Investing in a just transition to net zero

Read this to understand:

• How swiftly capital must be invested to meet the net-zero target by 2050
• How multiple stakeholders – central banks, regulators and asset owners – can support the transition
• How companies addressing people’s needs and skills transfer can contribute to levelling up

Thousands of column inches have been written about the climate crisis and numerous countries and companies have signalled their support for decarbonisation. But detailed plans are in short supply, and climate action failure is one of the most significant risks for the global economy over the next ten years.

Nick Robins, Professor in Practice of Sustainable Finance at the Grantham Research Institute on Climate Change and the Environment has years of experience in financial markets on the buy- and sell-side, and has been guiding central banks, asset managers and other financial institutions on addressing the net-zero challenge.

We spoke to him about the scale of capital required to hit net-zero targets, and the need to focus on the human dimension – ensuring the economic transformation is a transition for all.

How much capital is needed to achieve net zero by 2050 and how quickly?

The key message in the Intergovernmental Panel on Climate Change’s (IPCC) mitigation report is that if we want to hit the 1.5-degree target by 2050, global emissions need to peak before 2025, then reduce by just over 40 per cent by 2030. We don’t have much time (see Figure 1).

Figure 1: Reaching net zero by 2050: Urgent action needed now (GtCO₂-eq yr.)

Note: *NDCs until 2030.
Source: IPCC, 2022¹

While the situation is challenging, we have options available now to deploy. We know the cost of renewable technologies has fallen dramatically and become the cheapest forms of new power generation. Recent supply chain issues have impacted on the roll-out of renewables along with other parts of the economy. But the escalating commodities crisis that has been exacerbated by the Russian invasion of Ukraine have added energy security to the climate case for reducing energy demand and phasing out fossil fuels.

To make this shift, we need to increase capital investment in the real economy significantly this decade. Globally, the IPCC points to the need for a three to six-fold investment boost, with the bulk of this required in developing and emerging economies: southern Asia, for example, must expand investment by seven to sixteen times by the end of the decade. Energy efficiency is the area where greatest capital is needed, but it is sustainable agriculture and land use where the fastest growth (from a low base) will be required (see Figure 2).

Figure 2: Connecting savings with real economy needs (US$bn)

Note: Actual yearly flows compared to average annual needs. 2015 yr^-1.
Source: IPCC, 2022²

This pattern is repeated in the UK. One conclusion of The Road to Net-Zero Finance report we wrote for the Climate Change Committee was the estimate that we need a five-fold increase in annual net-zero investments from around £10 billion to £50 billion by 2030. Another dimension of this surge in investment is that net-zero investments will then peak around 2035. This makes sense: you need to invest to achieve the emissions reduction, then after that you can start to wind down obsolete assets.

We need to be thinking about the sustainability of fossil fuels through two lenses; not just the emissions that are created, but also the inherent geopolitical risks that come from reliance on non-renewable sources of energy supply.

As we move through the transition, this investment will contribute to reduced damage from a planetary perspective, but it should also bring other benefits as well. We can see scope for large cuts in operating costs in many sectors, particularly in the energy used for transport, housing and industry. Then you have wider benefits which are perhaps not being priced in, in terms of health gains for the population and enhanced resilience for the economy.

All in all, net-zero investment will be productivity enhancing by the early 2030s. This will be a net positive for the growth of the economy, as capital is redirected from foreign resource imports to investment in UK skills, technology and infrastructure. The task ahead is how investors can connect the pools of capital they manage with these real economy needs.

You outlined the need for a huge shift in investment, most notably to developing countries at a time when globalisation is rolling back and developed countries are facing squeezes on government balance sheets. How likely is it to happen?

The big difference now compared with five years ago is that a sufficient slice of global capital is committed to achieving net zero. We have the Glasgow Finance Alliance for Net Zero, which means those controlling about 40 per cent of financial assets via banks, insurers and asset managers have pledged to reach net zero before 2050. Of course, promises are one thing, delivery is another.

That’s why one of the top sustainable finance priorities for the year ahead is for these 500 leading companies – and ultimately all financial firms – to publish credible net-zero transition plans. These plans should then guide their allocation of capital across all asset classes, steer the engagement with the companies they hold and frame the dialogue that investors and others have with governments to get the policy frameworks right.

One big gap to fill is the lack of cutting-edge public finance to create new markets and reduce investment risks, not least in developing countries. We need a lot more concessionary, market-building capital, particularly in emerging economies, to build out the pipeline. Sadly, the reality to date is that many industrialised countries have failed to deliver on their climate finance commitments, and we now have the challenge of dealing with the fallout from the Russia-Ukraine war.

This needs to be the year for a comprehensive finance package that drives an investment-led recovery from both COVID and the geopolitical crisis we face. Globally, this means the development banks stepping up their climate investment efforts – and in the UK, it means the UK Infrastructure Bank and the British Business Bank stepping in to support long-term sustainable investment as business confidence wanes in the face of the cost of living crisis. 

What about the just transition – ensuring the benefits of the change are shared?

This is rapidly rising up the investment agenda. We need to think through the human dimension of net zero and stop thinking in environmental and social silos. If we can bring these together, the climate transition could be a great story for the global economy.

The energy transition is set to be a significant positive. We believe there will be more employment in a net-zero economy than in the fossil-fuel economy, equivalent to around 30 million new jobs by 2030. But we know the change will also bring job losses – about five million by the end of the decade – concentrated in particular sectors and places. The key to the just transition is making sure these people and communities are not left behind – and to ensure the new jobs in the green economy respect human rights and deliver decent work.

Figure 3: Managing social upside opportunities and downside risks - just transition and Sustainable Development Goals

Source: Grantham Research Institute on Climate Change and the Environment, December 2018³

If the process is poorly managed, you will not just have stranded assets in your portfolios; you will have stranded workers, stranded communities and potentially stranded countries. Clearly, this could undermine public support for climate action.

For investors, supporting the just transition is the right thing to do, applying longstanding (but often weakly implemented) labour and human rights standards to greening the economy. It's about appreciating how people might be affected, involving people affected by change in the decisions and then thinking about place-based dimensions. In the UK, for instance, what will it mean for Scotland, where you have historical dependence on oil and gas, but also huge opportunities in the offshore renewable economy?

It’s also the smart thing for investors to do as it means making sure companies have thought through the social risks and opportunities of net zero for their workers, supply chains, communities and consumers. A growing number of investors are starting to incorporate just transition principles into their climate engagement with businesses – and results are starting to emerge.

In the UK, energy utility SSE became the first of a growing number of companies to set out a just transition strategy, in part in response to investor engagement. The companies addressing this should be more resilient investments with the skills and capabilities in place to succeed with net zero.

Is there much investment innovation taking place to achieve specific social goals?

Bonds are well-suited for linking the green and social dimensions of the net-zero transition. A growing number of firms and countries are issuing sustainability-linked, green and social bonds.

In the UK, we’ve proposed what we call a ‘Green Plus’ framework, whereby the government would issue a green sovereign bond, but also consciously incorporate social factors in the way the proceeds are spent. When the Chancellor announced the green sovereign bond programme last year, he committed to report on these social benefits in terms of jobs and community benefits. This model could be picked up by corporate issuers too, for example, showing the employment and other impacts of investing in renewable infrastructure or retrofitting buildings.

More generally, investors also need to factor in a country’s net-zero plans, its just transition strategy and exposure to physical impacts as part of their assessment of sovereign risk. This will include analysing how a country’s fiscal system will be impacted by the shift away from fossil fuels.

What would be the implications of a higher carbon price for the just transition?

We currently have market failure and an obvious way of fixing this is through putting a price on the damage done by carbon emissions. All things being equal, however, a carbon price will disproportionately impact low-income consumers. This is exactly what we're seeing now with the oil price shock, which is increasing the numbers living in fuel poverty. Unless you take specific action, a carbon price is going to lead to social issues. In France, the plan to introduce a carbon price in the transport sector triggered the gilet jaune protests.

This is not to say: ‘don't price carbon’. We need it, but also need to think about how it is designed and phased in. Public capital could be invested upfront to retrofit insulation in housing, for example, before carbon pricing comes in. Equally, the revenues from carbon pricing can be recirculated back to consumers, but on a per capita basis so that low-income households benefit. It’s about recognising and anticipating the social consequences of good and necessary policies to get to net zero.

How do we ensure responses to climate risks are fair and just?

One of the critical priorities that has not been resolved is addressing loss and damage; in other words, how will people and countries who have already seen their livelihoods affected by the physical shocks of the climate crisis be compensated. We will need a compensation mechanism that recognises parts of the world have mainly benefited from a high carbon lifestyle, while greater costs have accrued elsewhere, particularly in the developing world. This will be a top priority for this year’s climate summit in Egypt.

There are important income considerations to bear in mind too. Those with earnings in the top five per cent are responsible for the bulk of global emissions. If you were to add in the emissions associated with their investment portfolios, the figures would be even larger. It makes sense to focus on reducing emissions here where there is a clear ability to pay: this is a key part of the just transition too.

More broadly, we know that inequality is increasingly recognised as a systemic risk to the economy and society. As we take action to confront the systemic risk of climate change, we need to make sure we’re not worsening the inequality risks – but rather shaping the transition so it reduces these risks.

Is government intervention what we need to translate hypothetical transition risk into shifts large enough for markets to respond?

Governments are rarely brave. They need to be confident any policies introduced will be supported by people, business and investors. That’s why signalling from investors and business that they are in favour of net zero is important to raise ambition to do the big, bold things that are needed.

We need to think in terms of system change. It’s not government action or action by markets, it’s not a carbon price or ESG strategies, but finding the way that these efforts are complementary and reinforcing. Investors can’t wait for perfect carbon price: they need to advocate for policy reforms that make markets tell the climate truth and at the same time position their portfolios for the inevitable shift to net zero.

Another key player in this multi-factor system change is the role of central banks. The Bank of England has done its first round of stress tests, highlighting the importance of early action by financial institutions to avoid stranded assets in the future. Now, in a rising rates environment, there are discussions about whether there should be differential rates, so access to central bank liquidity could be at lower rates for transition-aligned projects.

The key to success lies in making these connections. In the UK, this means joining the dots between net zero and the government’s levelling up ambitions to reduce regional inequality.⁴ At the moment, we see a ‘missing middle’ between the pools of capital held by those who say they want to invest in net zero and the places that need the capital across the country. That's the gap we see needing to be closed. To achieve net zero and a just transition, it all needs to be connected.