Decarbonization: The new frontier for investment and innovation

| Interview

McKinsey’s recent conversations with Dr. Andrew Steer, president and CEO at the Bezos Earth Fund, and Dr. Jang Ping Thia, lead economist at the Asian Infrastructure Investment Bank (AIIB) respectively, illuminated the importance of collaboration and the sharing of a collective vision in achieving decarbonization. Mindset, industry collaboration, and communication are key to moving Asia forward to net zero.

Dr. Andrew Steer

McKinsey: What do you see as the top three challenges in Asia’s transition towards net zero?

Andrew Steer: Perhaps the most important is a mindset challenge. It’s grappling with and understanding the new economics of decarbonization. The second challenge relates to whether there’s a plan and a collective vision led by the government, the citizens, and the corporations of the country in question. The third challenge is dealing with the fact that while a country as a whole will benefit from moving toward net zero, some vested interests will understandably fight against it.

The economics of even up to ten years ago was really an economics of trade-off. It was believed that if we did address climate change, there’d be gains to be had down the road—ten, 20, 40 years from now; but in the short term, there would be costs in terms of jobs, competitiveness, and dynamism in the economy. We now have a new economics where the best economists in the world are showing that smart, bold action on climate change leads to more economic efficiency: we use resources better; it drives new technology, lowers risks, and reshapes expectations about the future. Those four things together are powerful drivers of dynamism in the economy.

That message is not yet intuitive to many politicians and even some businesspeople, but it’s starting to take root in some parts of the world. We see it when President Xi Jinping says, “Green is the new gold.” When Prime Minister Modi comes into power, instead of accepting his previous government’s goal of 20 gigawatts of solar, he says, “No, let’s go to 100 gigawatts.”

He’s saying that because he understands the new economy: that if you do things incrementally, you won’t get that boost. You have to do things disruptively. That then creates a shift in expectations. Entrepreneurs say, “I see, there’s a new industry here. There’s a brand new world out there, therefore I will invest in it.” There’s a revolution that’s just beginning in economics. Asia, to some extent, is at the forefront of this.

McKinsey: What role have you seen corporations and investors play in this revolution?

Andrew Steer: One of the exciting things that’s happened in the last few years is that leading corporations haven’t waited for governments to paint that glorious vision with perfect policies. The best way that a corporation can help is not only to be willing to put its own risk capital on the line, but to engage with others on a pre-competitive journey. There are now new multi-stakeholder groups, the Mission Possible Partnership for example, that say, “Let’s take seven hard-to-abate sectors, like steel, shipping, aviation … Let’s ask what it would take to decarbonize those.”

If you get the leading steel producers, cement producers, and shipping organizations together, all of them will need new sources of energy. If someone’s going to put $2 billion into a green hydrogen plant, they need to know that other serious stakeholders are committed. And if you have a group that’s ready to come alongside those investors, you can talk to governments and say, "We need the right kind of confidence in policies, and we need some de-risking in the short term.”

What emerges is an ambition loop, when you have an ambitious leader who can only do so much on her own, so you put her together with 20 other leaders in both a horizontal and vertical sense. That way, you can change the world and you can change government policy. What government doesn’t want to join in when the corporate sector is saying, “Hey, this could work for us, this can actually be good for our long-term profitability and jobs”? Government responds to this, and we’re starting to see it in some exciting areas.

Indonesia is in the lead-up to G20; they’ll be hosting the ASEAN Conference next year to champion the idea of decommissioning coal plants or transforming coal plants into plants that are fueled by novel, cheaper, renewable energy. That cannot be done just by government, nor by any individual set; it’s a jigsaw puzzle. And what’s happening in Indonesia, where different players are wanting to be part of a solution to decarbonize, is quite exciting. It’s not easy; it only works if you have all the key players taking their own flags down and working as a team to drive monumental change.

Double exposure of trees and buildings - stock photo

Shapers of Sustainability

McKinsey: How does the mechanics of blended finance help to encourage these partnerships that cut across public and private sectors, and balance the risk-return trade-offs to mobilize even more capital into decarbonization?

Andrew Steer: In its early days, when risks seemed high, it was very unlikely that individual financial institutions could solve the problem. Blended finance can now bring different financial players to the financial stack.

A part of that is de-risking. It’s important when you consider, for example, the role of philanthropy in blended finance—which is not just to take a piece of that stack and the first loss or the direct-cash subsidy. It’s to play a role upfront as well because philanthropists can act more quickly. They can take much bigger risks. They don’t expect a return to themselves; they expect to return to the world. They can finance early work, political lobbying, and elements of the overall package that are required to put things in place. They could also finance accountability and monitoring, because there’s too much greenwashing in all of this, of course. The multilateral institutions can also play the role of honest broker, supporting the good governments that are wanting to make change.

Dr. Jang Ping Thia

McKinsey: What do you see as the top three challenges in Asia’s transition towards zero?

Jang Ping Thia: A big challenge is the lack of state capacity to organize the economy and create the right regulations to facilitate a transition towards net zero. For example, if there is a large share of renewables in power generation, the complexity that must be managed intensifies. Renewables activated by companies originate in different regions and different time zones, with intermittency, which has to be matched against fluctuating demand. There is a need to have distributed technology to monitor and to curtail demand. Governments also must invest in nascent battery technology.

Solar-energy production in itself is not complex, nor is the production of wind power. Rather, the coordination across time zones, geography, demand, businesses and consumer households is complex compared to the more stable and familiar fossil-fuel energy-production processes. Governments are still reluctant to invest. Imagine you are policy makers in a developing economy: if you have trouble collecting and enforcing tariffs from households and businesses, pursuing renewable energy is going to be more challenging.

The second challenge is that at a macro level there is still a lack of consensus among citizens. The climate-change mission is very important, but we need to understand the historical context. Poorer citizens in developing economies shouldn’t have to take on a large transition burden. There is hence still a lack of supportive common interest and grassroots pressure to switch to net zero. Maybe this will change soon as climate change is increasingly felt on the local level, such as with more flooding. These early warning signals can create the groundswell that should incite policymakers into action.

The last thing that is really slowing the transition is the lack a realistic carbon price. This may be related to the second problem, a lack of political support. A carbon price fixes a few externalities. With a carbon price, there will be less fossil fuel use. You also create more incentives for local SMEs, local businesses, not just to conserve electricity but also to innovate business processes that will be greener and more productive. Without a carbon price the transformation pressure is still not sharp enough.

McKinsey: What can be done to increase transformational pressure and in particular to mobilize capital into this transition—from a private or a public perspective?

Jang Ping Thia: On a social level, citizens of developing countries see the effects of climate change. That itself is a source of pressure on politics and policies. What governments can do is to improve the credibility and the articulation of a long-term transition plan. Businesses and citizens are waiting for that.

For example, if you are uncertain whether the government is going to roll out charging infrastructure, you will be very reluctant to change to electric vehicles. And if businesses or consumers are very reluctant to switch to electric vehicles, then the battery makers will have less incentive to invest in capacity. If the battery makers face uncertainty about the market, the suppliers of battery components will also have less incentive to invest. Hence, without the government organizing and optimizing across the entire value chain, each player is just seeing a small piece of action, with a lot of uncertainties. If one can organize the entire chain, the entire private sector will help to accelerate the process.

Carbon pricing will keep coming back as a source of pressure that drives change. When inflation is so high, it’s very difficult for governments to talk about carbon pricing. However, governments must approach it with a multiyear plan. Maybe governments don’t have carbon pricing today—but talk about it and create awareness. After a few years, we could come to a steeper carbon price and commit to that kind of credible trajectory in the future. It’s no different from central banking, where you have to create credibility around a monetary policy. Likewise, you have to create credibility around official policy; with that you can move the entire market with you.

McKinsey: Could you share some perspective on which sectors you feel would be most impacted or accelerated in terms of achieving transition through blended finance?

Jang Ping Thia: Blended finance is limited in supply and cannot meet all transition needs. Where I think blended finance can play a critical role is in the area of social projects or infrastructure with large social impact. For example, monetizing flood-control measures is challenging. In a simplified model, you would need some kind of blended finance to work with the government and municipalities in order to bring about more such infrastructure.

Nascent technology is another area where blended finance can have an impact. For example, if a country has no experience in installing batteries as a backup power source, blended finance would be needed to create a grant for project preparation or take in first loss, to make investment viable.

We should push transition in the private sector using a carbon price. I would target blended finance for more social-adaptation measures and nascent technologies that scale for the transition towards net zero.

Explore a career with us