Moving the needle on decarbonizing economies

In order to halt the trajectory of climate change, the single biggest task for the United Nations’ Conference of the Parties (COP28) in Dubai and beyond is to reverse the expansion of fossil fuels. Even as the global economy faces a “polycrisis,” it’s time to deal with the governance and policy causes of the failure to decarbonize.

The continued addiction to carbon-intensive growth is dramatized by an underlying paradox of an abundant quantity and plummeting cost of solar energy coexisting with fossil fuels, whose share of global energy has been stuck at over 80% for decades. The explanation for this and the implication for reform lie in the subsidized dependency of production on fossil fuels, coupled with their oligopolistic markets.

The levelized cost of solar energy has never been so low—less than $0.05 per kilowatt-hour in U.S. power sales—yet it contributes less than 5% to the global electricity supply. Consumption of modern renewable energy, comprising solar, wind, hydro, and geothermal, has been rising steadily over the past decade, and yet it comprises only some 11% of total energy. Immediate market expectation of future profitability also seems to be on the side of fossil fuels relative to renewables. From a peak in January 2023, the S&P Global Clean Energy index has lost more than 30% in value, while the S&P500 Oil and Gas Exploration and Production is up by more than 12% since June.  Clean energy companies lose far more value than fossil fuel companies.

What begins to explain this paradox of sharply falling supply prices of renewables and rising profitability— actual and perceived —of fossil fuels is perverse valuation and pricing. Sound analysis would call for a tax on fossil fuels in view of their negative spillovers, especially in vast health and climate damage. But the reality is the opposite, one of subsidies for fossil fuels operating in oligopolistic markets. In the U.S., for example, the current pricing method for energy, in the absence of a carbon tax, is carbon agnostic at its core. It hides the risk of fossil fuels and the value of clean energy.

Consequently, the clean energy companies’ contribution in the U.S. to converting the grid infrastructure—where 70% of the equipment needs replacement, risking blackouts—is unduly stalled. Instead of buying up the low-priced clean energy companies, fossil fuel companies are doubling down on increasing greenhouse gas emissions at full price, with Chevron buying up Hess in a $53 billion all-stock transaction and Exxon striking a deal with shale producer Pioneer in an all-share purchase valued at $60 billion.

A key to reversing the enormous harm from carbon-intensive growth is a radical shift toward carbon pricing, including in the U.S., which has been a reluctant participant with only some degree of pricing in some states. Instead of the current COP28 language to “encourage pricing of all emissions,” an implementation trajectory needs to be set out for a unique and universal carbon price, showing the cost of emitting one ton of carbon. This price would be guided by the ICE Carbon Futures Index Family contract, as a weighted average of four cap-and-trade programs: Europe, California, the U.K., and Massachusetts. The futures contract could be expanded by rolling out Article 6 of the Paris Treaty.

Another obvious direction is slashing global fossil fuel subsidies which the IMF estimated at $7 trillion in 2022, equivalent to nearly 7.1% of global GDP. Explicit financial subsidies to the industry account for 18% of the total while implicit subsidies (enabling health and environmental damages) account for 82%. The IMF could identify the extent of these subsidies, by country, which then can be redirected by the countries—importantly toward accelerating decarbonization and dealing with domestic budget deficits.

Furthermore, a social cost-benefit analysis would come out on the side of halting further exploration of oil and gas beyond the $1 trillion level incurred in 2023. During the phase-out, it would be desirable for bank financing of new coal, gas, and oil exploration to be matched with a full capital weighting, i.e., every $1 of a bank loan will trigger $1 of equity. This exploration phase-out, together with full pricing of the carbon content of fossil fuels, should see a reversal of the energy mix from 80% fossil fuels and 20% nuclear and renewables to 90% renewable energy, including nuclear, and 10% fossil fuels by 2040.

Of great importance would also be amending the remit of central banks to help integrate non-monetary variables (planetary boundaries, climate findings, carbon stock and flow) into monetary policies. This is a matter of global governance, but one where COP28 and future climate conferences can be influential. An enhanced remit becomes essential to abate supply chain disruption risk, new inflation, and distressed-asset creation. It would help if global central banks monitored carbon price trends, with a minimum floor price adjusted to the remaining carbon reserve and informed by estimates of the damage from emissions.

Each of these steps faces stiff opposition from the strong fossil fuel lobby. Drawing on the experience with other crises, including pandemics and financial crises, it would help to have public opinion on the side of the reform. COP28 could lay out the unvarnished truth on fossil fuels, start a conversation on the urgency for reform, and help steer the planet toward a cleaner economy. Failing this, the summit will have left only a larger footprint than what it set out to reduce, accelerating planetary chaos.