How are changing political priorities affecting climate transition risk?

As leaders across the public and private sector convene in New York for Climate Week to discuss their plans and progress in accelerating action on climate goals, the focus will be on how shifting priorities and political pressures are pushing policymakers to rethink the economics of the energy transition.

What we’re watching:

The climate policy paradigm appeared to have shifted from a doom-and-gloom view (where economic growth wasn’t seen as possible) to a more constructive model (in which growth and a sustainable environment can coexist). However, intensifying geopolitical uncertainty and changing spending priorities are now prompting many countries to gradually shift away from (and, in many cases, slow) their energy transition policies .

Following the surge in public spending to bolster economies during the pandemic and support households during the energy crisis, governments around the world have been tightening their belts as interest rates started to rise in 2022—and are now focusing instead on cost-of-living initiatives, economic competitiveness, defense spending, and energy security.

Public sentiment appears to be changing, too. For example, European voters are seemingly more concerned about geopolitical risks and inflation than they are about climate change—as reflected in voter surveys, the European parliamentary elections this year, and the European Commission’s strategic agenda that placed the green transition in the back seat.

Even if countries align on a climate policy paradigm as the time to meet climate commitments closes in, other developments may impede their ability to reach net-zero as quickly and efficiently as necessary for the global economy. New political priorities are increasingly reflected in countries’ industrial and trade policies, but also in how they balance the energy trilemma of energy security, affordability, and sustainability priorities.

Energy security, related to and resulting from geopolitical conflict, is a key driver of this prioritization recalibration and can either help or hinder the adoption of lower-carbon energy policies and actions. In a year packed with elections worldwide, the social impacts of the climate transition are in the spotlight—with a focus on which populations carry the costs of energy prices, which industries (and, thus, jobs) will emerge as the winners and losers of the transition, and whether governments are well positioned to manage the implications.

What we think and why:

The potential impacts of a slowed or stopped transition are substantial, particularly when considering the potential costs and credit materiality of climate change . Changes will not be linear, with tipping points —defined by the U.N. Intergovernmental Panel on Climate Change as critical thresholds in a system which, when breached, can lead to significant and irreversible changes—that may permanently detriment our ability to grow and restore natural capital.

Physical risks linked to climate change will become an increasing source of supply-side shocks for the global economy, particularly if adaptation and resilience investments are not stepped up. Our research shows that, if global warming does not stay well below 2 degrees Celsius and we do not adapt, up to 4.4% of global GDP could be lost annually by 2050. This will test countries' adaptation plans—particularly those of lower-income nations that are disproportionately (4.4 times) more exposed to climate risks than their wealthier peers.

Political priorities will diverge around the world, as the economics of the energy transition differ across countries and regions. The decoupling of economic growth and greenhouse gas emissions has so far happened only in advanced economies . Progress in reducing global greenhouse gas emissions has been offset by rapid growth of carbon emissions in emerging markets, in particular China and India.

What could change:

The agreement to transition away from fossil fuels in energy systems at COP28 and various regulatory initiatives around the globe mandating transparency, verification, and disclosure for credible transition plans signal that a turning point for transition finance may be on the horizon. But countries' approaches to covering energy-transition investments differ, and increasing investments quickly to limit the impact of climate change is challenging in a more fragmented world.

Looking at policies, the EU has mainly opted for carbon taxing, while the U.S. and China have taken more active industrial policies. Both approaches provide different incentives for companies to enhance green technology industries locally. With international competition in those technologies growing, some governments have attempted to protect their local industries by imposing tariffs on green technology products.

Nonetheless, establishing or maintaining energy security amid fossil fuel price shocks spurred by geopolitical tensions adds to the impetus to expand renewables capacity, particularly for net energy importers. Green technologies, especially renewable power, are cost-competitive and sometimes even cheaper than fossil fuel alternatives. The push for higher renewable investments was most pronounced when energy prices in Europe peaked in 2022 and policymakers tried to increase energy independence from Russia.

As the energy transition gathers pace, social aspects related to climate policy are becoming more visible. Lower-income households generally spend a larger share of their disposable income on energy than their more affluent compatriots do and have been hit harder by recent runaway inflation. To the extent that energy transition policies such as carbon pricing increase energy prices, lower-income households would be disproportionally affected. On the flipside, governments that slow the pace of their transitions will likely have to continue spending what can amount to considerable costs on fossil fuel subsidies as long as energy prices remain elevated.

To be sure, the investment required to achieve the transition remains much higher in emerging and developing economies—due to both how quickly energy demand in emerging and frontier economies is increasing and infrastructure gaps. We estimate that emerging and frontier markets will need to invest 6.3% of GDP (about $2.6 trillion, or $1.4 trillion excluding China) by 2030 to achieve the committed share of renewables in electricity production under the International Energy Agency's Stated Policies Scenario.

CreditWeek, Edition 42

Contributors: Marion Amiot, Ludwig Heinz, and Christa Clapp

Written by: Molly Mintz and Joe Maguire

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