Global leaders must find a common policy to tackle climate change, and must do so immediately, regardless of the additional challenges posed by the economic downturn.
Kevin Parker, Global head, Deutsche asset management
Climate change is real, it is happening, the science is not disputed. However, as we look around the world, adaptation and mitigation measures have been uneven to date, and so are the plans for future action. As we enter the finishing stretch on the road to Copenhagen, it will be crucial that leaders of the major greenhouse gas-emitting countries find common ground toward a meaningful global deal that will enable us to transform the world economy towards low-carbon growth.
The recession poses an additional challenge to the already arduous task of addressing climate change. However, it should not distract from the urgency of the task if global warming is to be limited to two degrees Celsius. Why? Because the drop in output will only provide very temporary relief from emissions. Because even if immediate action is taken, concentrations of greenhouse gases in the atmosphere are already at a perilously high 467.9 parts per million (ppm), as shown by our carbon counter in New York, and each year of delay costs another irreversible three ppm, or 24 billion tonnes of carbon dioxide per year. And because it will take decades to scale up the low-carbon infrastructure and restructure high-carbon supply chains.
Indeed, the current economic downturn presents governments the world over with a historic opportunity to 'climate proof' their economies, put in place the right policies and upgrade infrastructure as a core response to the economic downturn with the attendant benefit of creating 'green' jobs. After all, it is policy that creates environmental markets in the first place. Regulation is needed in order to internalise the environmental externality, change relative prices and impact resource allocation. In fact, these times of economic difficulties present an opportunity to reset economic models (for example, in terms of different development models for emerging markets) - we can think of new urbanisation or transportation models, or infrastructure-led recovery models in the West that will also improve the framework conditions for the substantial investments necessary for effective decarbonisation.
A challenge to be met
Deutsche Bank is involved in Project Catalyst, an initiative led by the ClimateWorks Foundation with analytical support from McKinsey. This analysis suggests that between now and 2020, technologies need to be deployed globally that will reduce emissions by 17 gigatonnes relative to the business as usual trajectory - a near 30% reduction. A challenge, but one that can be met with technologies that are commercial or near-commercial today at a cost of €60 per ton of carbon dioxide emissions. About one-third of the abatement can be achieved from energy efficiency; low-carbon power can deliver another 20%; and better management of forests and agriculture can yield about half. A significant share of the abatement potential, about two-thirds, is identified in emerging markets.
The good news is that it is understood which policies have been effective. To encourage energy efficiency, standards and codes are needed: for low-carbon power, a combination of renewable portfolio standards and feed-in tariffs have worked; policies to avoid deforestation, increase reforestation, and encourage higher productivity land-use and low-carbon agricultural management can go a long way to reduce emissions in forestry and agriculture; and finally, carbon markets are key to creating economy-wide price signals that encourage low-carbon investments and practices. In particular, a properly designed cap-and-trade system can achieve large-scale emissions reductions from large stationary sources within the energy and industrial sectors at the lowest cost.
A number of countries have adopted some of these policies, but of course widespread co-ordinated and consistent adoption is required to deliver the results needed. Each country in effect should develop and implement low-carbon growth plans that are built around these policies appropriately targeted to the circumstances within their country. In addition, there should be caps in developed countries, and the prospect of future caps in developing countries. The caps need to be tight and carbon prices sufficiently high to send the proper signals to induce investments into clean alternatives.
Financing flows
Policy frameworks are only one side of the coin - the other is financing. Under an average 25% reduction target for developed countries by 2020, carbon markets could contribute significantly to low-carbon investment in developing countries as industrial countries will need to buy offsets to meet their targets. In fact, such financing flows could be on the order of €20bn a year at prices of €15 to €30 per ton, reflecting an offset market of about three gigatonnes.
However, this is far from sufficient to fund the incremental costs of developing countries' mitigation and adaptation actions between 2010 and 2020. For that, average financing equal to about €65bn to €100bn a year needs to be mobilised. To incentivise emerging markets to carry out the additional nine gigatonnes of abatement that can technically be delivered, public finance must be used in the form of concessional loans, grants and risk mitigation instruments in the case of projects that are net present value negative (about six gigatonnes). For projects that are in the self-interest of developing countries, mostly in the energy efficiency area, support will most likely take the shape of capacity building.
Unlocking private sector investment in climate change will be vital. The International Energy Agency's World Energy Outlook 2008 report establishes that $500bn a year is needed between now and 2030 for clean technology infrastructure. Policy-makers and finance experts need to think creatively to identify public-private funding solutions that can address the different types of risks associated with different technologies and different countries. This is even more important now given the ongoing financial and economic dislocations that have already created a detour for clean energy investment and other abatement projects over the past year.
Just consider renewable technologies. There was approximately $148bn and $155bn of new clean energy investments in 2007 and 2008, respectively. The financing of new solar, wind and biofuels projects has seen significant asset flow: $71bn in 2007 and $85bn in 2008. However, the first half of 2009 saw $26bn of project investment flow, representing a 42% decrease from the same period in 2008, according to New Energy Finance (2009).
In part, this slowdown reflects the tight credit market conditions and the recession, as well as the sharp drop in carbon prices in Europe, which has not helped matters. In the EU, emissions trading scheme prices fell to as low as €8 per ton in February, from more than €30 per ton last July. While prices are back at about €15 per ton, such low prices will not incentivise the right investment, for example, in carbon capture and sequestration (CCS). Our research shows that a price of €30 and €40 per ton today (discounted from €60 and €70 per ton in 2020) would be a price trajectory for making CCS commercially viable. Otherwise, the EU's power companies will not have sufficient confidence to make the necessary investments in 2009 that will be required to make CCS commercially viable by 2020.
While a price on carbon remains the most important market incentive to switch the economy toward low-carbon activities, it will unfortunately be some time before a global marketplace for emissions will emerge. In the interim, other policies will have to be deployed aggressively and most companies would be wise to adjust early to minimise the impact of the inevitable - namely a very high price for carbon as emission rights will be in high demand with only limited supply available.
Our conclusions are clear:
- We have no time to waste.
- The current crisis clearly poses an additional challenge to the already mountainous task of addressing climate change.
- But we know we can deliver the tonnes - it is technically feasible.
- Policies need to be stepped up, including in emerging markets where emission growth needs to slow dramatically.
- And therefore, we need to identify clever, innovative financing mechanisms that can help ensure mitigation action in the developing world.
Caio Koch-Weser is vice-chairman of Deutsche Bank. Previously he was deputy finance minister for Germany and chairman of the supervisory board of the German Federal Financial Supervisory Authority. Kevin Parker is global head of Deutsche Asset Management.
