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McKinsey Global Institute

Article| Newsweek International

Not sky-high

November 15, 2008 | byJeremy Oppenheim, Eric Beinhocker, and Diana Farrell

With the global financial system in crisis and the economy in a downturn, there is a risk that momentum for investing in clean energy and tackling climate change may ebb. Some argue that action is too expensive when the economy is weak; others say it will hurt economic growth and force consumers to make changes in their lifestyle they will not like.

But new research by the McKinsey Global Institute and McKinsey's Climate Change Special Initiative shows that this need not be the case. With the right mix of policies, investments, new technologies, and changes in behavior, we can shift to a clean-energy economy while continuing to grow. The key is dramatically increasing the “carbon productivity” of the economy.

Just as one can measure labor productivity—the amount of output created per hour worked—one can measure the “carbon productivity” of an economy as the amount of output produced per metric ton of carbon dioxide and other equivalent greenhouse gases emitted into the atmosphere. If we are to meet the twin goals of reviving the economy and tackling climate change, then we need to dramatically boost the world's carbon productivity.

Today, carbon productivity is at $740 of gross domestic product (GDP) per metric ton of emissions. But if we are to continue to reduce poverty in the developing world, maintain growth in the developed world, and accommodate three billion more people on the planet by 2050, then world GDP will need to grow by at least 3 percent per year. Likewise, to avoid the potential nightmares of global warming, such as mass migrations from flooded cities and starvation due to drought, the scientific consensus is we need to cut carbon emissions by at least 50 percent from 1990 levels by 2050. Combining these targets means carbon productivity must reach $7,300 by 2050—a tenfold increase over today.

To make this more personal, the average citizen of a developed country emits 27 to 63 kilograms of carbon equivalents per day depending on where he or she lives. In order to minimize climate damage, that number needs to come down to less than 6 kilograms per day. To live on such a budget at today's levels of carbon productivity, one would be forced to choose between a taking 40-kilometer car ride, using air conditioning for the day, purchasing two new T-shirts (without driving to the shop), or eating two meals that included meat. In short, without a major boost in carbon productivity, stabilizing the climate would require a painful change in lifestyles in the developed world and the loss of hope for greater prosperity in the developing world.

A tenfold increase in carbon productivity sounds daunting, but it is a type of challenge that humankind has met before. US labor productivity increased tenfold over a 125-year period from 1830 to 1955. We now need a clean-energy revolution on the same scale as the Industrial Revolution. But we probably have less than 40 years before emissions lead to irreversible damage. The clean-energy revolution has to happen three times faster than the Industrial Revolution did.

Our colleagues from around the world have conducted a detailed bottom-up analysis of just what such a clean-energy revolution would entail and how much it would cost—country by country and industry sector by industry sector. Overall, the shift to a low-carbon economy would require new global capital investment averaging $570 billion per year between 2010 and 2030.

This sounds like a lot, but it is only about 2 to 4 percent of expected capital expenditures during this period. And because the money would largely go into long-life assets (e.g., better buildings, cleaner power sources, low-emissions transport), most of it would be financed through borrowing over time. And many of these “costs” are actually long-term investments—new clean power and industry infrastructure—that have the potential to spur economic growth and create jobs, just as the “costs” of building the Internet ultimately led to new sources of growth.

The first step in the clean-energy revolution is to dramatically improve energy efficiency. Through a variety of measures ranging from better building efficiency and low-energy lighting to more fuel-efficient vehicles, we have the potential to cut world energy-demand growth by more than 64 million barrels of oil a day—equivalent to one and a half times current annual US energy consumption.

Best of all, improvements in energy efficiency more than pay for themselves. We estimate that dramatically increasing energy efficiency would require annual investments of $170 billion over the next 13 years. But these investments would generate a return of well over $900 billion annually by 2020 through lower energy costs.

Energy efficiency is the low-hanging fruit of the clean-energy revolution.

To radically increase carbon productivity we not only need to slow growth in energy demand, we also need to cut emissions while keeping economic output up. That means the power sector needs to decarbonize while still producing the megawatts, and the transportation sector needs to cut emissions while still getting us from point A to point B.

Some argue that this can be achieved only with fundamental breakthroughs in technology. But our analysis estimates that 70 percent of the technologies needed are either available today or are likely to be commercially viable in the coming decade. Renewable technologies, such as solar, wind, and geothermal, already account for 12 percent of Germany's power today and have the potential for dramatic expansion. For example, we estimate that the renewables share of US power could almost triple from 8 percent today to 23 percent by 2030 at a reasonable cost.

But even with rapid renewables growth, other low-carbon sources will be needed. Nuclear is controversial, but it will be a part of the low-carbon strategy for some countries. Another controversial technology is carbon capture and storage (CCS), sometimes called “clean coal.” Using CCS, carbon emissions from power and industrial plants are captured and stored deep underground, often in disused oil and natural-gas fields. The technology has been used by the oil and gas industry for many years, but never at the enormous scales required by the power sector. Significant investment is required to pilot such CCS programs at a commercial scale.

In the transport sector there is a race among technologies. Auto engineers believe they can modify conventional engine designs to double or even triple fuel efficiency with a minimal impact on performance. Likewise, new generations of hybrids are in the works; there is much effort going into better battery designs for electric vehicles; and the next generation of biofuels promises more performance for less money, and with minimal impact on land usage and food prices. Finally, city planners continue to find ways to better leverage public transport and design smart cities that reduce commuting distances.

Still, we will need more. Even though 70 percent of the technologies required are available or on the horizon, that still leaves 30 percent to come from new technologies we don't have today. Entrepreneurs, venture capitalists, and company labs around the world are working on a plethora of innovations. But at $10 billion per year, these investments are still tiny compared with the $369 billion the world will spend this year exploring for new sources of oil.

Efforts to increase carbon productivity must go even beyond new technologies. Preserving and expanding the world's tropical forests could make a significant dent in carbon emissions. When trees in these forests are cut down, their absorptive capacity is lost and net emissions go up. Deforestation is often driven by the economic needs of very poor people and thus is a complex issue. But recognizing the value of the world's forests and paying to keep trees standing may be significantly cheaper than other ways of reducing emissions.

Finally, businesses and consumers will need to team up to change long-ingrained behaviors. For example, Wal-Mart made a commitment through the Clinton Global Initiative to sell only concentrated laundry detergents, which it estimates will save 1.5 billion liters of water, 43,000 metric tons of plastic, and 57,000 metric tons of cardboard, not to mention the energy and carbon emissions to manufacture and transport this unnecessary material. Independent studies show that concentrated detergents have 20 percent lower carbon emissions through their life cycle than traditional products.

Changes such as these involve no lifestyle loss to consumers—they still get clean clothes. Meanwhile, as carbon productivity increases, GDP goes up (detergent sales continue to grow) while emissions go down. But such changes do require reeducation, as consumers need to be convinced that detergent in a smaller bottle works just as well as detergent in a big bottle. This is one small example, but if businesses start seriously taking carbon into account in the design, packaging, supply chains, and logistics of their products, the impact could be enormous.

Since 1990, carbon productivity has been increasing at 1.2 percent per year as technologies have improved and awareness of environmental issues has grown. But at this rate, it will take almost 200 years to get the tenfold improvement we need—far too late. The deep changes required across the global economy will not happen without new incentives and policies at the national and international level. In particular, we need to put a price on the carbon we emit—something the European Union has done through its cap-and-trade system. We also need stronger energy-efficiency standards, transition incentives for renewables, expanded funding for research and development, and a way to reflect the true value of the world's forests. These policies must also include significant funding and support for developing countries, where many of the lowest cost-abatement opportunities lie, but whose citizens have fewer resources to capture those opportunities and less historic responsibility for the carbon emitted to date.

Economic growth and a healthy climate need not be opposing goals. By dramatically increasing carbon productivity, just as we have increased labor and capital productivity in the past, we can have both. Investments in new clean-energy infrastructure and technologies can provide a boost to the global economy just when it is needed. We have had agricultural, industrial and information revolutions—now it is time for a clean-energy revolution.

Jeremy Oppenheim leads McKinsey's Climate Change Special Initiative, Eric Beinhocker is a senior fellow at the McKinsey Global Institute (MGI), and Diana Farrell is the director of MGI.

This article originally ran in Newsweek International.