In retrospect, the most significant outcome of COP26—the UN Climate Change Conference that convened in Glasgow on October 31, after a yearlong postponement—may not have been the formal agreement hammered out by diplomats in the main plenary hall but the momentum that emerged from the meetings and conversations among global business leaders that took place along the sidelines.
From the outset, the sheer size of the private-sector turnout at COP26 suggested that industry was no longer prepared to stand by and wait for government action. By the time the summit concluded on November 13, many of the world’s largest companies and financial institutions had voluntarily announced bold new plans aimed at mitigating global warming. More than 5,200 businesses pledged to meet net-zero carbon targets by 2050, and some 450 banks, insurers, and investors—collectively representing $130 trillion in assets and 40 percent of the world’s private capital—committed to making their portfolios climate neutral during the same period. A group of major automakers pledged to stop selling fossil-fuel-powered vehicles by 2035. And the Mission Possible Partnership, an expansive industry-backed group focused on developing decarbonization road maps sector by sector, unveiled plans for three industries that have been among the hardest to transition: steel, shipping, and aviation. More sectors will follow.
The challenge will be making these plans a reality, not just for a few first movers but for whole industries. A new McKinsey analysis found that capital spending to reach net-zero emissions would need to increase from $5.7 trillion annually today to $9.2 trillion annually over the next three decades.1 That is an estimated increase of $105 trillion over 30 years. Such a massive reallocation of capital would likely trigger a period of rapid innovation and growth, likely reshaping entire industries and revolutionizing the way businesses create value across industries.
Although this transition will generate new opportunities for many, with great opportunity comes great risk. And because no single firm can bear these risks on its own, managing them will require cooperation across industries and between industry and government. For business leaders, the biggest uncertainties concern whether technology, capital, and policy will come together in ways that allow firms to break away from old production methods and invest in new lines of business and new supply chains.
Boldly pledging to reduce emissions and actually implementing the changes that will make these reductions possible are two very different things. And as industries embark on decarbonization, their ability to make good on their COP26 pledges will largely depend on three factors: technological innovation, the pace at which carbon-intensive “brown” businesses can be converted into greener ones, and the deployment of massive waves of new capital.
At the center of the coming industrial transformation is technology. The International Energy Agency (IEA) estimates that to reach net-zero emissions, half the carbon reductions in 2050 will require technologies that today are in the R&D or demonstration stage and not yet ready for commercial deployment. The innovations needed include “game changer” technologies that will be highly disruptive, especially in industries that have so far proved difficult to decarbonize.
There is no shortage of interesting technical ideas, but the process of turning these innovations into scalable businesses is capital intensive and fraught with risk. Significant investment may be necessary before it can be determined that a seemingly promising technology is even effective, let alone cost competitive. Risk-sharing mechanisms will be critical to developing, proving, and scaling up these first-of-a-kind technologies.
A decade ago, during the first wave of the energy transition, businesses developing commercial-scale solar components, biofuels, and battery-storage systems faced similar challenges. A key lesson from this first wave was that market forces on their own weren’t enough to help first movers develop and commercialize these technologies. The initial funding required was often too high for venture capital investors, yet the commercialization risk of new technologies was too high for mainstream debt and equity investors. For most successful technologies, such as solar, the solution turned out to be a combination of policy supports, including tax credits, direct subsidies, and loan products, that backstopped the technology commercialization risks of scale-up projects.2 The industry learned that when government and businesses worked together, they could help unleash private capital—debt financing, mainly—that allowed rapid scaling and helped drive down costs and improve technical performance.
Looking to the future, deep cuts in emissions from across the industrial system will depend on a cluster of critical technologies. Those likely include electric power plants that have zero emissions but could ramp up and down as needed—keeping the lights on even as wind and solar generators shift their output with the vagaries of the breeze and the sun. Hydrogen-fueled power plants are a leading candidate. Hydrogen could be a game changer in other sectors as well because, once produced, it is easy to store. Hydrogen fuel cells could thus be useful for applications, such as heavy trucks or ships, where batteries aren’t a practical way to store the huge volumes of needed energy on board.
Despite their promise, these types of technologies are nascent today—and so are viable business models. Here, lessons from the first wave should be applied. Government support will likely be necessary so that good ideas don’t perish before they can be tested by business. Particularly important will be mechanisms such as government-backed loans for early, risky projects. The technologies that will be most crucial to achieving deep cuts in emissions will be capital intensive to scale and will thus benefit from low-cost debt financing.
Brown to green
Decarbonizing the high-emitting industries that today account for nearly 80 percent of global emissions presents another major challenge. The US energy transition that began during the 19th century—a shift from biomass to coal, which was jump-started by technological improvements to the steam engine—took nearly 100 years. If the world is to avoid the worst impacts of climate change, it must transition to net-zero emissions at a much swifter pace over the next few decades.3
Many analyses of the coming energy transition focus on the industries of the future. In reality, success will depend for the most part on how quickly the industries of today can transition from brown to green by phasing out carbon-intensive operations. The IEA and McKinsey have separately estimated that decarbonization of the industrial and energy systems comprises over 50 percent of the volume of carbon that must be cut over the next decade. McKinsey’s estimates have suggested that decarbonizing industrial and power systems, as well as scaling low-emissions power capacity, would require $60 trillion cumulatively over the next 30 years.
The brown-to-green transition was an important emerging theme at Glasgow, as firms in some of the world’s highest-emitting industries, such as steel, cement, oil production, and electric power, made pledges to cut pollution. Implementing brown-to-green strategies will require firms to deploy technologies to help decarbonize industrial processes. Oil companies, for example, are using a suite of technologies—including crop genetics, chemical engineering, and refining—to develop biofuels that will help make fuel sales carbon neutral. A rapid uptick in government and industry pledges for clean fuel production has resulted in a market for biofuels that can replace jet fuel, for example. Investors are already rewarding some firms that have successfully executed brown-to-green transformations in this sector. Over the past decade, for example, the Finland-based company Neste has transformed itself from a regional oil refiner to the world’s largest producer of renewable fuels. Its valuation has more than doubled.
Many opportunities in the shift from brown to green involve electricity. Thus, the greatest risks and opportunities today may lie in the industries that remain difficult to electrify, such as air transport, heavy mining, oil refining, and the production of steel and cement. Some of the most interesting opportunities in these sectors involve technologies for capturing carbon and storing it safely underground and technologies for shifting away from fossil fuels and using hydrogen as a fuel. Many firms in high-emitting industries are well poised to develop and deploy these technologies at scale given their existing skills in areas such as geology, chemical engineering, and complex project development. When it comes to testing whether the overall effort will be enough to mitigate warming globally, what will be key to watch is how many companies execute brown-to-green transformations on timelines like that of Neste.
A rapid shift toward green will mean accelerating the retirement of high-emitting assets to create space for cleaner alternatives. The transition away from conventional coal is already well under way across the Western world and has begun accelerating globally. About two dozen nations announced commitments to phase out coal power at COP26, and member nations of the Organisation for Economic Co-operation and Development (OECD) made a five-year, $8.5 billion commitment to help South Africa move away from coal, which today fuels 90 percent of the country’s electric power demands. In the United States, some state regulators are speeding the retirement of coal by softening the financial blow—for example, by incorporating the cost of shutting coal plants into the rate base of the companies they regulate. Although these are important developments, the global transition away from coal is just getting started, and action on one of the key challenges—helping the workers and communities that will bear the economic brunt of this shift—remains uneven.
Investing in decarbonization
A huge shift in the expectations of the world’s bankers and asset allocators is now under way, helping create more urgency around decarbonization. The newly formed Glasgow Financial Alliance for Net Zero (GFANZ) has brought a group of financial institutions together to identify ways to collectively invest in high-emitting sectors that might speed their efforts to develop zero-carbon technologies and to responsibly retire assets such as coal-fired plants.
Many other alliances are emerging—which will prove most important is hard to pin down, but what is clear is that financiers are beginning to shift their capital deployment to make it more consistent with the goal of net zero by midcentury.
Lenders have begun considering the risk that high-emissions industries won’t fare well in the future and linking debt issuances to company sustainability objectives, although the mechanisms for doing so are still maturing. Determining the risk profiles of the various opportunities for sustainable investment that currently present themselves, such as green retrofits for oil and gas production or industrial plants, remains a major challenge for lenders. Without better metrics, efforts to invest in decarbonization could bring about many unintended consequences, including locking out the financing that will be critical to decarbonizing high-emitting assets. Industry players and investors are working to address this problem by developing quantitative parameters for assessing risks and returns in order to facilitate the flow of appropriately risked capital into decarbonization investments, but there is still much work to be done.
COP26 helped focus the global business community on decarbonization, providing momentum for new investment and spurring the formation of new partnerships in the process. The challenge today lies in helping investors channel capital to brown-to-green transformations in which novel third-party financing and public–private partnerships help unlock financial returns. Although private capital providers are already seeking opportunities to invest in brown-to-green asset transitions, this is most evident in countries where the policy guidance is clear and future financial rewards seem assured.
The larger picture remains sobering. Climate change is a global problem, and the challenges in the developing world are very different from those that are most familiar to industry leaders in developed economies. Two-thirds of emissions are produced in developing countries, and around half come from industries in which the technological and business solutions to reducing emissions remain unclear. The next major global climate conference, COP27, which will take place in Egypt, will be an overdue opportunity to spotlight that next frontier.
This article was first published in Foreign Affairs and republished under license.