To stabilize the climate and limit physical climate risks, climate science tells us that it is necessary to reduce the addition of greenhouse gases to the atmosphere to net zero (see sidebar “Physical risks will continue to build up until net zero is achieved”). Seven energy and land-use systems act as direct sources of global emissions. One system—forestry and other land use—also acts as a natural sink for carbon dioxide (CO2) and would need to increase its rate of emissions absorption. The systems and their emissions footprints are the following:
- Power, consisting of electricity and heat generation: 30 percent of CO2 emissions and 3 percent of nitrous oxide (N2O) emissions
- Industry, consisting of various industrial processes, including production of steel, cement, and chemicals, and extraction and refining of oil, gas, and coal: 30 percent of CO2 emissions, 33 percent of methane emissions, 8 percent of N2O emissions
- Mobility, consisting of road, aviation, rail, maritime, and other forms of transportation: 19 percent of CO2 emissions and 2 percent of N2O emissions
- Buildings, including heating and cooking: 6 percent of CO2 emissions
- Agriculture, consisting of direct on-farm energy use and emissions from agricultural practices and fishing: 1 percent of CO2 emissions, 38 percent of methane emissions, and 79 percent of N2O emissions
- Forestry and other land use, primarily land cover change: 14 percent of CO2 emissions, 5 percent of methane emissions, and 5 percent of N2O emissions
- Waste, consisting of solid waste disposal and treatment, incineration, and wastewater treatment: 23 percent of methane emissions and 3 percent of N2O emissions
Explore COP28 with McKinsey
Carbon dioxide in each case is emitted through the combustion of fossil fuels to produce energy (oil, gas, and coal), as well as through nonenergy emissions (for example, emissions associated with industrial processes like the reduction of iron ore to produce steel and with deforestation). Based on current accounting methodologies, energy-related emissions make up as much as 83 percent of CO2 emissions (exhibit). (This is based on the current system of emissions measurement, in which forestry emissions in particular are classified as net emissions, considering their role as both sources and sinks of greenhouse gases. Considering only their role as sources of emissions and accounting for second-order effects of deforestation would substantially increase the contribution of forestry as sources of emissions.)
Effective decarbonization actions include shifting the energy mix away from fossil fuels and toward zero-emissions electricity and other low-emissions energy carriers such as hydrogen; adapting industrial and agricultural processes; increasing energy efficiency and managing demand for energy; utilizing the circular economy; consuming fewer emissions-intensive goods; deploying carbon capture, utilization, and storage (CCS) technology; and enhancing sinks of both long-lived and short-lived greenhouse gases.
Our research methodology: Sources, scenarios, limitations, and uncertainties
We assess the net-zero transition along two dimensions: sectors and geographies. For the first, we examine energy and land-use systems that account for about 85 percent of global emissions: power, mobility (in particular, road transportation), industry (steel and cement production), buildings, agriculture and food, and forestry and other land use. We also looked at fossil fuels that supply energy to many of these systems. For the geographic dimension, we analyze effects in depth for 69 countries, which make up about 95 percent of global GDP.
We chose not to develop our own transition scenarios and rely instead on widely used scenarios created by other institutions. Specifically, we analyze potential effects under the Net Zero 2050 scenario defined by the Network for Greening the Financial System (NGFS). This hypothetical scenario mirrors global aspirations to cut emissions by about half by 2030 and to net zero by 2050 (exhibit). It reaches net-zero CO2 emissions by 2050 for the economy as a whole; this means there are some low residual gross CO2 emissions in hard-to-abate sectors and some regions that are counterbalanced by CO2 removals. We chose to work with the NGFS scenarios because they cover all major energy and land-use systems in a coherent manner, provide regional granularity, are designed for use in risk and opportunity analysis, and are becoming the standard scenarios used by financial institutions, regulators, and supervisors.
In some cases, as a counterfactual for comparison, we also use the NGFS Current Policies scenario. This scenario projects the greenhouse gas emissions that would occur if only today’s mitigation policies remain in place (based on an NGFS assessment of policies as of the start of 2020), and it anticipates a little over 3°C of warming by 2100. The comparison allows us to account for how other factors such as GDP growth or population growth could affect the economy between now and 2050. We also collaborated with Vivid Economics to use the two NGFS scenarios to generate more granular sector variables where needed (for example, sales of new automobiles), in a manner that was based on and compliant with the NGFS scenarios. In such cases, we still refer to the specific sector variable as being based on the relevant NGFS scenario.
We performed the analysis as follows. First, we used the NGFS scenarios and downscaling by Vivid Economics to quantify changes in important variables in each energy and land-use system (for example, changes in power production by source). The downscaling was done to provide sectoral or technological granularity where not available from NGFS. We used this to assess changes in demand and then assessed the implications for capital stock and investment, producer and consumer costs, and employment based on information about decarbonization technologies and their capital and operating costs, labor intensity, and effects on value chains. Where possible, we used region-specific costs and labor assumptions, as well as expected technology learning curves over time, based on McKinsey analysis.
Limitations of our approach and uncertainties. We recognize the limitations of the NGFS scenarios, as with any transition scenario, given that this is an emerging field of research. First, while some variables are explored at the sector level, the scenarios often do not provide enough detail to explore how different types of activities will be affected, thus requiring downscaling to achieve the necessary sectoral granularity. Second, the models underpinning the NGFS scenarios may not capture important dynamics or constraints within a sector. For example, the model we used favors more economy-wide use of biomass in energy and industry (for example, hydrogen production) than may be considered feasible in other sector-specific decarbonization pathways. Third, although the models do capture ongoing learning and technological innovation, they may fail to sufficiently anticipate the emergence of disruptive technologies that may change decarbonization pathways and lower cost trajectories faster than anticipated. Fourth, while some NGFS scenarios have begun to incorporate damages from physical risks in the economic modeling, further work is needed to fully integrate physical risks into the decarbonization pathways. As a result, we have focused here on scenarios that do not incorporate physical risk. This approach also allows us to focus our analysis on the effects of the transition alone. Finally, the scenarios reflect climate policies and technological trends in place before the COVID-19 pandemic and climate negotiations and pledges at COP26 in Glasgow in November 2021.
Our analysis largely consists of an analysis of first-order effects. Various uncertainties could influence the magnitude of outcomes highlighted here. While some of these factors could result in lower outcomes than those sized in this research, some factors suggest that additional costs and effects will likely occur as the transition unfolds. By the same token, the costs of physical climate risks could likely prove higher than those described here.
Key uncertainties include the following:
- Warming scenario and emissions pathway. A higher warming scenario (for example, 2.0°C) may lead to smaller transition effects than a 1.5°C warming scenario, given the lower degree of emissions reduction and deviation from today’s production and consumption patterns it entails.
- Sectors’ decarbonization actions and activity levels. Because the focus of our work is assessing the nature and magnitude of economic shifts and not identifying decarbonization actions, we used a prespecified net-zero scenario from NGFS. It is feasible that an alternate technology mix could result in lower costs and different shifts than those described here, and that further technological innovation could result in a different pathway with lower costs. It is also feasible that the path the world undertakes to decarbonize is different from the one described here. For instance, an alternate scenario may consist of substantially more use of carbon capture and storage (CCS) technologies and a focus on decarbonizing the hydrocarbon value chain. For example, this could happen if capture costs fall, regulatory frameworks are put in place to incentivize CCS use, and markets mature for recycled CO2 as a material feedstock.
- Magnitude of direct and indirect socioeconomic effects. Some effects could be larger than described here, for example, if executing the transition is more complex than the scenario here suggests, and additional capital spending is needed to maintain flexibility and redundancy in energy systems. If supply of key materials or low emissions of sources of energy do not keep up with demand, this could result in shortages and price increases, which we have not considered in our quantification. Higher-order effects could magnify risks and increase costs, particularly in the short term. For example, depending on how the transition is financed, the effects on the overall economy could be substantially higher than sized here. Finally, effects could also be larger under an abrupt or delayed transition.
- Economic and societal adjustments needed for the transition. Costs and investments could be higher than sized here, for example to implement social support schemes to aid economic and societal adjustments. Similarly, additional costs may arise from delays, setbacks, and urgently needed adaptation measures, particularly if restricting warming to 1.5°C proves not to be possible. For our analysis, we quantify the scale of first-order effects and describe qualitatively the adjustments needed.
Aspects we did not cover. Topics we did not cover include the likelihood, validity, and comparative costs associated with various decarbonization scenarios; the comparative merits of different emissions-reduction technologies; constraints to implement and deploy decarbonization technologies (for example, scaling up supply chains); the actions needed to drive and incentivize decarbonization; quantification of higher-order economic effects of the transition, including on output, growth, value pools, valuations, trade flows, and human well-being: relative costs and merits of decarbonization and adaptation; and impacts that could result from physical climate hazards. We use benchmarks from the external literature and our past research to describe these latter possibilities. As discussed above, our analysis here represents first-order estimates. Fully quantifying the costs of rising physical risks and the transition is complex. It would require estimating impacts from rising physical risks and the cost of adaptation actions, building robust estimates of the impact of the net-zero transition on the economy that takes into account the higher-order effects described above, and doing so over time and while grappling with the various uncertainties described previously.
A key feature of any transition to net-zero emissions is its universality, across energy and land-use systems and throughout the global economy. This is for two reasons. First, each of these energy and land-use systems contributes substantially to emissions. Thus, every one of these systems will need to undergo transformation if the net-zero goal is to be achieved. Second, these systems are highly interdependent; actions to reduce emissions must take place in concert and at scale across systems, economic sectors, and geographies. For instance, electric vehicles are valuable only to the extent that low-emissions electricity production has been achieved. All sectors of the economy participate in these energy and land-use systems across global value chains. Similarly, all countries contribute to emissions, either directly or through their role in value chains. Reaching net-zero emissions will thus require a transformation of the global economy (see sidebar “Our research methodology: Sources, scenarios, limitations, and uncertainties”).
