Keeping 1.5°C alive: Credible policies and innovation can take us there

In the face of slow progress on decarbonisation and mounting climate research suggesting a pending climate catastrophe without faster efforts to reduce emissions, there has been a recent wave of calls to abandon the 1.5°C warming target all together. This is despite the economic research that increasingly suggests the economic transition to keep warming around 1.5°C is in fact achievable. So why do some people want to abandon the target? Principal Economist for Sustainable Investment Janos Hidi outlines two key drivers, unpacks what’s holding us back, and argues it’s ultimately not too late; credible real economy policies, commitment from the financial sector, and state subsidies to fuel innovation can take us there.

1. There is a significant net zero investment gap

In this latest report, the IPCC warns that we are heading for climate catastrophe if we do not reduce greenhouse gas emissions fast enough to keep global warming below 1.5°C. More warming could cause irreversible natural and economic damage. However, investment in decarbonisation, i.e. to replace fuels that release greenhouse gases into the atmosphere, is behind what is needed to keep warming at 1.5°C. This so-called net zero investment gap is quite significant and the current rate of annual investment needs to increase by three to six times over the next decade if we are to hit the 1.5°C target.

2. It’s ‘cheaper’ to prepare for the consequences

It is often said that the 1.5°C objective is considered unattainable, and scenarios used for long-term planning are being replaced by 2 – 2.5°C variants.

Given that the current level of warming is already at 1.1°C, and the concentration of greenhouse gases in the atmosphere is already high, it is indeed easy to imagine that we will overshoot the 1.5°C target, especially because, according to the International Energy Agency (IEA), we cannot afford additional fossil-based investments to keep under target.

No wonder some argue that we should rather focus on ‘preparing for the consequences’ of high warming rather than trying to avoid it. It is most likely that under the current regulatory and technological conditions the world is heading towards a warming level of 2.5-3.0°C, along with the associated catastrophic impact.

The 1.5°C target is not as costly as many people think

The 1.5°C target is not as costly as many people think. Only an additional annual investment of a few percent of GDP is needed to roll out the required decarbonisation solutions, 70 percent of which should be spent in the electricity sector (zero-emission power generation, grid expansion and enforcement, improving grid flexibility, including electricity storage solutions).

A significant part of these investments are recoverable, which bring benefits beyond lowering emissions:

• improved security of energy supply
• improved trade balances for oil-importing countries
• higher global employment (1.5°C scenarios suggest that more ‘green’ jobs will be created than non-green jobs lost)
• additional benefits of improved health and quality of life due to cleaner air

What’s holding us back?

The reason is market and institutional failure, because although it is clear that it would be cheaper to act quickly than to not act, the progress is still too slow. The required investments should be undertaken now, or the harmful consequences of inaction will be felt later and distributed around the world.

The fossil energy sector is benefiting from unpriced externalities and a competitive advantage from sunk costs of past investments which have been written off by now. In comparison, carbon-neutral solutions require new investments, new legislations, innovation, risk taking, and requires some behavioural changes, too. It will be a huge task to increase annual decarbonisation investments by 3-6 times in the coming years, when the associated returns – both financial and non-financial – are remote and uncertain.

So how can we achieve the 1.5°C target?

1. We need a credible real economy regulation so that investors face less uncertainty. These include ambitious short- and long-term targets for renewable energy production, energy efficiency improvements, electrification, decarbonisation of heavy industry, transport, and agriculture.
2. Targeted state subsidies can facilitate the development and the initial deployment of new technologies, including the mining and production of raw materials necessary for transition, the construction of charging infrastructure in transport, and the use of carbon capture and storage (CCS) solutions in industry.
3. There is also a need for commitment from the financial sector to achieve a carbon-neutral investment portfolio.

And how do we get there quickly?

What we can hope for, are favourable technological, political and economic breakthroughs that can push the system over positive tipping points, accelerating the transition.

A good example of passing through a positive political and economic tipping point is the war in Ukraine, which, though temporarily increased coal consumption in Europe, seems to have strengthened political and economic commitment towards renewables and electrification. These investments simultaneously improve energy independence, trade balance and can usher in the era of clean and cheap energy. Signs of such reinforced ambitions can be seen in the EU, the United States and China as well.

Similarly, technological positive tipping points have already been successfully reached by wind and solar power generation, which have become the cheapest options for new electricity generation in many parts of the world. In 2022 more investments were made in renewables, energy efficiency and other decarbonisation solutions than in fossil fuels.

Battery electric cars are currently approaching a similar tipping point, whereby initially strong regulatory pressure has accelerated innovation, early adoption helped reduce production costs, technical capabilities improved (such as EV range), the roll-out of charging infrastructure accelerated, and as a result consumers are now increasingly welcoming this new technology. We are now at a point where government subsidies can be reduced in some countries, while there is excess demand for electric cars globally. We may soon reach a point where electric cars and trucks will be the cost-effective choice for most buyers.

There are potential breakthrough affects in many other sectors, from agriculture to the cement and steel sectors, where the initial regulatory push, constant innovation and gradual market uptake of new technologies will lead to a tipping point where low carbon options will be the disruptive technologies that become the mainstream solution.

With the right regulatory support, these positive breakthroughs can be launched and accelerated, and in the process, a carbon-free economy can eventually be achieved at an accelerating pace without major economic shocks.

Janos Hidi – Sustainable Investment Manager