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COP-26 – the underlying levers and why a just transition is a pre-condition for success

There have been quite a lot of speculations about what the 26th UN Climate Change Conference of Parties at Glasgow may achieve this November. With the current global average temperature already at 1.1 C above pre-industrial levels, this global summit is of extraordinary importance for two primary reasons: (i) this is the first global climate summit since the Paris Agreement when the current national targets set by the signatories of the Paris Agreement will be negotiated and reviewed against global targets, and (ii) this may be one of the last opportunities for the signatories to collectively agree and commit to a change in course to limit the global warming to the Paris target of 1.5 C.

Our ESG Base research team looked at the role of the main underlying levers like NDCs, policies, and market forces that will need to work in sync to drive the transition towards Paris targets, and discussed why progress may be deterred in the absence of a just transition.

The role of NDCs, policies and market forces in the transition

Although the primary lever to be negotiated at Glasgow is the NDC (Nationally Determined Contribution) target, it is important to look more holistically at NDCs and policies when reviewing the current positions of the Paris signatories.

NDCs represent the individual targets set by each country to reduce national emissions and adapt to the goals of the Paris agreement. The collective NDCs of all signatories provide an indication of the global emissions reduction that is being targeted.

Policies represent the efforts toward the targets – each signatory’s policies embody the detailed plan that the signatory has put in place to achieve its own NDC target. Policies are where the rubber meets the road in stimulating the transition.

As the Paris signatories make earnest effort to meet their NDC targets, the effects of the policies are expected to converge to the NDC targets. This wouldn’t necessarily be the case if market forces by themselves could lead to a greater degree of emissions reduction than what the policies mandate. However, historically, we have seen that polices have been highly instrumental in shaping the market forces to act on emission reductions, rather than the other way round. The policy-led shaping of market forces has primarily been required because of the high switching costs associated with the transition to low-emissions infrastructure. Although several low emission technologies are now highly competitive with the incumbent high emission technologies, the switching costs have acted as barriers to deep transition, especially where policies have not stepped in sufficiently to remove the barriers.

The policy maker’s dilemma: When the current national economy is heavily dependent on high emissions activities, such as in China, the USA, India, Germany, etc., the policy makers find it difficult to make drastic changes in policies. The risk of displacing large workforces from their current economic activities is a big concern as policies to phase out current activities and initiate new ones are developed. In theory, the displaced workforces can be retrained and redeployed to the new economy, but the policy makers seldom have a budget to pay for the cost. This problem can be resolved if the for-profit sector, which would arguably be the beneficiaries of the retraining, finance the retraining. But often given the short-term outlook of corporate entities, the corporate sector recognises little incentive to capture the long term value that such investments in communities would create.

It is reasonable to assume that, at least in the current decade, policies will need to continue playing a key role in encouraging the market forces to execute the transition toward the NDC targets. As a corollary, a gap between NDC and policy targets may indicate a lack of commitment in the signatory to meet its own NDC target.

As of today, significant improvements in both the NDC targets and policies are required to meet the goals of the Paris agreement and avoid severe effects of climate change. Much of the dialogue at COP-26 will revolve around renegotiating and updating the collective NDC commitments closer to the Paris targets. Once the NDCs are set, post COP-26 the dialogues would shift more toward keeping the signatories accountable to implement national policies that converge with the NDC commitments.

Current NDC targets and policies barely make a dent in reaching the goals of the Paris agreement.

(Courtesy: Climate Action Tracker (adapted))

Why just transition is a pre-condition

Ensuring equity at different levels is a pre-condition for a successful transition. This is because inequities during transition can potentially derail the entire transition process. Below are examples of some scenarios that highlight this point.

The high switching cost of low emissions infrastructure presents a complex dynamic between the nations that must be dealt with during COP-26. In a highly connected global economy, the signatory nations that compete with other nations on production using high emissions infrastructures may face cost disadvantage if they pay for the switching cost of transitioning to low emissions infrastructure, while their competitor does not. This dynamic presents the unfortunate situation where a do-nothing or a do-little decision may create more favourable odds for gaining competitive advantage.

It is now well understood that the adverse effects of climate change will be felt disproportionately more in Asia and Africa, where many of the nations may be financially less equipped to deal with the effects. At the same time, nations that are likely to face less adverse effects may have less economic incentive to deal with the problem. In reality though, in an increasingly connected world, the slowdown of even a handful number of economies can cause a major slowdown of the global economy, including that of the countries where the direct effect of climate change may be relatively small. Such a slowdown can easily deter the momentum of the transition.

The disastrous effects of climate change are expected to be more pronounced on the poorest and the most vulnerable communities and people in the effected regions. Such losses and sufferings can potentially undermine the role of the governments in protecting their citizens and can lead to social instabilities and migration crises, thereby shifting focus away from the transition.

These and other issues of potential unfair transition at different levels need to be addressed during the negotiations at COP-26 to ensure that an achievable transition toward Paris targets can be targeted. To create a level playing field for transition among the nations, important policy levers would need to be implemented globally in agreement among the nations. Some examples of these levers are:

  • Global phase-out of coal

  • Implementation of carbon tax

  • Uniform standards for carbon offset mechanism

  • Standards for protection of ecosystems / biodiversity

Similarly, financial commitments need to be strengthened to increase the resilience and adaptability of more adversely affected nations. One of the goals of the COP-26 is to further strengthen the commitments of the developed countries to mobilise at least $100bn in climate finance per year toward this target.

Furthermore, collective, and collaborative actions are needed to protect the poorest and the most vulnerable communities from the effects of climate change. A global summit such as COP-26 presents an ideal venue for initiating new collaborations among nations to address these challenges.

An uphill task

The negotiators clearly have an uphill task at COP-26. The complex interplay between NDCs, policies, and market forces in shaping the transition, and the need for just transition at different levels will make it challenging for the negotiators to achieve substantial breakthroughs at the conference. Furthermore, the current emission reduction targets of major economies such as China, India, Japan, Australia, Brazil, Saudi Arabia, Russia, are currently not aligned with the need to achieve net-zero emissions by 2050 – realignment of these targets will be difficult to achieve in the two weeks of the conference. The possible absence of top leadership from China and Russia may also limit the progress made in the conference.

Based on our analysis, it is unlikely that difficult objectives such as (i) aligning NDCs to Paris targets, or (ii) setting a global price on carbon will be achieved in the conference. However we expect that some of the relatively low-hanging fruits, such as (i) setting a deadline for phasing out coal, (ii) setting a target for reduction of methane emissions, may be achieved. Given the recent global economic slowdown from the effects of the pandemic, the commitment to mobilise more capital from developed countries than the current target of $100 billion may be hard to achieve. However, in any case, the COP-26 conference will create greater public awareness around the issues of climate change and will help accelerate the availability of private capital toward sustainable projects. The conference will also stimulate further discussions and negotiations to be held on the topic in future G-7 and G-20 meetings.

Discover sustainable and bankable projects

The effects of climate change are already being felt across the world, and the pressure from the public to address the adverse effects of climate change are looming large. COP-26 will certainly act as a catalysing agent as the supply of capital looking for sustainable projects continues to accelerate.

To help you discover projects with positive financial and ESG credentials, ESG Base have developed cloud-based digital capabilities which help perform objective bottom-up science-based analysis of projects and benchmark their bankability, ESG risks, and material impact.

Get in touch with us to find out more about our ESG Base platform capabilities.

Who we are

ESG Base is a global premium provider of technology and data solutions enabling ESG investments in real assets.

We are “making ESG alignment easy” by offering scalable technology solutions for fund managers, investors, policy makers, and corporate strategists to discover, analyze and monitor the best ESG aligned investments.

ESG Base is supported by London Business School, The University of Cambridge, Santander Bank, European Regional Development Fund, and is part of the G20 InfraChallenge building better, innovative and resilient infrastructure.

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