In this episode, we discuss the main priorities and challenges in the Asia Pacific with regards to climate change, the different technological advances, capital investments, and behavior changes needed to solve the net-zero equation, and how leaders and policymakers in the region can contribute to the commitments made at COP26.
COP26 and Implications for Asia
Gautam Kumra: I am Gautam Kumra, Chairman of McKinsey Asia, and you’re listening to the Future of Asia podcast series. The Asian century has begun. The region is now the world’s largest economy. As Asia’s economies evolve further, the region has the potential to fuel and shape the next normal. In each episode, we are going to feature conversations with leaders from across the region to discuss what Asia’s rise means for businesses across the globe.
Rajat Gupta: Hi, my name is Rajat Gupta. I am a senior partner with McKinsey and the leader of our Sustainability Practice in Asia. Thank you for being here for this podcast. I have two guests: first, I have Jonathan Woetzel, who’s Asia’s leader for the McKinsey Global Institute (MGI). He’s spent 30 years in Asia and he’s one of our most senior leaders at McKinsey. I also have Daniel Pacthod, the global leader of McKinsey’s Sustainability Practice based in the US.
My conversation will be with these two gentlemen around COP26 and its implications for Asia. I look forward to this conversation with you, Daniel and Jonathan. Let me first begin by asking you a question, Daniel. You were there at COP—what are your main takeaways from Glasgow? Is it all doom and gloom, as some commentators have said, or is it something different?
Daniel Pacthod: I had the pleasure of spending the first week at COP in Glasgow, and the first thing I would say is the weather was a lot better than expected—which was a good way to actually start the summit. The thing that struck me the most is I think this is really the first time the private sector has showed up in force. We had representatives from all the global leadership teams and global companies at COP. Frankly, the main reason was less about engaging with government officials, but more to engage amongst themselves and compare notes on sustainability and this path to net-zero. I do think what has made this COP different is that in the last 12 to 18 months, sustainability and getting to net-zero has really taken the C-suite and the boardroom by storm across all industry sectors. So, I think there was a very present private sector at COP and frankly, a lot of CEOs and a lot of leaders also asking a lot of questions. So, that’s perhaps one big observation.
I think the second one is a bit of a realization that we’re not spending more time on: ‘Why do we need to act?’ I think this has really now pivoted to ‘How?’ and ‘What do we need to do?’ Throughout the discussions—if you look at the physical climate risk and lots of different data points—something that struck me was in the next few years, we’ll have a billion people on the planet that will be living in unlivable conditions. One of the first CEO discussions we had, we actually had Al Gore join us. He’s been on this sustainability journey for 20 years but talked about what happens to the world if we have a billion climate refugees and the impact that would have on geopolitics, on socioeconomic dynamics, etc. I think that was also the realization that we’re way past discussion of, ‘Why is this important?’ and everybody’s realizing climate risk is front and center.
I think the third thing that was also really present is the financial sector was very much represented. You saw a lot of announcements on, for example, GE fans, on a lot of the capital providers getting together and committing to a certain amount. I think to some extent, we’re looking at this and we’re realizing this will be the biggest reallocation of capital ever. We talked about $3 to $5 trillion of capital reallocated per year. And over 30 years, depending on numbers, you’re talking about $150 trillion—that’s what we will need to rebuild or build a sustainable infrastructure for the world. These numbers were out there, and I think it was very clear that the financial sector was present at the table.
My last observation is that an enormous amount of work still needs to be done, and I think there were some disappointing moments. I think there were countries and industry sectors that thought people would commit to more. In one of the panels, I was with the head of strategy of a large oil and gas company and the word that was used was ‘humble’. Humble because when you look at the work that needs to get done, there are a lot of questions that haven’t been answered yet. I think there is a sense of optimism because there’s now capital and there’s a massive amount of technology innovation needed, but there’s an enormous amount of work that needs to get done for us to actually be remotely close to the target we set in Paris, which is 1.5°C of warming.
Rajat Gupta: Let me turn to you, Jonathan. In the context of what you heard from Daniel, what are Asia’s priorities in the context of climate change, and what is coming out of Glasgow? How does that differ by different parts of Asia?
Jonathan Woetzel: Thank you, Rajat. First of all, let me start by saying that Asia is very much at the center of whatever is going to happen on climate change. I think this was one of the things that became that much clearer throughout COP26, both in terms of the requirements to deal with the adaptation that’s needed for climate change, as well as the investments that will be needed to mitigate further climate change in the decades to come. I think the centrality of Asia, if you will, was one of those features in terms of the bright spots of Glasgow. For example, the US-China announcement on global collaboration really highlighted the opportunity that type of connectivity between Asia and the world can bring for climate change.
So, Asia is very much at the center. Of course, as we know there isn’t necessarily one Asia—we have many different parts of Asia. At MGI, we’ve often said there are four broad categories: there is Advanced Asia, the relatively higher income economies; there’s China as its own region; there is Emerging Asia, the lower-income but fast-growing markets and lower labor cost regions; and then there is India and Frontier Asia—the Asia that is between the rest of Asia and the rest of the world. So, those four categories are all quite different in their economic structures, their degree of integration, and with that, their exposure to climate change. I think that we’re going to see different policies because of that but there are some things that are true across Asia. Maybe if you allow me, I’ll go into one or two of them. But I’m actually going to turn the question back to you in just a second here.
Asia is very much at the center of whatever is going to happen on climate change. I think this was one of the things that became that much clearer throughout COP26, both in terms of the requirements to deal with the adaptation that’s needed for climate change, as well as the investments that will be needed to mitigate further climate change in the decades to come.
From a China perspective, China is definitely over exposed, if you will, to climate change. It’s one of the geographies that’s just going to be more impacted by extreme heat and by flooding. So, adaptation has already been very high on the Chinese agenda. That’s what they are looking for as part of the global consensus; an agreement on how to finance that, how to put in play the technologies that will be needed to future-proof our cities and our crops, and so forth. I think that’s a big part of what the collaboration conversations with the US might well be about.
Beyond that, China is also one of the countries which has a very large share of coal assets. So, this leads to a big economic challenge, notably around the stranding of those assets. China is looking for support but it’s also looking for replacement of those assets with something better. Notably, of course, solar, wind, and other power generation technologies. Decarbonizing the power grid at scale is definitely the other thing that’s very high on the Chinese agenda; how to build a competitive globally sustainable power generation sector and grid. So, that’s kind of where China is. It’s about winning the carbon transition and how to build a competitive power sector while adapting successfully to the physical environmental changes.
That’s a bit different than the context for Japan, Korea, and other economies in Advanced Asia. We put out research showing that there is a path to net-zero for Japan, particularly by 2050, but it’s going to take quite a lot of high technologies that haven’t really been commercialized yet; notably, CCUS (Carbon Capture, Usage, and Storage) and hydrogen technologies. These are going to be critical for a relatively lower growth but higher value-added economy like Japan, and especially as an economy that has some difficulty, given its geology, to put in place large-scale renewables. So, it’s going to be a different agenda for those advanced Asian countries where it’s about investment in this next generation of technology and winning the technology race to create a case for growth along with decarbonization.
The last geography I mentioned is Emerging Asia; it’s a vast and very differentiated landscape. If we were to pick out one or two examples, one that jumps out is Indonesia. Indonesia has a very different profile in the sense that there is a large role for nature-based solutions, and the role of land use as an early urbanizer in those early stages of moving people off the farms and into the cities. There’s a huge question about how that happens, where that happens, and of course, when that happens. But how we drive land use in agricultural practices in Indonesia can make a very big difference. With that, the priority for Indonesia is to essentially create recognition of the externality, so that somebody can support the investments that are needed in nature-based solutions. Very simply, Indonesia needs a carbon price that would recognize the value of its natural capital preserves and its biodiversity, while at the same time not penalizing it for its relatively lower incomes.
So, there are different priorities based on different economies. Maybe I could turn it back to you, Rajat, to talk a bit about India. I think you’re a lot closer than I am.
Rajat Gupta: Sure, Jonathan. Let me first start by talking about some of the pledges that India put forward at Glasgow. There is a bookend that India has put in place, which we did not have earlier, around reaching net-zero by 2070. I think it’s superb, because what it does is it concentrates our mind to put a plan forward that hopefully leads to stability and a single directional policy. It’s not like technology costs won’t change—there will be many things that will change over time, but at least there is a bookend, and the direction has been set. And in that, India will also hopefully put all the necessary policies in place to move us in that in that direction.
But India also increased some of its short-term targets to 2030, over what it had already announced in Paris. To me, these seem to be more of a continuation of what India has already committed to. For example, India had committed 30 to 35 percent reduced greenhouse gas intensity of GDP. Now, it’s increased to 45 percent. Not too difficult because in any event, this number changes by 1.5 to 2 percent every year as a lower income economy like India grows. India also upped its internal target of 450 gigawatts of renewables to 500 by 2030. Again, not a big shift but it’s still a challenge to get there—where will we find the land? How will we integrate so much infirm power into the Indian grid? The one thing that India did put forward is that 50 percent of its power and energy will be from non-fossil fuel sources. That’s my understanding of India’s commitment, though it’s not completely clear at this point of time. The trajectory India was on was probably was closer to 40 percent. So, to get to 50 percent, I think there’s additional work for India to do.
I think if I step back and look at it, a bookend has been provided, and some short-term targets have been upped. It’s heartening to see that India made a set of commitments a few years ago in Paris. It has performed against many of those commitments—in some cases aided by tailwinds like reducing solar costs—and has now updated targets.
Back to the question you asked me, Jonathan, on the important things or priorities for India—I might outline five. Firstly, I think one priority doesn’t change: India is at the frontier of development, and it has to continue to bring people out of poverty and improve their quality of life. And therefore, India has to keep costs of all kinds of services—of power, of the supply of water, of transportation—so that people can have more to eat and improve their quality of life. That remains a very important priority, and it comes into balance because some of the technologies that we are talking about that would abate carbon do lead to short-term cost increases.
The second thing is India will also, as you mentioned for China, have to deal with the challenge of adaptation. One example is heat stress in India—India’s likely to have 400 million people under heat stress so that 25 percent of the time, they would not be able to work in northern parts of the country. That’s a very large proportion of man hours lost, or lives put at risk if they have to continue working in heat. This is true today because a large proportion of India’s labor—about 45 to 50 percent—is still employed in farming, which is all performed outside.
The third priority or challenge India has to overcome is how to build India right. India can’t continue to battle down the path of building coal-based power plants and blast furnace-based steel plants and coal-based kilns for cement, which it needs in the short-term. Many of these things will get stranded a few years later when the tide turns, and these assets will not be at the end of their life at that point of time. Since 80 percent of India’s infrastructure, its industrial capacity, and its homes have yet to be built, how can India strike that balance and build India right?
Number four would be, where will India find the money? To invest in these climate-friendly technologies, which while in the long-term may call from an operating cost perspective—for example, solar technology costs more from an investment perspective. Our estimates are that India will need to invest an additional 10 to 15 points of GDP every year to be able to get to a net-zero path by 2050. This number may drop a little bit if we have to get to net zero by 2070—the current stated target for India—but it nevertheless will be more than what we are investing today. Now, in a land where a shampoo bottle is a capital investment, and as people go out to buy one rupee shampoo sachets to use, this is a very large sum of money to mobilize.
India’s likely to have 400 million people under heat stress so that 25 percent of the time, they would not be able to work in northern parts of the country. That’s a very large proportion of man hours lost, or lives put at risk if they have to continue working in heat. This is true today because a large proportion of India’s labor—about 45 to 50 percent—is still employed in farming, which is all performed outside.
Finally, I would say the regulatory load that the net-zero transition will involve in areas of uncertainty will be another set of challenges. I might say it’s regulatory load for the government, but it’s also a strategic load for our business leaders, who will have to strike a balance between doing the right things and doing them at the right time. Maybe with that, let me come back to my role as moderator of the session and ask you a question, Daniel. What is this net-zero equation, and why do you say that it doesn’t close or doesn’t solve? And particularly after COP26, do you think it solves better?
Daniel Pacthod: Our clients and we as a firm have been on this topic of the net-zero equation for a while now. For those who have a bit of a mass mindset, I think you’d say, “If you were to think about a net-zero target by 2050—which is, again, a science-based target, it’s what was committed to in the Paris agreements—as a set of pluses and minuses of carbon created and carbon removed to get to net-zero, that’s kind of this idea of this equation that we have to build.”
Unfortunately, it’s not just one equation; it’s a multitude of equations that are kind of connected at the same time. I think it’s a very complicated model to get right. What’s happening in the thinking around this equation is, “I’m going to take my electric vehicle share up to 30 or 40 percent.” But you need to make sure that the electric grid follows. You need to make sure green power is actually affordable, and that when we go to the whole value chain, we can produce the right rare earth materials in a sustainable way to actually build all these electric vehicles. So, you have to think about looking at a whole value chain and its multitude of value chains that have to be basically rebuilt to get to net-zero. That’s just one example.
What companies and leaders have to do is perhaps one of four or five things. You have to look at some assets that, frankly, will never make it. They have a level of carbon intensity that you can’t decarbonize, and over time, you’ll have to retire them. I think you then have to say, “I have to build a whole set of new green businesses.” One oil and gas leader said, “I’m moving from an oil and gas company to a carbon management company. I’m going to work on carbon capture, I’m going to create new hydrogen businesses, etc.”
I think the third is you take the core asset base and you decarbonize it—going from brown to green. How do you do that? How do you fund it? In some cases, external capital will be required for incumbents to be able to do it.
Then the last piece is really, how are you using nature-based resources and nature-based capital to actually be able to offset and build that? I think underlying all of that is also a sense that we need to get the mechanisms in place for carbon markets to really work; otherwise, you can’t actually get these equations to work. So, this is just an example.
We actually released thought piece on what it would take to solve this net-zero equation, and we identified nine requirements. In that article, we tee up 60 questions that need to be answered and as a CEO in Glasgow said, “I always look at people like McKinsey for answers, but it’s kind of rare that you would publish a report with 60 questions.” I think that’s exactly the reason: the net-zero equation(s) are going to be very difficult to close. Right now, they don’t close, right? We’re not on path to get to 1.5°C, we’re closer to 3°C right now. So, we’re going to have to answer all these questions and at the same time, it’s a bit a consequence of us not solving it. We’re going to have to work on resilience and mitigation—I think the realization is that if we don’t get in the 1.5°C zone, we will have more climate catastrophes and more risks we will have to manage. So, we have to really work on the resilience part of this as well.
Rajat Gupta: I have a question for both of you, what in your view are challenges or questions that you see business leaders grappling with? Jonathan, why don’t you go first.
Jonathan Woetzel: Well, as I think was probably said already, COP26 has really put net-zero out there as being a marker for business leaders around the world. If it wasn’t there before, it’s certainly there now. So, it’s not a question of ‘whether’, it’s much more about ‘when’—when will businesses make the transition, and what are the uncertainties? What are the risks associated with it? At this point, climate change is very much part of the risk agenda for pretty much every board of directors. But that said, actual timing is always dictated by business-specific concerns. Generally, we see five drivers of when a company can and will engage in the transition. They are in no particular order.
First of all, there are customers. Companies are wrestling with the rise of a younger, more environmentally conscious consumer, who is willing to choose products based on environmental values and the climate transition. So, addressing that—understanding its size, its scale, its preferences—is the first big uncertainty.
Secondly, of course, is the regulator. Companies are keeping a close eye on all of these standards and commitments, and even more importantly, incentives that are coming out of the regulator—be it local, national, or even multilateral or global. There are clearly uncertainties around the pace of the different transitions for power, mobility, and economics that are associated with that. Of course, there is also a very big question around a carbon price or somehow incorporating the externality of climate change in the economics of an industry, which is something that typically comes out of the regulator.
A third factor is the markets and the investors. We’ve seen more movement in the last 12 to 24 months on investors getting more transparency around climate and starting to evaluate companies based on their risk performance. So, that’s a third challenge for management is to say, “Well, how am I doing? What will happen to my sources of capital as these risks become more apparent?” Meeting that challenge and understanding the expectations of investors is a third issue they’re grappling with.
Fourthly, and this is very true for talent-driven organizations such as McKinsey, what is the proposition to employees? We are living through the ‘Great Attrition’, as they say, and that’s starting to be true in many Asian countries as we see higher rates of labor, mobility, and turnover with everything from automation. But simply put, appealing to the employee and sort of recognizing that our environmental values need to be credible within companies is a fourth level of uncertainty.
Finally, there’s the competition. I think there’s just a vast and growing set of attackers who are starting to stake out territory on these new technologies. We’ve seen, of course, a vast acceleration of technology-based competition. And this is equally true, if not more so, in the sustainability field—whether we’re talking about the electric vehicle or autonomous vehicle transition, or new forms of power, or reimagining cashmere, or, for that matter, quick serve retail. In each of these areas, the competition is the fifth uncertainty. So, those five factors are the ones that we see driving management to start thinking through not whether, but when, how, and at what pace they can make the climate transition.
Rajat Gupta: Thank you, Jonathan. Daniel?
Daniel Pacthod: One of the impressions from all these interactions with private sector leaders was it’s time for ‘Leadership’ with a big L. We talk a lot about the term, that we want leaders to get in this net-zero arena, and it’s time for leaders to lead. If you were to just aggregate a little bit what you picked up from companies, I think leaders have realized this is not about only playing defense. Playing defense would be, “I have to commit to a certain set of targets. I have to report what I’m doing in sustainability, net-zero, and ESG (Environment, Social, Corporate Governance). I have to show what I’m doing in scope one, two, and three.” That’s playing defense—that’s table stakes, that’s what everybody needs to do.
I think the leaders of tomorrow—the ones that realize that’s not enough—recognize you have to play offense. Playing offense means you have a really bold vision on how sustainability and net-zero could be a way for you to really create value, compete differently, and frankly, reinvent your company. You need to have a bold vision. For example, one question a large beer manufacturer had is beer generates a lot of carbon and it’s not easy to create a net-zero path. Talk about a complicated equation—that’s a complicated equation to solve. But if the question was: if I knew what I knew today, if I had to just reinvent my company, based on the assets I have and the customers I had for sustainability, what would that look like? What kind of products would I have? And I think that reflection of almost, you have to decarbonize the core, and at the same time, build the new—that I think is a bit of the pivot we’ve seen the best leaders now starting to make.
I think the leaders of tomorrow…recognize you have to play offense. Playing offense means you have a really bold vision on how sustainability and net-zero could be a way for you to really create value, compete differently, and frankly, reinvent your company.
I think there’s also something really important on measurement. Of course, there is greenwashing. Of course, there are people making commitments without a plan to get there. But I think the realization that people will be held accountable—that companies and leaders will be held accountable—is important. And so, this notion of really understanding how we actually trace carbon, how we measure the progress against the net-zero trajectory is really important.
The last thing that was really front and center for leaders is the whole talent and people side of net-zero. To some extent, I think companies are realizing it’s important to have a narrative with an investor, and it’s really important to have an internal narrative with your employees. I think the younger generation coming to the workforce cares about this topic dearly and wants this topic to be part of the purpose of any institution, any company. To some extent, we at McKinsey have actually learned that’s the reason. We said we want to create this new client service growth platform focused on sustainability, and that’s the place we’re going to make the majority of our investments. We are also taking an enormous amount of feedback from our younger colleagues on how we want to be the biggest force for decarbonization in the private sector. That’s just our example, but I think every leader is now realizing there is an important talent and people consideration, and frankly, how leaders will take their companies or institutions to net-zero.
One of the reflections, and that is perhaps more in the category of the unsolved problems from COP26, is the north and south divide. I’m not sure I like that term, but it’s perhaps more about how we are going to manage a transition; a transition that should be orderly, just, and inclusive, and realizing that we got really upset with what happened on coal. I think coal is a good example—we had this discussion in one of our sessions with a few asset managers and leaders and realized that some countries don’t have an alternative right now. The question is, how? We talked about $3 to $5 trillion a year, so $100 to $150 trillion over 30 years—how are we going to help if you want emerging market countries to finance this transition? This will only work if we have a new level of collaboration globally.
One of the executives in the session in Glasgow talked about how we almost need to reinvent institutions like the World Bank, and it has to be all focused on a common or global market for carbon, where pluses and minuses globally are being accounted for. Frankly, we also need a global market for nature-based resources, so people and those providing offsets can get compensated for it. And then we also need a way to reallocate a bit like how the Marshall Plan did after the Second World War; a way to reallocate capital from the developed world to the developing world. I think that is the piece that has really not been solved. I think it’s more difficult given the geopolitical tensions in today’s world, but it will have to be solved. Otherwise, it’s going to be very difficult for us to get our planet to net-zero in an orderly, just, and inclusive transition—which I think is really critical if we want to achieve net-zero targets.
Rajat Gupta: I think in addition to my last question, and this is to you, Jonathan, is what are your messages to Asian leaders? What action should they be taking?
Jonathan Woetzel: Well, climate is definitely now on the agenda, so what do we do about it? I think we could chart out a nice, neat process, but we should start with the idea of understanding climate science—this is definitely a crash course for management and understanding a relatively new science. So, getting to grips with where the company is vis-à-vis climate science, having the capabilities in-house to allow an estimation of the risk that it’s taking, whether it’s the physical risk or the transition risk—this is the first step.
With that we can take the next step, which is to start to define things. What is going to be our contribution? What’s our strategy? How are we going to meet expectations? And how do we balance growth with the need to manage operations for sustainability and stability? That’s definitely a big boardroom conversation, but one which ultimately leads to the next step of embedding that conversation at every level of the organization. We know that transformations, particularly operational ones, require buy-in from across the organization; a tremendous amount of bottom-up mobilization is needed.
One of the things climate does is it actually goes beyond that; it’s not only top down, it’s also bottom up. It’s even more inside-out as engaging the entire ecosystem is really the only way one can address issues like the scope three emissions—what is one supply chain actually doing? This creates a third big challenge, which is to sort of embed the thinking not only within the company at lower levels, but beyond the company, with their customers and with the supply chain.
Then finally, that naturally leads to engagement. We have to engage outside of the company to have the conversation with stakeholders across the country. Because in many ways, this transition does require a whole of society effort, and business needs a voice, business needs a seat at the table. So, those are the four aspects: mapping, defining, embedding, and engaging. They can come in any order, but we need all of them.
Rajat Gupta: Thank you, Jonathan. This has been a fascinating conversation. Let me outline the three takeaways that I have from this. First and foremost, it sounds to me that the last year or two and culminating in COP, the nature of the problem has shifted from no longer being what to do, but how to get it done. The direction has clearly been set. I think the second takeaway for me is that Asia is a part of the problem, if not in the past, then certainly in the future as Asia develops. And it has to be a part of the solution. The third takeaway is this is a period of huge uncertainty for all kinds of leaders, including business leaders, and they have to be able to define their path forward in this period of uncertainty for their countries, for their regions, and for their companies. Leadership will be crucial.
Gautam Kumra: You have been listening to the Future of Asia Podcast by McKinsey and Company. To learn more about McKinsey, our people, our latest thinking, visit us at mck.co/foa or find us on LinkedIn, Twitter, Facebook, and Instagram.