📉 The economics of decarbonisation

COP26 is just around the corner, and we broadly know what to expect: statements, targets, pledges. But what does the reality of decarbonising the planet actually look like – and how much will it cost?

This week’s guest on my podcast, Michele Della Vigna, has spent years working that out. Michele runs the Carbonomics research programme at Goldman Sachs, and has an absolute wealth of knowledge about the practical steps needed to wean the world off fossil fuels. The team uses a cost curve which helps in visualising the price of various emissions-reducing strategies. (Readers will recognise this as a version of the GHG abatement curve pioneered by McKinsey back for the 2007 Kyoto meeting.)

Talking to Michele was fascinating. We discussed everything from carbon capture and the future of Big Oil to nuclear fusion, and why a rigorous, international carbon market is essential to keeping global temperature rises to below 2°C (or even 1.5°C…).

🎧📚 Our full conversation and the transcript are available here.

💬 Comments are open for members of Exponential View.

The Big Idea

Michele’s research is all about making the intangible tangible. Take infrastructure investment. Michele and his team think that $56tn of global infrastructure investment will be necessary if we’re to achieve net-zero carbon emissions by 2050. That’s hard to understand in the abstract – but makes more sense if you think of it in terms of global GDP. In a scenario where average worldwide temperatures rise no more than 1.5°C, they think investment in decarbonisation will have to peak at about 2.3% of global GDP by the mid-2030s.

By 2036, in that scenario, worldwide spending on decarbonisation infrastructure would have to be about $1.9tn a year. But for that to happen, Michele says, regulation has to be clearer:

When I look at four carbon-intensive global sectors with uncertain future regulation, energy, shipping, materials and mining, we are seeing those industries reinvesting today 40% less than they've done in the last decade. This is a missed opportunity to mobilise profitably this capex towards that fifty-six trillion dollars opportunity. But the reason why it's not happening is that these companies don't know what the regulation will be for the future… They could try to go for a net-zero solution, but that's not profitable today and may not be profitable for many years to come. In doubt, they delay the investment.

Of course, the oil and gas sector faces serious pressure amid the push for decarbonisation. That’s apparent in the cost of capital for oil and gas projects relative to the cost of funding for renewable energy projects. Financial conditions are tighter for new fossil-fuel projects than for their green equivalents.

In other words, fossil fuel projects are becoming relatively less attractive, and that’s driving a huge shift toward greener power. More from Michele:

If I look back to ten years ago, whether a company was developing oil, gas or renewable power, the cost of capital was broadly similar, somewhere between 8-10%. We estimate that since then, the cost of capital for oil has risen to almost 20% for long-cycle developments, and for renewable power, it's fallen to between 3-5%. That is an extraordinary divergence in the cost of capital, which is what really is leading to this unprecedented shift in capital allocation, where renewable power will be the largest area of energy investment in the world this year for the first time in history.

One part of decarbonisation that fascinates me is the role that nascent technologies will play. I asked Michele how the progress of techniques that aren’t yet widely used – things like direct air carbon capture, green hydrogen, or grid-scale energy storage – could affect the path toward decarbonisation:

[W]e will be surprised by the extent of technological innovation the moment the right financial incentives are there. My sense is some of those [innovations] that you've mentioned will become in-the-money in a net-zero world. In the meantime, I think we know these technologies are not ready to be deployed in large-scale this decade, and that's why this decade the focus will be on other technologies that can be grown in scale, but it's important that we innovate on these frontier technologies so that they are ready when we need them, most likely in the 20s, 30s and 40s to reach affordable net-zero.

Michele and I also discuss:

• ⚫ How carbon markets are broken, and why fixing them is crucial [11.05]

• 🛢️ The role of big oil companies in decarbonising the economy [18.06]

• 🤝 What Michele expects to see at COP26 [42.37]

Listen to this, too

Back in December, I spoke to Jesper Brodin, CEO of Ingka Group, which runs IKEA. We discussed IKEA’s aim of becoming “climate positive” – that is, of reducing more greenhouse gas emissions than it emits – by 2030. We also discussed COP26, and the necessity of government action in shaping greener customer behaviours. The conversation sheds light on what it takes to decarbonise a $40bn multinational corporation, and clarifies how private and public bodies can work together to reach their climate goals. You can listen to that episode here.

Further Reading

‘Carbonomics: Five Themes of Progress for COP26’ – Goldman Sachs