Things will get worse before they get better — it seems the analyst’s pet phrase now applies to climate finance too.
At today’s pace, global temperatures are set to reach 2.5–2.7°C above pre-industrial levels by mid-century. While the world has the means to cap global warming to the 1.5°C limit agreed in the Paris Accords, the accelerated energy transition will come with a hefty price tag, warns UK-based natural resource research and consultancy group Wood Mackenzie.
“While preventing more extreme warming is likely to have a positive economic impact over the next 30 years, the action required to deliver it could have an offsetting negative effect. Net, we estimate that keeping warming to 1.5°C would shave 2% off our base-case GDP forecast for 2050,” says Peter Martin, WoodMac’s chief economist.
But there may be a happy ending for both the planet and our pockets, says WoodMac. While global economic output is likely to take a hit until 2050, markets could recover that capital by the end of the century, reads WoodMac’s report, No Pain, No Gain: The economic consequences of accelerating the energy transition, released Jan 20.
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With the crisis averted, those funds can be earned once more, says Martin. “A turning point is reached after 2035. Under our 1.5°C scenario, global GDP growth outpaces the base case, kickstarting the slow convergence of GDP levels. Lost economic output is eventually recouped before the end of the century,” he adds.
The biggest loser
Under WoodMac’s base-case outlook, the global economy is set to double in real terms — from US$85.6 trillion ($115.2 trillion) to US$169 trillion — by 2050. Accelerating the energy transition will inevitably alter this trajectory.
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“We estimate that avoiding a higher temperature increase could boost global GDP, on aggregate, by 1.6% in 2050. At the same time, however, the actions required to successfully mitigate global warming to 1.5°C could knock 3.6% off GDP in 2050,” says WoodMac.
The net result is a 2.0% hit to the basecase forecast of global GDP in 2050, with the cumulative loss of US$75 trillion over 2022 to 2050. From the perspective of WoodMac, while material, this amounts to just 2.1% of total economic output over the period.
Of that sacrificial sum, more than a quarter (27%) will be borne by China, while a third (34%) will be billed to the rest of the world. The US is set to shoulder 12% of the US$75 trillion economic loss, while the EU will bear 11%.
The economic impact will be unequal; some economies will feel the effects more than others, says Martin. Less-developed and low-income economies are likely to bear a disproportionately high burden during this transition.
To determine the distribution of the GDP impact, WoodMac assessed countries on their resilience to climate change and the impact of actions to avoid it.
Carbon-intensive economies that export hydrocarbons will incur the biggest losses, says WoodMac. Countries that diversify their economic activity can soften the blow. Some, such as Saudi Arabia, have substantial financial reserves to invest in non-hydrocarbon sectors. Others, such as Iraq, do not.
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Martin says: “Iraq is the country most vulnerable to the energy transition, with hydrocarbon revenues accounting for 95% of all government revenue and the oil sector making up 36% of GDP. An accelerated energy transition would slash Iraq’s GDP by 10% in 2050 versus our base-case outlook.”
On the flip side, economies with high renewable penetration in power generation and advanced power grids are well placed for a low-carbon future. “For a fortunate few, the transition need not result in economic loss at all. Those that are better positioned — typically wealthier economies with a strong propensity to invest in new technologies — may even benefit by 2050,” says Martin.
He adds: “An accelerated transition could pay off in the end, in economic terms. It is likely to lead to stronger economic growth rates for some economies beyond 2030, enabling losses to be recouped before the end of the century. That is the essence of transition economics — short-term pain for longterm gain.”
Too fast, too furious?
Before flooring the accelerator, however, best check for speed bumps ahead. Critics think a rapid transition to renewables could be the culprit behind massive fiscal spending. It may even accelerate another problem instead: runaway inflation.
“Thank god for the oil producers,” said Ray Dalio, founder of hedge fund Bridgewater Associates, as they provide reliable supply amid an energy crunch.
Speaking on a panel at the Abu Dhabi Sustainability Week summit on Jan 18, Dalio warned against transitioning away from fossil fuels too rapidly, as it would have a destabilising effect as inflation soars.
According to Bloomberg, Dalio called for a “smart” shift to a green economy and warned that it is dangerous to “cram” too much into the transition phase. “Inflation is an issue,” he adds.
European Central Bank (ECB) board member Isabel Schnabel said in early January that the transition to green energy could be fuelling inflation, and rising energy prices may force the ECB to stop “looking through” high inflation and act to temper price growth.
Due to supply shortages, Europe paid record prices for electricity in 2021. As at Dec 30 last year, the average cost of power for delivery in the short term soared over 200% in Germany, France, Spain and the UK. In the Nordic region — where vast supplies of hydro power tend to cap prices — costs surged 470% from a year earlier.
“The green transition poses upside risks to medium-term inflation,” said Schnabel. “Rising energy prices may require a departure from a ‘looking through’ policy.”
However, Fatih Birol, the head of the International Energy Agency (IEA), disputes this link between inflation and the green transition, saying in September that “it is inaccurate and unfair to explain these high energy prices as a result of clean energy transition policies”.
The Paris-based watchdog said in October that annual clean energy investment worldwide will need to more than triple by 2030 in order to reach net zero emissions by 2050.
If that sounds intimidating, it may already be an attempt to sweeten the truth. Wind and solar are only cheap during the early stages of transition, says Lucas Toh, international fellow in Columbia University’s Master of Public Administration programme with a concentration in energy and environment.
“Until now, renewables have been viable because of the massive base of fossil fuel generation that supplies most of our electricity needs and also stands in for intermittent wind and solar. But this changes as renewable penetration increases,” he adds in his October 2021 opinion piece titled “Let’s come clean: the renewable energy transition will be expensive”.
“As countries like Germany and Britain have built out their wind and solar capacity, the energy supply becomes more unpredictable and variable, thus increasing reliance on gas to make up for when the wind doesn’t blow and the sun doesn’t shine,” writes Toh.
Most — if not all — roads lead back to the numbers. “Environmentalists, politicians, and regulators need to be honest about what it will take to avert the worst catastrophes of climate change: US$30.3 trillion of investment in clean energy and infrastructure by 2030, according to the [IEA’s] World Energy Outlook 2021,” says Toh.
“To move beyond fossil fuels, we cannot mislead the public about these costs. Telling them that a green future will come easy may get things going in the short term, but will backfire as the world moves into the thornier stages of the transition.”
Photo: Bloomberg
Infographics: WoodMac, Bloomberg
