Divergent Net Zero policies are an underappreciated risk to global climate action

• The IEA’s World Economic Outlook provides some cause for optimism for a 1.5° C future if coordinated climate action comes out of COP 26, but remains at risk from an ‘ambition gap’ between announced policies and what is needed for Net Zero by 2050
• The best outcomes in terms of limiting the damage from climate change won’t be possible if they create a ‘two-track’ world if financing and technology committed by developed countries doesn’t arrive
• Global efforts to coordinate with and support emerging & developing economies will lower risks across the board from adverse climate impacts and climate transition outcomes, but it could be imperiled by too narrow focus on national Net Zero targets

The IEA in its latest World Energy Outlook has warned of significant risks to the global focus on national net zero targets, which will make it difficult to achieve a least-cost net zero economic transition and risks creating a “two-track world”. In some countries, emissions are falling according to an orderly transition, while other countries face spillovers from net zero policies succeeding in other countries and regions.

The IEA WEO criticizes strategies that have a “narrow focus on achieving national net zero pledges in some countries, [which] is coupled with limited efforts to prioritize emissions reductions in others, and little attention is given to technological spillovers or to the scope for working in partnership”. The outcomes that these narrowly focused efforts could create, even if they achieve net zero on a country or regional basis under currently announced policies, are more likely on average to result in greater than 2° C of warming by 2100. These proposals come in as significantly less desirable and more risky in relation to the IEA’s Net Zero by 2050 roadmap, which gives the world a greater than two-thirds chance of holding warming under 1.5° C over the same period.

The gap between the two scenarios has long-term consequences in terms of global temperature trends that could seem distant from today’s perspective. However, the trajectory chosen between now and 2030 will have much more immediate consequences over the next few years. In developed countries, the implementation of strong net zero policies with carbon pricing could fund investment in low-carbon technology.

That technology, if available globally and implemented in a coordinated fashion, could help the world achieve Net Zero by 2050. However, if it is not equally accessible, it could conversely entrench the position of developed countries that benefited most from historically emitting greenhouse gases, shown in motion over time recently in a chart from CarbonBrief, and leave emerging & developing countries behind.

One of the most important features of emerging net zero policies in regions such as the European Union focuses on sealing off opportunities for high-carbon production to simply move outside of the boundaries of measurement instead of reducing its own emissions footprint. The EU’s proposal that would help achieve this goal would be based on adoption of a carbon border adjustment tariff, which narrowly serves the purpose of equalizing the cost of carbon within the European Union as well as outside of it.

The critique made implicitly in the IEA’s World Economic Outlook is centered on the externalities that a country-by-country effort to reach net zero creates (what has been described elsewhere, like in the scenarios developed by the Network for Greening the Financial System, as ‘divergent net zero’). The IEA explains how Covid-19 has accentuated the problems of investment in low-carbon transitions in emerging & developing economies, clearly linking the immediate challenges of the Covid-19 pandemic with longer-term challenges on energy transition.

“The pandemic […] has further strained the finances of the utilities that are key investors in grids and off-takers for renewable projects. Increased borrowing to cope with the effects of the pandemic has left little room for many governments to kick-start investment in sustainable recoveries; the annual boost to clean energy coming from public recovery spending amounts to less than $10 billion by 2023.”

The result of the two challenges together (budgetary impact of the pandemic and the effects of narrowly focused, or ‘divergent net zero’, targets) for emerging and developing countries and their investors and financial institutions is significant. The path towards a cleaner future will be less accessible, while the risks of delaying the transition will become more concentrated. A simplified example would be an export-oriented economy facing a carbon border adjustment tariff that makes a meaningful portion of its exports uncompetitive.

The emerging economy will still need to make investments to support immediate growth, but will find it harder to maintain access to the embedded green technology that it imports from developed market trade partner. Even if it prioritizes replacing these technologies with investments made domestically, it will struggle to invest with the same results it would achieve if it could select the best technologies domestically or from abroad. The outcome will be a lose-lose for developed, emerging and developing countries because climate impacts don’t follow national borders or trade flows; they affect everyone.

The IEA concludes that even reaching the committed flow of financing of $100 billion per year from developed to developing countries will not be enough on its own, although it is critically important. “[This] climate finance is necessary, but not sufficient. Development finance institutions (DFIs) have a central part to play, and will need to focus on financing emissions reductions across a broad range of sectors and activities, as well as stepping up delivery efforts.” [emphasis added]

The emissions outcomes for an economy will be impacted significantly by its electricity and energy sectors, which form a significant share of current emissions and determine a large part of future emissions. Absent efforts to promote global approaches and build partnerships, the strength of each country’s export capacity will influence how readily it can secure, disseminate and adopt knowledge and technology above and beyond what capacity it can develop locally.

For financial institutions and investors, what happens in the electricity or energy markets is that the impacts won’t be felt just within the electricity sector or the energy sector. They will be distributed throughout the economy in proportion to how much access there is to emerging low-carbon technologies, which will shape the evolution of different sectors’ viability and their resilience to climate change.

Therefore, it will be critical that coming out of COP 26 in Glasgow next month there will be a renewed commitment towards a collaborative approach towards global Net Zero by 2050. It’s a complicated task because it requires balancing the important national efforts to move towards net zero with a perspective on how the implementation of different policy choices impacts others.

For financial institutions and investors, whatever the result of COP 26, they will need to spend more time focusing on how different scenarios would impact them directly, those they finance, and the economies in which they operate. That will provide a more complete picture about how climate-related risks (both physical and transition) could echo through their investments and financing portfolios, and what they should do to come out in a strong position to finance efforts towards a global Net Zero economy by 2050.

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