for long- term decarbonization, deploying capital more cost- effectively, and empowering and educating customers to manage rising costs.

Modeled scenarios underlying our analyses

For the purpose of this article, a more orderly transition pathway has been modeled as a scenario in which the United States achieves its stated commitments of a 50 to 52 percent reduction (from 2005 levels) in economy-wide greenhouse-gas (GHG) emissions by 2030 and 100 percent carbon-free electricity by 2035. We call this the “Achieved Commitments” scenario. It is modeled to align with a global pathway that limits warming to about 1.7°C, which can still result in severe climate change impacts. Further action will be required to go beyond commitments and hold warming below 1.5°C. We contrast the Achieved Commitments scenario with two other scenarios: 1. The Current Trajectory scenario, in which the current path of technology cost decline continues, though active policies remain insufficient to close the gap required to meet policy objectives. The Current Trajectory scenario is modeled to align with a global pathway that reaches 2.4°C of global warming. 2. A Delayed Trajectory scenario, in which the United States continues on the Current Trajectory until 2030 and then needs to “catch up” to achieve the same cumulative GHG emissions as the Achieved Commitments scenario by 2050. Under the Delayed Trajectory scenario, the United States must both accelerate deployment of clean technologies after 2030 and invest in abatement technologies such as direct air capture to negate earlier emissions.

1. Planning investments for long-term decarbon ization. Energy infrastructure is depreciated over long periods, potentially requiring

customers to bear costs over many decades. The assets that go into the ground this year will affect costs and the system composition through the 2040s and ’50s. The exact makeup of a decarbonized power system is uncertain, so scenario planning will be helpful in identifying investments that could be valuable under a range of decarbonization scenarios and hence more judicious in the near term. By incorporating new asset types, utilities could identify and plan the right portfolio to deliver the energy transition at a lower cost. These include hydrogen-related assets; carbon capture, utilization, and storage assets; nuclear power; electric-vehicle-charging infrastructure; batteries; and long-duration energy storage.

ACTION AREA 1 Designing and deploying a capital- efficient and affordable system Meeting the US government’s 2030 emissions- reduction goals would require more than $500 billion in additional generation, transmission, and distribution infrastructure investments compared with the current trajectory of the US power system (Exhibit 2). That figure does not include so-called stranded investments: assets such as fossil fuel–intensive thermal plants that are retired early or are no longer used to the extent originally planned. However,

Accelerating the journey to net zero

Exhibit 2 A more orderly transition could save the United States more than $1.5 trillion compared with achieving the same emissions under a less orderly path.

Generation and additional abatement capital investment, 2022–50, $ billions

US cumulative GHG¹ emissions from 2022, Gt CO²e²

Delayed Trajectory without abatement Delayed Trajectory with additional abatement

20,000

Generation

Additional abatement

15,000

0 2,000 4,000 6,000

10,000

Achieved Commitments

5,000

Delayed Trajectory

2025 2030 2035 2040 2045 2050

¹Greenhouse-gas. ²Metric gigatons of carbon dioxide equivalent. Source: McKinsey Energy Insights Global Energy Perspective 2022; McKinsey Power Model; McKinsey analysis

McKinsey & Company

reduction in economy-wide GHG emissions by 2030 and 100 percent carbon-free electricity by 2035. See sidebar “Modeled scenarios underlying our analyses.”) Capital that otherwise would have been spent on maintaining coal assets could be significantly reallocated across other asset types, such as solar and wind. 2. Deploying capital more cost-effectively. All companies and utilities along the electric value chain could identify opportunities to reduce costs. The most significant target would likely be capital efficiency, given that investment accounts for 70 percent of overall costs by 2030 under the Achieved Commitments scenario, and there are ways to lower those costs significantly. In our work with renewables developers, we found that they can drive capital productivity through three key levers: design and engineering, contracting and procurement, and project execution. Combined, these could reduce capital expenditure by about 10 to 20 percent. In another example, we found that better planning and project design reduced transmission spending by 13 to 19 percent.

In addition, investments in fossil-fuel assets would best be made based on their anticipated useful life, with a view to ensuring what is needed for a reliable and affordable energy system in the shorter term while aiming to making assets less carbon-intensive, more flexible in their usage, and potentially used for a shorter duration. Asset owners could look for ways to repurpose assets that are no longer used and useful—for example, by using brownfield coal sites for new nuclear assets or upgrading gas pipelines to transport hydrogen. Lean-asset retirement and removal (decommissioning) could improve efficiency of processes and reduce costs. Investing in the right assets could have massive impact. Under the current trajectory, for example, 110 gigawatts (GW) of existing coal capacity would remain online in 2030. However, the Achieved Commitments scenario, in which the United States meets its emissions-reduction goals, would call for only 60 GW, a 45 percent difference. (In the Achieved Commitments scenario, the United States would achieve its stated commitments of a 50 to 52 percent

Accelerating the journey to net zero

Investments and affordability

The economics of the energy transition is a critical piece of the puzzle: significant investments will be needed in the coming decades, but they must be made with affordability in mind. Fortunately, these capital investments will likely result in an energy system that costs less overall to operate as society transitions away from a fuel-intensive system (such as oil for vehicles and natural gas and coal for power). Nevertheless, making capital as efficient as possible will require action. Additional measures will also likely be required to mitigate costs, particularly for low-income customers who are disproportionately affected by rising energy costs. 1. The energy transition will require increased capital investment The energy transition will require energy companies to effectively manage significant infrastructure investment. McKinsey analysis found that the US power sector may need more than $500 billion in additional capital invest ment between 2020 and 2030 to build and upgrade generation, transmission, and distribution in line with the Achieved Commitments scenario. That represents a 40 percent increase compared with the Current Trajectory. 1 - The incremental investment needed will vary by state. For example, in the case of distribution grid infrastructure, states with quicker adoption of electric vehicles (EVs) will need more distribution spend than those with slower adoption. Also, while significant distribution spend is required in the Current Trajectory, much of that investment becomes even more critical

lead to a dramatically more expensive pathway in the future, as shown by the Delayed Trajectory scenario. Of course, parallel progress of continued innovation and deployment will likely also be needed to enable a more orderly and less onerous energy transition as costs come down (see “Action area 6: Accelerate technological innovation to ensure timely deployment of new clean technologies”). Technologies in earlier stages than solar and onshore wind, including hydrogen and offshore wind, are forecast to begin ramping up in this decade. Acting early to plan, pilot, and demonstrate these and other technologies could inflect the cost curves for their larger-scale deployment in the 2030s and beyond. 2. Beyond 2050, a more orderly energy transition could lower overall energy system costs Historically, ongoing fuel costs have made up the bulk of the spend in the energy sector. By contrast, through 2030, almost 75 percent of energy-sector transition spending will go toward capital invest ments under the Achieved Commitments scenario, such as to deploy more renew able-energy facilities and boost elec tric-grid capacity. By 2050, the power system enabled by those investments would require only half as much expendi ture on primary fuels as today’s fossil fuel–based system would under the Achieved Commitments scenario. - - - Customer-side transitions show similar results. For example, the Department of Energy’s Office of Science estimates that a battery electric vehicle reaches -

for the energy transition. For example, many customers may not want to buy an EV if they think the grid is too unreliable for them to charge it when they need to. In the long term, delay and inaction will ultimately require far more investment than the Achieved Commitments scenario. While meeting the US government’s commitments would be costly, inaction could cost significantly more, both in economic terms and in the effects of climate change on livelihoods. 2 In addition, waiting to act until 2030, and then seeking to achieve the same cumulative net emissions by 2050, will likely be significantly more expensive than acting today. For example, investment for generation alone could increase by almost 40 percent by 2050 if the United States continued on its current trajectory and then attempted to make up ground starting in 2030. Much of the additional cost would come from technologies to remove carbon from the air to achieve the same cumulative emissions as the Achieved Commitments scenario. These “negative emission” technologies are still precommercial, making them a high-risk option. While some advocate for waiting for tech nology costs to come down before scaling investment, solar and onshore wind can already be deployed cost-effectively today; they make up approximately 75 percent of new generation capacity forecast in the Achieved Commitments scenario. Despite near-term supply chain challenges that bottleneck deployment today, not deploy ing renewables in the coming years would - -

1 This analysis does not incorporate impacts of the Inflation Reduction Act (IRA) of 2022. Under the IRA, the federal government supports these investments with tax credits, grants, and other policy instruments that might be funded through the bill instead of being recovered directly by energy users. 2 Climate risk and response: Physical hazards and socioeconomic impacts , McKinsey, January 2020.

Accelerating the journey to net zero

Page 1 Page 2 Page 3 Page 4 Page 5 Page 6 Page 7 Page 8 Page 9 Page 10 Page 11 Page 12 Page 13 Page 14 Page 15 Page 16 Page 17 Page 18 Page 19 Page 20 Page 21 Page 22 Page 23 Page 24 Page 25 Page 26 Page 27 Page 28 Page 29 Page 30 Page 31 Page 32 Page 33 Page 34 Page 35 Page 36 Page 37 Page 38 Page 39 Page 40 Page 41 Page 42 Page 43 Page 44 Page 45 Page 46 Page 47 Page 48 Page 49 Page 50 Page 51 Page 52 Page 53 Page 54 Page 55 Page 56 Page 57 Page 58 Page 59 Page 60 Page 61 Page 62 Page 63 Page 64 Page 65 Page 66 Page 67 Page 68 Page 69 Page 70 Page 71 Page 72 Page 73 Page 74 Page 75 Page 76 Page 77 Page 78 Page 79 Page 80 Page 81 Page 82 Page 83 Page 84 Page 85 Page 86 Page 87 Page 88 Page 89 Page 90 Page 91 Page 92 Page 93 Page 94 Page 95 Page 96 Page 97 Page 98 Page 99 Page 100 Page 101 Page 102 Page 103 Page 104 Page 105 Page 106 Page 107 Page 108 Page 109 Page 110 Page 111 Page 112 Page 113 Page 114 Page 115 Page 116 Page 117 Page 118 Page 119 Page 120 Page 121 Page 122 Page 123 Page 124 Page 125 Page 126 Page 127 Page 128 Page 129 Page 130 Page 131 Page 132 Page 133 Page 134 Page 135 Page 136 Page 137 Page 138 Page 139 Page 140 Page 141 Page 142 Page 143 Page 144 Page 145 Page 146 Page 147 Page 148 Page 149 Page 150 Page 151 Page 152 Page 153 Page 154 Page 155 Page 156

Made with FlippingBook Online newsletter maker