The European Union’s financial watchdog has warned of the risks of leaving the transition to a low-carbon economy until it’s too late.
The European Systemic Risk Board (ESRB), which was established in 2010 in the wake of the ongoing financial crisis, has released a report (PDF) investigating the risks associated with transitioning too late to a low-carbon economy. According to the ESRB, the situation is simple:
Keeping global warming below 2°C will require substantial reductions in global greenhouse gas emissions over the next few decades. To reduce emissions, economies must reduce their carbon intensity; given current technology, this implies a decisive shift away from fossil-fuel energy and related physical capital.
The ESRB present two scenarios: In its “benign scenario,” the transition to a low-carbon economy happens gradually, allowing for management adjustment costs, and meaning that the repricing of carbon assets probably doesn’t entail any systemic risk to investors. Sadly, the ESRB notes that, even in its benign scenario, “in the absence of additional policy intervention or technological breakthroughs, it is likely that the stock of greenhouse gases in the atmosphere would continue to grow over the medium term.”
The report itself, however, focuses primarily on the “adverse scenario,” in which “the transition to a low-carbon economy occurs late and abruptly.” The ESRB believes that such a late transition “could result in an abrupt implementation of quantity constraints on the use of carbon-intensive energy sources,” resulting in “correspondingly higher” transition costs.
With regards to the report’s focus on the systemic risk of a transition, the authors highlight three main channels the adverse scenario could affect systemic risk. First, any sudden transition away from fossil-fuel energy is likely to harm the country’s Gross Domestic Product (GDP) because alternative sources of energy will likely be restricted in supply and more expensive at the margin. Secondly, a sudden repricing of carbon-intensive assets, which are financed in large part by debt, could bring trouble. Third, a parallel increase in natural catastrophes related to climate change could raise general insurers’ and reinsurers’ liabilities.
The authors of the report believe that, “If governments make an early start in implementing existing pledges, a “soft landing” is likely.”
“The transition to a low-carbon economy would be gradual, allowing adequate time for the physical capital stock to be replenished and for technological progress to keep energy costs at reasonable levels.”
Obviously, “The adverse scenario for the EU financial system is one of late adjustment, resulting in a “hard landing”,” and would be “exacerbated by a lack of technological progress,” because they were not given the attention and investment and political backing they needed now, to affect changes later on.
The full report is available from the European Systemic Risk Board (PDF)
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