With the recent tumble in world stock markets, prices for fossil fuels have continued their year-plus collapse. Prices for coal and oil are currently low and volatile and now look to be firmly entrenched in systemic oversupply – not a great status quo for an investment or business proposition. Fossil fuel oversupply and the attendant economic risks will only worsen in a fossil fuel demand-constrained environment. As a recent report by Citigroup stated, “$100 trillion of assets could be ‘carbon stranded’, if not already economically so.”
Citigroup’s report, ENERGY DARWINISM II: Why a Low Carbon Future Doesn’t Have to Cost the Earth, significantly adds to CIEL’s own analysis, (Mis)calculated Risk and Climate Change: Are Rating Agencies Repeating Credit Crisis Mistakes, and two additional analyses released this summer: the Economist’s Intelligence Unit’s (EIU) The cost of inaction: Recognising the value at risk from climate change and Mercer’s Investing in a Time of Climate Change. These analyses show that (1) a low carbon future is necessary; (2) a low carbon future is relatively inexpensive and achievable, and (3) investors must act to avoid the worst impacts of climate change, as well as facilitate the transition to a low carbon economy. Because each of the above suppositions could merit its own tome, I am going to tackle each of them as a 3 part blog series. For part 1, I start with what I believe is the most surprising idea – a low carbon future is relatively inexpensive and achievable.
Can a Low Carbon Future Truly be Inexpensive?
Energy needs are increasing and will only continue to grow as the globe’s population becomes larger and richer, unless we decouple human development from increased energy use. By 2050, the number of those living in absolute poverty is expected to decrease, and the population will reach 9.6 billion. These trends create the potential for increased demand for energy from two directions – more wealth and more people. So how can we address that demand with a low carbon future and how can it actually be cheaper than our current status quo?
This is why Citi’s Energy Darwinism II is so exciting. Citi’s Energy Darwinism II finds that even excluding the deleterious costs of climate change ($20-$72 trillion), taking action on climate change in the energy sector actually results in saving $1.8 trillion. In other words, over the next 25 years, the status quo even without all the damages from climate change actually costs more than taking action in the energy sector to mitigate climate change. This is because the amount spent on fossil fuels and fossil fuel capital expenditures (an Inaction scenario of $192 trillion) is actually more than the amount needed for investing more heavily in low emissions technologies and energy efficiency (an Action scenario of $190.2 trillion).
As Citi puts it:
With a limited differential in the total bill of Action vs Inaction (in fact a saving on an undiscounted basis), potentially enormous liabilities avoided and the simple fact that cleaner air must be preferable to pollution, a very strong “Why would you not?” argument regarding action on climate change begins to form.
Citi’s simple statement above belies the important point that we face the similar costs in both scenarios (actually marginally less costs for mitigation), but what we buy/get is dramatically different. Under an Inaction scenario, the results are catastrophic, while under an Action scenario, the most catastrophic climate impacts are averted and there is even less air and other pollution. Moreover, as we raised in (Mis)calculated Risk, transitioning to a low carbon economy can build capacity in the global financial system (e.g., create more and diverse economic and investment opportunities). Building that capacity and resilience is especially important in light of the recent turbulence of global markets.
So why then are we continuing to invest in fossil fuels? Citi argues that, in the very near term, fossil fuels are superficially less expensive than clean energy alternatives. In other words, a low carbon economy requires more investment now while the Inaction scenario spreads the cost over the 25 years. Citi suggests that we need to tweak the incentives (e.g., enact legislation to force change) so that market participants act in their long-term interests triggering an Action scenario, rather than the short-term interests of an Inaction scenario.
Therefore, while an Action scenario may have higher upfront costs for energy now, within the next 25 years, Citi’s report shows that a low carbon economy is actually less expensive than the status quo. And as I will discuss in Part II of this blog series, the four analyses, ENERGY DARWINISM II: Why a Low Carbon Future Doesn’t Have to Cost the Earth, (Mis)calculated Risk and Climate Change: Are Rating Agencies Repeating Credit Crisis Mistakes, The cost of inaction: Recognising the value at risk from climate change and Investing in a Time of Climate Change demonstrate the necessity of a low-carbon economy and the reasoning for why investors should act to facilitate that transition.
Originally posted on September 10, 2015.