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The cost of climate change: action versus inaction

The IPCC’s latest update on physical sciences stated that “it was more likely” than not that temperature increases would exceed the 1.5 degree limit targeted in COP 21 (Paris 2015). The upcoming COP 26 in Glasgow has been described as “the world’s best last chance to get runaway climate change under control”.

Critical action is required now says David Page Head of Macro Research, AXA Investment Managers. The global community has begun to take heed. Both the US and China – the world’s largest CO₂ emitters – have committed to net zero emission targets this year, joining most other large economies which have already made similar pledges.

Costing the transition

The challenge of reducing greenhouse gas (GHG) emissions to net zero in the coming decades is staggering and it‘s cost significant.

Princeton University estimates the US would need to invest $2.5trn (11% of GDP) by 2030 to deliver its net-zero-by-2050 goal. The European Commission forecasts €3.5trn over the coming decade (25% of GDP) while Tsinghua University predicts that China’s plan would cost RMB 138trn (circa $21.6trn) and 122% of GDP over the coming four decades.[i]

Most recently, the International Energy Agency warned that global warming is expected to breach the most conservative Paris Agreement target even if all current government pledges are met on time.

It called for faster progress in the energy transition as it predicted warming would hit 2.1°C by 2100 under the current scenario. Current pledges, it estimates, would achieve just 20% of the emissions cuts needed by 2030, to keep the goal of net zero by 2050 a possibility. To reach the net zero goal, it said up to $4trn in annual investment was needed over the next 10 years – and most of that investment must be channelled into developing economies.[ii]

Investment, not cost

Yet what is identified above are estimates of investment plans – not costs. Investment will deliver a positive boost to economic activity, directly bolstering demand. But beyond this direct boost to activity, we can expect additional potential benefits, all of which should be of interest to investors. They include:

  • Cost reductions: Investment in solar panels, spurred by government subsidisation in many countries, has delivered a dramatic fall in costs over recent decades. Since 2010, the average price of solar panels has fallen by 82% in the US, to the equivalent of $0.068 per kilowatt hour (kWh), compared with coal at $0.32kWh, with solar and onshore wind now the cheapest sources of energy in the world.[iii] Future investment in other technologies is likely to lower other transitional costs
  • Productivity boosts: Investment in new technologies should also increase efficiencies, bolstering overall productivity and raising potential economic growth
  • Overcoming underinvestment and positive externalities: Infrastructure is a public good and is often underprovided in market economies. Increased investment in key infrastructure may deliver additional positive externalities, for example increasing electricity grid resilience
  • Health benefits: The reduction of coal-fired generation and a decisive move to electric vehicles will reduce particulate emissions that contribute to poor air quality, which create a myriad of associated health problems, for example asthma. Fewer health problems should reduce future healthcare costs, lowering the net cost of the initial investment

Estimating the net cost of avoidance

The assessment of the combined effects is naturally uncertain. The Organisation for Economic Co-operation and Development (OECD) concluded that a “decisive transition” could boost global GDP by 2.5% by 2050. However, the International Monetary Fund (IMF) estimates that by limiting temperature increases to 1.5˚C, global GDP would be 1% lower by 2050.[iv]

The Network for Greening the Financial System (NGFS) estimates that a scenario consistent with net zero would likely reduce global GDP by around 2% by 2050 through to 2100. However, it also expects that a ‘delayed transition’ could be markedly higher, reducing GDP by around 5% by 2050, before losses are reduced to around 2.5% by 2100.[v]

The price of unmitigated climate change

The most vital comparison is with the costs of unmitigated climate change. And although inevitably such estimates are highly uncertain, the forecasts make for grim reading.

The NGFS forecasts that losses would exceed 6% of global GDP by 2050 while the OECD anticipates that by 2100, total losses would total 10% – 12% of GDP. The IMF’s current worst-case scenario forecasts an output loss of 25%.[vi]

A further complication in assessing the costs of avoiding climate change is that losses occur in the short term, but benefits accrue only over the much longer term. Further, costs will differ across different economies and geographies. Different areas will be subject to more or less of the loss of output from mitigating climate change and would be affected to a greater or lesser extent by climate change itself.

A brighter future

The cost for mitigating climate change is undoubtedly gargantuan. But if the world doesn’t come together to take on this emergency, the potential losses associated with unbridled climate change are estimated to be much higher given the potential for more extreme weather events, social disruption and the loss of economic activity.

Fundamentally, if we fail to transition to a low-carbon world, the overall integrity of the global economy is threatened. But by transitioning to a low-carbon world, we can foresee a stronger and more sustainable economic future. The transition should help new technologies and industries flourish. It can help deliver additional absolute economic growth, more sustainable investment returns and a better global environment for all.

By David Page Head of Macro Research, AXA Investment Managers

[i] European Commission, Princeton University, Tsinghua University and AXA IM Research, September 2021

[ii] World Energy Outlook 2021 – Analysis – IEA

[iii] International Renewable Energy Agency (IRENA) 2019

[iv] OECD, IMF – AXA IM The cost of climate change: Action versus inaction | AXA IM Corporate (axa-im.com)

[v] NGFS / AXA IM The cost of climate change: Action versus inaction | AXA IM Corporate (axa-im.com)

[vi] NGFS / IMF / AXA IM September 2021

 

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