Net zero in Colombia: Resisting the pull of a slow energy transition

Matt Huxham director, Sovereign Transition Risk, Climate Practice, at WTW, explains why for Colombia, delaying transition to net zero could cost the country more than $88 billion and what this means for fossil fuel producing countries worldwide.

In November 2021, at the COP26 climate conference in Glasgow, amidst a blizzard of announcements about enhanced climate ambition, the pledges made by the Colombian government helped the country position itself not only as a leader on climate action in Latin America, but globally.

Colombia would, in the space of nine years, reduce deforestation – historically the country’s largest source of greenhouse gas emissions – to “net zero”. The deforestation pledge was part of the country’s wider-ranging strategy to bring all greenhouse gas emissions to net zero by 2050.

Yet, Colombia’s current economic model is highly dependent on rents from extracting coal, oil and gas. Substantially reducing economic reliance on these sectors, which contributed 55% of exports in 2020, would be no small feat. If the country hopes to minimise the volatility and costs associated with a long-run decline of the global fossil fuel trade, it will need to start developing and implementing contingency plans in the current decade.

Geopolitics of the energy transition

In the months that followed COP26, Colombia continued to release more detail on its low carbon development plans, including roadmaps for hydrogen and offshore wind industries, the issuance of Latin America’s first local currency sovereign green bond, the launch of a green taxonomy aimed at both private and public spending, and a range of new financing arrangements with development partners. These moves have been the latest in a series of actions over the last few years aimed at kickstarting (and attracting investment in) accelerated Colombian decarbonisation, particularly in power generation.

Colombia has so far dedicated much more effort to the promotion of investment in new industries than it has to the question of transition – and ultimately wind-down – of existing industries, such as coal mining, which are currently a significant generator of export revenues, taxes and jobs.

Designing a plan for decarbonising Colombia’s steel or cement sectors is not just a question of understanding the relative costs and benefits of different technological options, but also recognising the changing nature of the global situation in which Colombia will be implementing its transition.

Colombia’s climate “vision” documents to-date seem optimistic about issues such as the long-run competitiveness of Colombian coal companies in Asian markets, as well as the potential for unconventional production to enable an upswing in Colombian hydrocarbon production and a return to self-sufficiency. Implicitly, these policies assume that Colombia will be able to meet its long-term goals without significant change to its economic model.

However, Colombia is not facing its transition challenges in a vacuum, rather it is planning a transition in a world where most other countries are pursuing a similar objective, albeit down different paths and at different speeds.

The challenge of scaling up to phase down

Given the risks posed by Colombia’s exposure to the global transition (external transition risks that Colombia has limited control over), a slow transition and eventual transformation of Colombia’s fossil fuel production and emissions-intensive industries may actually be a very risky choice, with implications for economic and financial stability. By contrast, an accelerated wind-down of carbon-intensive industries that is not matched by an accelerated scale-up of lower carbon industries of appropriate size could also weaken the country’s economy and threaten social consent in Colombia’s long-term transition goals.

A successful series of low carbon transition policies will therefore require a sophisticated and evolving attitude to downside risks and opportunities, a commitment to basing policy decisions on evidence about short- and long-term consequences, a generally proactive approach from policymakers and regulators, and a commitment to ensure that downside risk is not placed on those with limited capacity to bear it.

WTW, in partnership with the Centre for Sustainable Finance (CFS) of the Universidad de Los Andes (UniAndes) and support from the Agence Française de Développement (AFD), recently researched Colombia’s climate transition risks and opportunities, as well as developing a series of recommendations for how Colombian policymakers, central bankers, financial institutions and corporates could more effectively incorporate these risks and opportunities into their planning.

The two-year project revealed that if Colombian policymakers do not respond proactively to these risks, the country could face lost economic output of more than $88 billion (or 27% of 2019 GDP) between now and 2050 in a world that decarbonises in line with the Paris Agreement.

A business-as-usual approach could prove destabilising for the Colombian economy, with potential impacts including declining corporate profits, a weakening trade balance, falling tax revenues and rising public debt. This could put pressure on Colombia’s sovereign credit rating. These effects would increase the cost of Colombia’s climate mitigation and adaptation investments and cost many thousands of jobs.

According to our analysis, an accelerated transition of Colombia’s economic structure (including growth sectors with export potential, such as copper) to a low carbon base could create economic benefits that offset some of the projected decline. The economic benefits, however, may not accrue over the same timeframes, in the same locations and to the same economic groups as the downsides.

In cases where the costs of global and Colombian low carbon transitions could fall on places and economic groups with limited economic resilience (such as mining workers and local governments), our report recommends that Colombia’s government proactively provides economic and other support to ease the burden. This support could be funded by a combination of new domestic and international transition-related funding sources, such as “Just Energy Transition Partnerships”.

A transition to a low-carbon economy that replaces lost tax revenues and jobs is not only a big task for Colombia, but for all emerging economies in Latin America and worldwide that historically have funded development spending from the proceeds of coal, oil and gas extraction.

If the world limits global warming in line with the goal of the Paris Agreement, demand for these commodities on international markets will be substantially lower than producing countries expect. These external risks that countries have limited control over are too often forgotten as countries build transition plans. Greater international collaboration will be essential to ensure the benefits of a low-carbon transition are shared while supporting those set to lose out.