Following the UN Climate Change Conference in Glasgow (COP26), businesses may be asking themselves: what are transition risks? What do they mean for their operations? And how effective was the conference at addressing them? This blog addresses these questions in turn and draws out some key conclusions.
Transition risks are the policy, legal, market, and reputational risks that will result from society’s shift to a low-carbon economy. These could impose financial costs on businesses, especially those that fail to position themselves for the changes to come. They are different from physical risks, which are those extreme weather and climatic events that are becoming more frequent and severe as the planet gets hotter.
Many transition risks are highly likely to unfold because of countries’ climate change commitments. The Inevitable Policy Response (IPR), a consortium backed by the UN’s Principles for Responsible Investment, forecasts “a dramatic acceleration of climate policy” because of governments’ need to make changes to align with the “well below 2°C” pathway dictated by the Paris Agreement. In October, the IPR forecast higher policy ambition across eight key policy levers: carbon pricing, coal phase-out, 100% clean power, zero-emission vehicles, low-carbon buildings, clean industry, low-emissions agriculture, and forestry. Businesses affected by these may face elevated transition risks if the IPR forecast plays out. They should therefore study these eight policy levers and examine how they can stay ahead of the risks they pose because if they wait for the policies to actually be implemented, they will be too late.
Other kinds of transition risks could follow technological changes. The International Energy Agency (IEA), an intergovernmental organization set up by developed countries, published a ‘Net Zero Emissions by 2050 Scenario’ (NZE) earlier this year that sets out over 400 milestones to guide the world’s transition to net zero. These include an immediate halt to new investments in fossil fuel projects and unabated coal plants. In the near term, the NZE scenario also calls for a massive scaling up of clean energy capacity and improvements in energy efficiency, plus an acceleration of renewable energy innovation. If governments and corporations follow this scenario, big changes to the global energy system will result over a short period of time — disrupting businesses that fail to prepare.
However, the low-carbon transition presents plenty of opportunities as well as risks, especially in the areas of resource efficiency, energy supply, and products and services that help reduce and capture carbon emissions. Bank of America, in a recent report, estimated that the total cost of transitioning to net-zero by 2050 will amount to $150 trillion over the next 30 years. That’s an amount of money capable of transforming whole sectors of the economy. Businesses should consider now how they could ride this wave of investment to a more profitable future.
In order to achieve these ambitious goals, there is a need for global cooperation. Luckily, more and more pledges for net-zero are emerging not only from countries but also from investors and companies. Businesses are understanding that this is now a cost of operation.
And climate action cannot wait. We are at a crucial decade that may determine whether we deal with the impending climate crisis effectively or not. Changes must be made by 2030, not just 2050.
How effective was COP26 at addressing transition risks? The conference brought about a series of commitments from financial institutions and corporations on achieving net-zero. Governments too pledged to ramp up investment in renewable energy and other clean technologies.
However, the conference’s participants fell short in key areas. For instance, the Pact called on all Parties to accelerate efforts to “phase-down unabated coal power and inefficient fossil fuel subsidies, recognizing the need for support towards a just transition” but its language allowed for the limited continuation of coal-fired power, and gave countries discretion over determining what fossil fuel subsidies count as “inefficient.” In addition, the pledges made were simply not enough to tackle the current climate crisis
COP26 did move the needle on addressing transition risks. But now it is up to investors and corporations to make the business decisions that bring about a low-carbon world. Will they succeed? Only time will tell.