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Roadmap to net zero: Who will pay for the $3.5 trillion transition?

Dr Jonathan Woetzel, Senior Partner at McKinsey and Director McKinsey Global Institute, explains the way forward

Dr Jonathan Woetzel, Senior Partner at McKinsey and Director McKinsey Global Institute (MGI), has been instrumental in building McKinsey's China operations since he moved there in 1985.

He also leads McKinsey's Cities Special Initiative and is responsible for convening McKinsey's work with city, regional, and national authorities in more than 40 geographies around the world.

Khaleej Times spoke with Dr Woetzel on McKinsey's recent survey on the net-zero transition in 2050 and sustainability.

Edited excerpts from the interview:

The net-zero transition in 2050 will require an additional $3.5 (Dh12.86) trillion. Where will this money come from?

A key question arising from the net-zero transition is one of "who pays". Various aspects to consider include who provides the financing (for example, public versus private actors, and the mix of financing provided by developed and developing countries), how capital is raised (for example, debt versus equity, through taxes on companies or consumers), and various combinations thereof. For example, public financing can come through raising taxes on companies, carbon taxes, taxes on consumers, or through taking on debt, to name a few approaches. In deciding the optimal approach to financing the transition, stakeholders will need to consider three factors. First, which approach would raise capital at the speed and scale needed and incentivise the deployment of this capital. Second, how financing can best include principles of equity, including what equity would require based on the history of emissions and who has the ability to pay. And finally, what are the broader knock-on consequences of different financing approaches. The latter is especially important because it can profoundly influence the socioeconomic consequences of a net-zero transition. First, some ways of raising capital — for example, taxes on consumers — could curtail spending in other parts of the economy if not balanced, for example, with fiscal stimulus elsewhere. This, in turn, could have knock-on effects on corporate revenues for affected sectors, on job creation, and on growth more broadly. Second, the source of financing could exacerbate existing inequalities if not carefully managed. Developing countries, for example, may find it challenging to raise the capital needed for the transition on their own. Third, the type of financing could have a role in influencing the pace of the net-zero transition. Certain technologies, such as electric vehicle (EV) charging infrastructure, may require public financing at scale to reach the speed of deployment needed to achieve net-zero.

What are the six characteristics that define the net-zero transition?

The transition to net-zero will be 1) Universal, 2) Significant, 3) Front-loaded, 4) Uneven, 5) Exposed to risk, 6) Rich in opportunity.

How can the transition be universal as the biggest challenge is decarbonise the world order?

As all seven major energy and land-use systems contribute meaningfully to global GHG emissions, the world will only reach net-zero if each and every one of these systems decarbonise. Countries and sectors participate in the systems across global supply chains. Thus, the transition would also impact every sector and every country around the world, directly or indirectly.

How can countries look at extensive labour reallocations and economic transformations?

Countries will need to consider social support and compensating mechanisms as job shifts are likely to be uneven across sectors and regions of the economy. Governments can support vulnerable stakeholders by Instituting reskilling, redeployment, and social support programs for workers and managing negative effects on lower-income consumers. Governments have various options when it comes to retraining workers for the jobs needed in a low-carbon economy, ensuring that new entrants into the workforce have appropriate skills, and supporting workers who are making job transitions. The Scottish government, for example, worked with the national skills agency to retrain and reskill oil and gas workers after the closure of a number of facilities in the sector—enabling 89 per cent of participants to find new jobs. Social support programs can also assist displaced workers. Similarly, governments can play a role in supporting lower-income consumers, for example, via subsidies or managing energy price increases. Enabling institutions can also support workers in these shifts by elevating risks and opportunities for workers and communities. Civil-society institutions can help integrate the voices of affected communities into decision making.

How can the expenditures be front-loaded?

Spending on physical assets would need to rise to almost 9 per cent of gross domestic product (GDP) between 2026 and 2030 from about 7 per cent today before falling. This front-loading is in large part driven by the need to build out low-emissions power infrastructure in the early years of the transition.

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It is highly likely that the impact will be unevenly distributed among sectors, geographies and communities. How to strike a middle path as disruptions in world economies loom large?

As we describe in the research, it is important to approach the transition in a spirit of collaboration to address the uneven effects of the transition. Moreover, all groups must also consider their opportunities from a net-zero transition (for example, new industries that are created).

What are the primary calls to action for the stakeholders?

This research aims to highlight the nature and magnitude of the economic transformation that a net-zero transition would require. While the challenges ahead are large, the findings of this research should be seen for what they are: a call for more thoughtful, decisive, and urgent action to secure a more orderly transition to net-zero emissions by 2050. Everyone would have a role to play, including governments, businesses, and individuals. To ease stakeholders' adjustments to these effects, governments and businesses will likely need to adopt a long-term perspective and coordinate action in a spirit of unity, resolve, and cooperation and, at the same time, take near-term actions to manage their own risks and capture opportunities.

What decisive action can the UAE take to mitigate these challenges?

Our research does not take a policy stand for countries. However, we describe a four-part agenda for countries to consider: the decarbonisation actions and the investments they would need to make towards net-zero, managing the exposure of their economies to shifts under a net-zero transition, seeking to capture transition opportunities, and addressing physical risks that are "locked in". For example, the UAE would have one of the highest solar energy potentials in the world. They also have a relatively high level of science, technology, engineering and mathematics (STEM) graduates (more than 20 per cent), which could allow them to capture new opportunities in the net-zero transition.

What about other Gulf Cooperation Council (CCC) nations, which are largely oil-dependent economies?

For the countries with higher shares of fossil-fuel production in particular, various challenges could exist: the potential loss of government revenues from exposed sectors, the reallocation of capital spending from high- to low-emissions assets, and the potential need to diversify their economies. Many countries could also experience rising physical risks; countries in this grouping that are near the equator will become hotter and more humid as warming increases. At the same time, a net-zero transition offers opportunities that these countries can tap into, though capturing them and sufficiently compensating for the loss in revenues and exports could also come with challenges. They generally have high solar-power or win-power potential, which they could use to develop capacity for renewable-energy generation and make green hydrogen. Some fossil fuel producers, for example, those in the Middle East, also have relatively low levels of carbon intensity associated with their oil and gas extraction and have relatively lower costs; thus, they could be the last standing providers of the remaining fossil fuels needed in a net-zero economy, in the scenario modelled in our research.

What are the growth opportunities as decarbonisation creates efficiency and opens up markets for low-emission products and services?

There will be opportunities for developing low-emissions products and processes that replace established high-emissions options. For example, carmakers might produce EVs instead of internal combustion engine (ICE) vehicles. Steelmakers can implement low-carbon production processes such as direct reduced iron–electric arc furnaces (DRI-EAF) powered by green hydrogen. Utilities might set up wind or solar farms to generate renewable electricity, while energy companies could introduce biofuels and hydrogen. Inputs, physical capital, infrastructure, and support services will also be important. New offerings will be needed to support production in new markets and low-emission product categories. These offerings include inputs such as lithium and cobalt for battery manufacturing, physical capital such as solar panels and batteries, and infrastructures such as EV charging stations and hydrogen refuelling stations. Technical services such as forest management, engineering and design, and power-system integration will help with the management of low-carbon assets. Services such as financing, risk management, certification. All of this creates opportunities for companies and for countries. As the world looks to build an entirely new net-zero economy, countries can consider how their endowments of natural, human, technological, and physical capital can position them well to capture entirely new opportunities. Countries should therefore take a broad view of areas in which they can invest and compete.

joydeep@khaleejtimes.com