FRANKFURT – In six months, representatives from countries around the world will gather in Paris in an effort to reach a global accord to fight climate change. When the G-7’s leaders meet next week in Germany, they should use the occasion to take the first steps toward avoiding the most dangerous consequences of global warming. With the world’s safety and prosperity at stake, the question is not whether or when to begin the transition to a low-carbon economy, but how to manage the effort.
In 2014, investments in clean energy reached a new high of $310 billion, after two years of decline. That is good news, but it is still far short of the $1.1 trillion per year that the International Energy Agency (IEA) estimates is needed in the low-carbon energy sector. In the meantime, some $950 billion was invested in oil, gas, and coal in 2013 – a figure that has doubled in real terms since 2000.
The value of an investment is based largely on the perception of how risky it is. Investment will not shift decisively toward greener sources of energy unless and until portfolio managers begin to account for the risks of dangerous climate change. Investors also need to consider “carbon bubbles,” the overvaluation of fossil-fuel companies based on the assumption that they will be able to continue burning the world’s reserves until depletion.
Until recently, traditional forms of energy production have had the advantage of being based on established and mature industries. But the tides are shifting. Sovereign wealth funds and institutional and private investors are increasingly recognizing that climate change will undermine their returns, and that governments eventually will begin to address the problem.
Likewise, the Bank of England is undertaking important work on the risk that assets like coal or oil reserves could be “stranded” by policy changes intended to limit dangerous climate change. And the G-20 finance ministers recently requested that the Financial Stability Board undertake a broad assessment of climate-related risks and opportunities.
The G-7 countries should clearly signal that they are serious about the low-carbon transition, and the most effective way to do that would be to support a global goal of cutting net greenhouse-gas emissions to zero by 2050. In addition, governments and regulators can take concrete steps to stimulate private-sector investment in cleaner forms of energy.
For starters, governments should take the equivalent of the Hippocratic oath and pledge to do no active harm to the planet. The New Climate Economy Report, released by the Global Commission on the Economy and Climate, on which I serve, underlines the importance of phasing out fossil-fuel subsidies and questions the wisdom of allowing export credit agencies to finance coal projects. Governments must set themselves a firm four-year deadline to end fossil-fuel subsidies and redirect funding to areas like green infrastructure projects and development assistance.
Second, governments must lead by example. High-level meetings in Addis Ababa and Paris later this year offer the opportunity to create synergies between the fight against climate change and financing for development and infrastructure. Governments should also encourage public pension funds to invest responsibly, especially when it comes to the climate. More, too, could be done to support the market for green bonds, including by issuing green government bonds.
Third, governments must create policy frameworks that foster low-carbon investments. Putting a price on carbon is critical. The slow but steady progress that countries are making toward this goal is encouraging. In the meantime, governments should use a shadow carbon price and carbon discount rate in their decision-making processes.
In addition, governments and regulators should adopt policies ensuring sustainable financial-sector practices, including annual reporting by companies and investors on environmental, social, and governance issues and due diligence and risk models regarding environmental hazards. Consideration of the possibility of stranded assets must be systematically expanded.
Finally, policymakers should foster partnerships and new instruments that nudge the economy toward low-carbon alternatives. Development banks, for example, can help leverage private-sector investment. And new institutions like the Asian Infrastructure Investment Bank are in a position to make sustainability a core mandate.
Managing the transition from an economy based on fossil fuels to one based on low-carbon alternatives will not be easy. But that is why it is essential to begin today. It is time for the G-7 to recognize its responsibility and lead the world toward a sustainable future.