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The Cost to Achieve a Net-Zero Economy

This article is an analysis of McKinsey Report, The net-zero transition: what it would cost, what it could bring.

A lot of attention has been spared for the innovation required in a net-zero transition. Ground-breaking technologies, new supply chains, and the hunt for bigger and better renewable sources are clear headline winners in the global green journey.

But the economic and societal costs of the transition are as demanding, and more complex. Raising capital, managing risk/return trade-offs, driving capital flows to developing countries, and addressing the technological uncertainty of investment are the financial challenges faced by nations today.

It is true the transition needs to happen soon, but like everything, it comes at a cost. For the global community, how much exactly do we need to give up, to achieve the green agenda?

Upfront capital needed

In a report by McKinsey, the global consultancy outlined six characteristics of the net-zero transition and estimated that the front-loaded total capital spending on physical assets between 2021 and 2050 for the transition would amount to US$ 275 trillion.

This represents investment specifically on physical assets, such as new renewable power plants, grid upgrades, and other infrastructure and technology required to decarbonise assets. This figure does not yet include other adjustments – for example, the cost to reskill workers, create new economic sectors, and compensate for stranded assets.

It’s hard to put such a large figure into perspective, but consider this: ASEAN’s combined gross domestic product (GDP) in 2020 was US$3.08 trillion; it would take nearly 100 times that figure to deploy new, decarbonised assets by 2050.

At present, US$3.7 trillion—or 65% of total global spending—is channelled annually toward high-emissions assets, such as coal-fired power plants and vehicles with internal combustion engines. In the transition, about $1 trillion of that would need to be reallocated to low-emissions assets.

Most of the spending will happen in the first quarter of the century. It is estimated that spend would rise from 6.8% of the GDP today to as much as 8.8% over the next few years, before falling after 2030. The entire process demands appropriate financial tools and planning. As much as there is innovation in the technological arena today, similar creativity is needed in the financial space.

Economic sector disruptions

The cost of the transition also runs beyond the budget needed to deploy new assets. As key economic sectors are disrupted, the trickle-down effects will impact many jobs, families, and communities. Crucially, the transition will unevenly impact lower-income nations and countries with large fossil fuel economies. Myanmar, Laos, Cambodia, and Philippines, all have a significantly lower GDP per capita compared to neighbours Singapore, Brunei, and Malaysia.

Agriculture-based economies, like the Philippines, will need to adjust to low-carbon farming practices, which would require mobilising millions of grassroots stakeholders. Land-use intensive countries, like Malaysia, will have to balance the trade-off of land use for different sectors, for example, forestry and agriculture, which comprise a significant share of its GDP.

Emissions-intensive producers, like Indonesia, Thailand, and Vietnam are particularly exposed to asset stranding. These countries derive a large chunk of their GDP from high-emissions manufacturing, fossil fuel-based power, and agriculture.

Globally, fossil-fuel producers like coal giant Australia and oil king Saudi Arabia will also be exposed to lower revenue and risks involved with budget reallocation toward low-emissions assets. The effects do differ from each country; for example, Australia draws only 3% of its GDP from fossil fuels, while Qatar draws more than 30%.

Rising costs before the fall

Transitioning high-emission sectors will require strong planning and delicate balancing.

Production costs, reflected by changing operating costs and costs for asset depreciation and other new investments, will also shift. Those production costs, if passed on to consumers, will cause consumer goods’ prices to hike up.

In the steel and cement sectors for example, production costs, including operating costs, capital charges, and depreciation, could rise by about 30% and 45% respectively. These costs would include investments to install carbon capture and storage (CCS) equipment, create new processes, and shift to low-carbon fuels, such as hydrogen.

Mobility will also be disrupted. Perhaps one of the more welcomed disruptions, the transition to e-vehicles is one that many countries are preparing for. Across ASEAN, Singapore, Malaysia, Thailand, and Indonesia have all rolled out roadmaps to transition to e-mobility. Buildings, another carbon-emitting sector, also require carved out budgets to install energy efficient equipment and electric-powered heating and cooking furnishings.

In transitioning the power sector, the global average delivered cost of electricity is expected to increase before falling from their peak. McKinsey’s report estimates that costs would increase by about 25% by 2040, compared to current levels. These costs stem from investment needed to develop renewables and upgrade existing power grids. Additionally, some fossil-based power assets would continue to incur capital costs, even if they are underutilised or retired prematurely.

Today, these high-emissions sectors — power, mobility, industry, agriculture, and buildings — contribute to roughly 20% of global GDP. Transitioning those sectors will require strong planning and delicate balancing.

Jobs and the socio-economic impact

The transition could result in a gain of about 200 million and a loss of about 185 million direct and indirect jobs globally by 2050. Demand for jobs in carbon-intensive industries, such as fossil fuel extraction and production sectors and fossil-based power sectors, could fall by about 9 million and 4 million respectively. On the other hand, demand for about 8 million direct jobs would be created in renewable power, hydrogen, and biofuels by 2050.

Although the green transition will deliver a net growth in the amount of jobs, the labour force and locations where jobs are created or removed may not align, and as such, measures are needed to safeguard against the negative impacts of decarbonisation. Reskilling the workforce will be crucial, as will be creating robust protection mechanisms and platforms.

Who will pay for the transition?

Achieving the Net-Zero 2050 scenario that will limit global temperature rise at 1.5 degrees will require collective action, willpower, and cooperation from all stakeholders.

It remains to be seen whether these costs will be absorbed by the government, power company, or end user. If passed on to consumers, those costs might bear an unfair impact on lower-income communities.

With the majority of Southeast Asia still reliant on cheaper coal, gas, and oil – the transition to clean electricity and power presents a challenge. Much of the investment will be front-loaded, that is, it will be heavier in the early years.

There is no simple resolution to the energy trilemma: the three-pronged challenge to deliver affordable, equitable, and sustainable energy all at once. Governments are still unsure the long-term benefits of a transition warrants the short-term sacrifices demanded of citizens.

Despite the high spend needed, many of these investments yield high positive returns, and should not be viewed merely as costs. Countries are well-positioned to take advantage of existing natural resources such as wind, solar, and hydro, to continue powering future decades.

Ultimately, all parties must convene to take steps towards a carbon-zero future. Achieving the Net-Zero 2050 scenario that will limit global temperature rise at 1.5 degrees will require collective action, willpower, and cooperation from all stakeholders.

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