World needs to work towards orderly transition as other option remains unthinkable

The head of Climate Transition within broker WTW’s Climate Practice has said the world is  facing a significant challenge as it looks to avoid what has been termed an uncoordinated and misaligned transition to a low carbon future.

David Nelson was speaking to Emerging Risks after the broker said its research had concluded that there was still not enough understanding over the impact of an “uncoordinated and misaligned” transition.

He said there remained a view by some analysts that with appropriate and coordinated policy and market action, the net impact of climate transition on overall global economic growth could be negligible or even positive – albeit with substantial distributional effects between sectors and regions.

“We have seen models which have concluded that an organised and orderly transition would see no net economic and financial impact on the global economy,” he explained. “The view is that this organised transition to a low carbon economy would see a deliberate alignment between the phase out of existing high carbon assets alongside the deployment of low cost carbon free replacements.

“When we say there will be little or no impact on the global economy, there will clearly be those sectors and businesses which will be negatively affected, but the winners will balance out the losers.”

Nelson said that the energy industry was pivotal to the way the transition will need to be managed.

“If you take the oil industry. They will spend  billions drilling though often deep water and maybe two kilometres of rock, and you may or may not find hydrocarbons, and if you do you are selling those in a highly volatile market.

“Wind power is different. It is much lower risk and after the capital costs you are likely to see a return of 5% given the risk, while investors in oil may require a 15% return given the higher volatility.”

He added: “The total economic costs are the same, but as we transition there will be losers, OPEC for example.”

Nelson warned the world needed to understand the larger picture.

“The bigger problem would be a disorderly scenario,” he explained. “If we see a mismatch between the phase out of the old and the phaseout of the new.

“If we bring in renewable energy on time but continue to invest in oil and gas, the price of oil and gas will fall as the need for its decreases. The result would be the creation of a hole in which there will be trillions of dollars of stranded assets.

“If we phase out oil and gas too early or do not build the renewable capabilities fast enough, we create a shortage and that is likely to result in a rise in energy prices and with it the risk of unemployment and recession.”

When asked what governments and policymakers can do about the threat, Nelson said the solution was complex.

“Our models show the dangers of the situation which creates stranded assets is lower than the dangers that will be posed by shortages,” he replied. “Accelerating the build up of renewable energy capabilities is important. Energy firms are adapting their strategies to what is a volatile world. They are investing more short terms project such as fracking where the return can be delivered over two to three years.”

Nelson added a part of the solution may well be the creation of a similar system to the US strategic petroleum reserve.

It may also potentially require national governments to work with energy firms to increase or reduce output as a strategic part of the global transition and the effort to reduce energy volatility.

Governments face some harsh choices and the political will to drive organised transition may not be there.

“The issue we have is how do we explain this in a world of disinformation and distrust,” Nelson explained. “There will be geopolitical losers.”

He said the insurance industry has a role to be posited at the centre of the negotiations around transition and support the risk mitigation efforts. Secondly it will be required to help to create the tool which will support companies  to begin to manage the risks.

However, he warned the world was behind the curve when it came to the transition to a low carbon future on an orderly basis.

“In reality the strategies should have been implemented ion the late noughties, the volatility we see is getting worse. What we can now see there is a complete acceptance there is a transition was happening.”

However, Nelson  said that one of the biggest challenges in the transition is the human impact within the economy.

“We have seen in recent weeks two examples which highlight the issues we need to address,” he added. “We have seen at Tata Steel workers raising concerns over the loss of jobs due to the transition to low carbon steel. We have also seen the united auto workers looking at industrial actions due to a move to the manufacture of electric vehicles and automation which will result in job losses.

“Labour will need to be moved in this transition and we need to be clear on those movements and the way in which labour will be part of the transition.”