Decoding decarbonisation

The high dependence on fossil fuels for revenue and GDP growth is impeding the transition to a low-carbon economy

The World Meteorological Organisation recently reported that the world was on track for an accelerated global temperature rise. Earth’s temperature would breach the 1.5 degrees Celsius level within the next 5 years, far earlier than the previously projected timeframe for the breach, 2033–2037. Accelerating the transition to a low-carbon economy is imperative for all nations.

Globally, stakeholders, from policymakers to investors, are increasingly recognising the risks of burning fossil fuels and their stranded assets for financial systems. The recent commitments of India’s Maharatna fossil fuel companies, NTPC and ONGC, to new investments in green energy align with the country’s renewable energy targets. However, the decarbonisation strategy appears to lower the ambition with “two-pronged” investments in new fossil fuel capacity as well. This seems counter-productive as renewable energy, particularly solar, is already less expensive than fossil fuel-based energy and is becoming more affordable each year. What is slowing down the transition given the long-term goals of decarbonisation?

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The main barriers are infrastructure considerations, social costs, revenue dependence, and investor interests. These barriers are likely to prompt investments in both the fossil fuel and renewable energy sectors in the near future. Over decades, the fossil fuel industry has built a vast infrastructure of power plants, pipelines, refineries, and distribution networks. Transitioning to renewable energy requires retrofitting this legacy infrastructure with significant investments and planning. Fossil fuels have historically provided reliable and dispatchable power, ensuring a consistent energy supply. In contrast, renewable energy sources like solar and wind are intermittent and require advanced energy storage and grid technologies to ensure reliability. In a 2023 report, the International Forum for Environment, Sustainability, and Technology estimates that the cost of setting up clean energy infrastructure in India could be $472 billion by 2050.

The social dimension of the transition presents its own set of challenges. A comprehensive analysis incorporating the social costs of environmental damage and climate change disasters reveals that fossil fuel-based energy is costlier than renewable alternatives. Despite this, investments in fossil fuel infrastructure continue given their short-term profitability, perceived market stability, the desire to prolong asset returns, and concerns over potential job losses from a rapid transition. However, this further contributes to the cost of transitioning to renewable energy.

According to the above-cited report, an abrupt coal phase-out in India could result in job losses for over five million people. However, by investing around $900 billion over the next 30 years, India can facilitate an inclusive transition to clean energy. Progress towards renewable energy can be hindered by political and regulatory support for fossil fuel projects influenced by vested interests and lobbying. The International Labour Organisation (ILO) is actively discussing the impact of transition speed on workers. A just transition necessitates fairness and equity, taking into account the effects on workers, communities, and vulnerable populations; it involves tackling social and economic challenges such as job displacement, retraining and reskilling, and addressing inequality.

Global climate change presents a challenge that requires international cooperation. Bridging the gaps between the West and the Global South is essential, particularly regarding issues of development and responsibility for accumulated emissions in the atmosphere. Contentious points revolve around the terms of international finance, whether in the form of loans or reparations. The Global South argues against further debt for climate transition, as the capital for such initiatives was predominantly generated through the industrialization of the Global North, which ironically contributed to shrinking everyone’s carbon budgets.

The investments made by government pension plans and sovereign wealth funds in fossil fuel companies present significant obstacles to divestment efforts. The financial implications necessitate alternative investment strategies for pension plans for long-term stability. For instance, the state-owned LIC, India’s largest insurer, has been increasing its holdings in Coal India. Like many global insurance giants with substantial investments in the top 50 coal companies, LIC had $5.6 billion invested in 2015. It has also made significant investments in other fossil fuel companies. The expectation of investment returns acts as a deterrent to a swift transition.

Governments rely on revenue from the fossil fuel industry. According to a 2023 report from the Just Transitions Research Centre at IIT Kanpur, “the Indian coal industry pays a myriad of taxes to the state and central governments, including royalty, GST, GST compensation, cess on coal, state sales tax, central sales tax, clean energy cess, and others. Presently, the government of India is highly dependent on the energy sector, with the central and state governments’ dependence being at 25% and 13% of their tax revenues, respectively. The coal industry is responsible for 10% and 2% of the central and state governments’ energy tax revenues, respectively.”

Additionally, divesting from fossil fuel companies listed on stock markets can cause market instability and affect investor trust. Among the top 10 most profitable companies in India in FY23, two state-owned fossil fuel extractive corporations, ONGC and Coal India, have a combined contribution of over 15% to the overall profitability. The Indian oil and gas industries command a market capitalization of over $275 billion, with relatively high PE ratios averaging 14.2. Notably, Coal India alone recently achieved a market capitalization exceeding $17 billion. Finance ministries around the world face this conflict of interest.

Policymakers must carefully navigate the transition while still meeting GDP growth targets. Natural resource rents, which represent the difference between global resource values and extraction costs, do not contribute to GDP as they reflect depletion rather than production. However, these rents influence GDP. A recent study published by Taneja and his co-authors in the Journal of Risk and Financial Management (2023) revealed that India’s total natural resource rents (NRR) from coal, oil, gas, minerals, and forest timber expressed as a ratio of its GDP yielded 2.9%. Notably, the study concluded that India’s NRR had a positive effect on its GDP. According to a World Bank report, coal rent in India constituted slightly over 0.7% of GDP in 2020, a significant portion of the NRR. The pressure to maintain GDP growth hampers the speed of the transition process.

To expedite the transition to net zero, a holistic approach is crucial, involving technological advancements, aligning investor metrics with social goals, and governance reforms to rebalance the systems. Despite formidable obstacles, the recent WMO alert underscores the urgent need for all nations to accelerate their net zero efforts.

(The writer is a former faculty at leading B-schools in India, Singapore, and the US. His recent book is ‘The Art & Science of Managing Externality.’)