G20 disorderly transition all but inevitable: even climate-leading UK at risk

Out of the G20 economies the UK has made the most progress in tackling climate change, according to our new data. While on the surface this looks good for Downing Street ahead of COP26, the reality shown by our Carbon Policy Index is that the UK still lacks the regulatory framework to deliver on its commitments. This is bad news for markets and business. The G20 accounts for 80% of global emissions: if its best-performing member is struggling to meet its goals, then keeping the 2°C Paris Agreement target in sight will require widespread government intervention over the coming decade.

Major economies like the US, China, the UK, Germany and Japan will need to yank the handbrake on emissions to meet agreed climate goals – at the same time as dangerous rises in extreme weather events play an increasingly disruptive role in the global economy. These conditions will leave businesses in carbon-intense sectors facing the most disorderly of transitions to a low-carbon economy, with measures – such as restrictive emissions limits for factories, mandates for buying clean energy, and high levies on carbon – imposed with little warning.

80%

G20’s contribution to global emissions

The ability to identify where and when these changes will occur may help asset owners, managers and corporates offset some of the worst impacts of a poorly managed shift to a low-carbon world. And, with COP26 putting climate change front of mind for global governments, sovereign investors also have an opportunity to ramp up the pressure on laggards, and to influence leaders, in steering an energy transition that will only be more disruptive the longer it is delayed.

UK leading the low-carbon charge – but has more work to do

Figure 1 exposes the root causes of G20 countries’ underperformance since 2017 by picking out the three constituent pillars of our Sovereign Carbon Policy Index: the gap between current emissions and 2030 reduction goals; governments’ capacity and intent to introduce emissions mitigation policies; and a measure of each economy’s carbon intensity.

The UK is the standout success among the G20. Already well positioned in terms of policy by 2017 due to its Climate Change Act, the UK has closed the gap between its baseline emissions and its 2030 Paris Agreement target more than any other G20 country. Emissions have almost halved since 1990 due to industrial efficiency improvements and a near-total abandonment of coal that drives down carbon intensity.

But the UK can’t rest on its laurels. The new 78% emissions reduction target for 2035 effectively brings its 2050 goal 15 years forward. Yet, the UK’s current policies will not build the zero-carbon electricity, transport and heating infrastructure needed to achieve this goal, much less deliver carbon neutrality by 2050. Unless the UK starts to move legislation quickly it will need to rush through regulations later on, leaving business little time to adapt.

US, China – too little too late?

Even if the UK does manage to get back on track, it is the policy direction of the world’s carbon heavyweights that matters most to achieving the Paris target. China and the US have taken diverging paths since 2017, but neither is well placed to avoid a disorderly transition.

China has led the world in renewable energy investment, strengthened power plant emissions limits, and transformed a network of regional emissions trading schemes into the world’s largest carbon market. As a result, it is one of the few nations to move towards the upper right corner of the graph in Figure 1. This takes it past the US, where former President Trump rolled back limits for power plants, battled tailpipe emissions regulations, and gave up any pretence of complying with the Paris Agreement before ditching the accord.

But China continues to cling to high-carbon power sources and announced less ambitious goals in its latest Five Year Plan. The US re-entry into the climate arena under President Biden will put pressure on Beijing to increase its targets – or repeat its record of surpassing underwhelming targets, often achieved through abrupt factory closures that are hostile to investors and operators.

Neither China nor the US are well placed to avoid a disorderly transition.

However, significant political roadblocks stand in the way of Biden’s new 50% emissions goal for 2030 and plans for huge investments in renewable energy. Unless these barriers can be overcome soon, for the US to meet its targets will require harsh economy-wide interventions later in the decade, which would be near impossible under a future Republican administration.

European carbon agenda is best of the rest

EU emissions rival those of the US and China, but the bloc is trying to smooth the transition pathway by raising its 2030 emissions reduction goal to 55% and pumping out sustainable finance policies. Yet individually, the EU’s best G20 performers France and Germany lag behind the UK, and none of the bloc’s countries are insulated from a disorderly transition.

Elsewhere, Argentina’s framework climate change law, carbon tax and enhanced renewables policies moved it along the graph but have yet to impact its carbon intensity. India is starting to feel the impacts of industrial improvement and large-scale renewables programmes. Japan’s post-Fukushima embrace and subsequent rejection of coal has paid dividends, but its updated 46% 2030 target will require stronger policy measures and is not in line with Paris.

Sizeable fossil fuel exports, decentralised governance and confused national strategies are why Canada and Australia perform poorly. Oil and gas-dependent Russia and Saudi Arabia have targets so unambitious that achieving them is a near certainty, but this offers no protection from external pressure on exports or access to finance if they fail to improve.

Heavy emitters missing pandemic’s clean energy opportunity

Events of the last year have altered the climate dynamic for the worse. G20 countries’ COVID relief programmes are doubling down on fossil fuels rather than embracing the opportunity to kickstart low-carbon economies. As of April 2021, the G20 had pledged USD641 billion to energy sector recovery funding: Figure 2 shows 45% of this is directed to fossil fuels, compared to 38% towards clean energy. Continuing to finance high-carbon energy risks a rise in asset stranding as carbon restrictions tighten, creating real uncertainty for sovereign credit and a nation’s ability to raise finance for climate mitigation and adaptation measures.

Our data underscores that it is clear there is no longer any realistic chance of an orderly transition. Companies and investors across all asset classes must prepare for at best a disorderly transition and at worst a whiplash from a succession of rapid shifts in policy across a host of vulnerable sectors. And this doesn’t just apply to energy companies – transport, agriculture, logistics and mining operations must all work to identify the threats and opportunities a carbon-restricted future will open up for them. Tracking those countries and sectors most at risk will also enable asset managers to develop longer term climate hedges against what are still effectively unpriced risks.

Armed with this knowledge, sovereign debt investors in particular also have an opportunity to engage with policy-makers with the aim of both accelerating the low-carbon transition and reducing its fallout. Certain countries will be harder to engage with, but the clear case for avoiding political, economic and social upheaval should hit home, even in fossil fuel-reliant nations traditionally impervious to investor pressure. Individual investors are unlikely to have the heft to effect change, so a collective approach, similar to a sovereign-level Climate Action 100+, could be needed to build climate momentum in the short term. Similarly, it will increasingly be in the interests of leading corporates to steer rather than follow regulators through the transition.

What is clear is that the low-carbon transition is happening whether we like it or not. Governments, investors and corporates have just a few years to determine how smooth that passage is.