In coming years, a multi-trillion dollar low-emission energy investment drive will get underway.
Three catalysts will push it along: elimination of fossil-fuel subsides, introduction of carbon pricing and recycling of capital into badly-needed new infrastructure.
The result: a virtuous circle.
Tackled as an integrated bundle instead of a series of individual, unrelated problems — the challenges above can make the world a richer, cleaner, healthier, safer place by 2050.
Without a doubt, the largest distortion in global energy markets — and the place to start — is eliminating fossil fuel subsidies.
The International Monetary Fund estimates these at $5.3 trillion per year.1 That’s more than six percent of the global economy.
The second needed reform is aggressive carbon pricing. This will raise the cost of using dirty energy.
Energy experts generally agree carbon prices need to reach $40 or more per tonne to reduce use of dirty coal and encourage investment in cleaner energy sources.
Global energy companies like BP, Royal Dutch Shell, Total and Exxon are already evaluating future investments using internal shadow prices of $40-60 per tonne. Environmental groups generally agree the ‘social cost’ of pollution to society is $40 or higher.2
Health costs are are another uncompensated negative side effect of carbon pollution.
In China, for instance, the World Bank estimates air pollution costs 4% of GDP.3 Applied worldwide (creating, perhaps, a slight overcount given the relative severity of China’s air pollution problems), that’s $3.2 trillion per year.
Eliminating fossil fuel subsidies (amounting to $5.3 trillion annually) applying $40 carbon prices (or $1.3 trillion annually) and progressively eliminating the health costs of air pollution ($3 trillion) amounts to nearly $10 trillion per year, or about 15% of the world economy.
Recycling this money into things the world needs — like new and upgraded infrastructure, better health care and better long-term funding of government retirement schemes — creates a virtuous circle.
Much of the developed world’s infrastructure such as roads, rail and air transport needs upgrading. So do electricity grids and energy distribution systems. In parts of the developing world, much key infrastructure still remains to be built for the first time.
Meanwhile, large investments in low-emission and renewable energy need to be made to replace carbon-intensive fossil fuels.
In 2013, US management consultancy McKinsey & Co. estimated the world needs $57 trillion of new infrastructure investment over the 17-year period to 2030.4
That about $3.35 trillion per year. It’s also almost certainly an underestimate. The real number is likely to be much bigger — and the challenge longer — than 17 years. Even so, it offers a figure for analysis.
If energy market reforms can create roughly $10 trillion per year of investable funds (see table), much of it could be plowed into new infrastructure.
The remainder could help meet one of the world’s other biggest challenges: funding the retirement needs of an aging global populace.
With very few exceptions, governments and individuals are badly prepared for this. Virtually everywhere, state-funded schemes remain underfunded.
Estimates in the developed world are in the tens of trillions, but this is a minority of the world’s population. Some higher long-term estimates put the shortfall to 2050 as high as $100 trillion.
Economic reforms coupled with global infrastructure investment aimed at solving climate change can help create needed long-term income streams to pay government longevity commitments to the elderly.
Infrastructure projects generally have long-lived and predictable cash flows. That makes these less risky than investing in stock markets for generating long-term retirement income.
On the ‘macro,’ — or big picture level — this infrastructure investment can be steered by organizations such as China’s Asian Infrastructure Investment Bank, South Korea’s Green Climate Fund, the Asian Development Bank and the World Bank.
So: where to look for progress?
Signs look good that this December’s COP21 meeting in Paris may finally get serious about tacking climate change at the global level. This United Nations sponsored meeting now looks as if it might be able to reach agreement on binding global cuts to greenhouse gas emissions to 2050.
Once this occurs, the issue can shift to how to achieve the goals and pay for them. At that point, planning can move on to implementing the economic reforms needed to pay for reaching those goals.
Carbon pricing is a good place to start, and the political ground has been laid. Businesses participating in COP21 — for instance — have officially called for carbon pricing to create better business certainty.5
That, in turn, will focus attention on getting world’ carbon markets up and running. China has plans to create several regional carbon markets with the aim of consolidating them over time. These should get underway in 2016 or 2017.6
South Korea and Japan also have carbon markets planned or operating. Together with China, they can help create a regional price for Asia. The European Union already has a carbon scheme operating, but with traded prices far too low to effect the needed long-term change to solve the global warming problem.
Therefore, progress toward raising carbon prices to around $40 per tonne can be viewed as a proxy for progress.
Separately, asset management and private equity firms, pension and insurance funds have appealed to teh World Bank to establish a Global Infrastructure Facility.7
This can act as a clearing house for infrastructure projects, helping ensure maximum coordination and creation of standards that can encourage future interconnection.
Looking on the bright side, it’s easy to see a number of positive developments moving the world toward solving the climate change challenge. The next hurdle lies in making the economic reforms that will change economic behavior.
Linking those to other challenges the world faces — like the need for new infrastructure and looming retirement needs — creates a more compelling case for reform. This now looks to be occurring – and it creates reasons for optimism.
1 “How Large Are Global Energy Subsides” IMF Working Paper,” May 15 2015
2 “The Cost of Carbon Pollution,” Environmental Defense Fund, the Institute for Policy Integrity, and the Natural Resources Defense Council. 2011
3 “Pollution: costs of inaction,” Organization for Economic Cooperation and Development, 2007
4 “Infrastructure productivity: How to save $1 trillion a year,” McKinsey & Co., 2013
5 “Businesses launch appeal for carbon pricing at COP 21,” EurActiv, May 22, 2015
6 “China climate official flags potential later start for national ETS,” Carbon Pulse, May 28, 2015
7 “World Bank Group Launches New Global Infrastructure Facility,” World Bank. Oct 9, 2014