Economic Pulse – November

Listen to our experts Paul McConnell, Tara Schmidt and Jeavon Lolay explore some of the current key challenges facing business. 

  • Moderator: Today, we'll be looking at climate change and the energy crisis. Ahead of the COP27 summit in Egypt and following the extreme weather events witnessed around the world this year, we will discuss the key trends in current climate change and predictions for the future. Additionally, at a time when the developed world is beset by rising interest rates due to high inflation, in large part driven by higher energy and food prices, what are the potential implications for this defining challenge of the 21st century? We will also look at the transition away from fossil fuels, and the growing need for adaptation, as climate change already outstrips the ability for many countries to cope. Joining me for today's discussion are 2 climate change experts, Paul McConnell, Executive Director, Energy and Climate Scenarios at S&P Global, and Tara Schmidt, Head of Climate and Sustainability Strategy at Lloyds Bank Corporate and Institutional Banking. Moving first to you Paul, how has your thinking about the pace and scale of low carbon energy transition changed given the events of the last 12 months? And if you can please, can you share some insights from your latest climate work?

    Paul McConnell: Sure. Well, I think really over the last 12 months the big change has been the, sort of, re-emergence, if you like, of energy security as being a really fundamental challenge for countries to address. Of course, that's based off the war in Ukraine, and the responses to that that we've seen in commodity markets. What I think's really interesting is that energy security has, kind of, come up to sit with climate as a key concern. It hasn't really displaced climate. So, you've now got this, sort of, interesting tension between those 2 factors, and countries are trying to address that in different ways. In Europe, in mainland Europe, we've got a policy really to accelerate decarbonisation of the economy, and by doing so not only address climate issues, but also reduce demand for fossil fuels, and therefore dependence on imported energy. This tension is playing out in slightly different ways however in different parts of the world. I guess, in terms of what we've seen, you know, our thinking about the future relative to where we were 12 months ago, things are probably going to be a little bit messier in the short-term.

    We certainly expect to see more consumption of fossil fuels as countries really wrestle with this, you know, demand to maximise energy security, but longer term, we do think that the energy transition will probably accelerate, and countries will start to look at decarbonisation as a solution to solving their longer-term energy security challenges.

    Moderator: So still, hopefully back on track. Looking more specifically at the UK, Paul I appreciate that the government net zero review is still ongoing but, what do you expect to hear is a move away from decarbonisation a strategic goal, and is it possible in your opinion?

    Paul McConnell: Well, the UK has been on a very interesting trajectory for many, many years. Even when we were part of the EU we were leading on decarbonising. The carbon intensity of the UK economy has been going down for decades really. Net zero is a manifesto commitment for the current government, and it does enjoy a pretty broad support I think across the general public. If we were to see a General Election, and the government might change, then I think we would probably still see a commitment towards decarbonisation over the long-term. Any potential government would probably share the same goals. Now, you know, the actual, sort of, pace, and the mechanism of delivery of that may be subject to some change over time. I think ultimately this goal towards net zero, we do of course have a legally-binding net zero target here in the UK, I think that's probably pretty well fixed.

    Moderator: Thanks Paul. Tara, now over to you. Following on from Paul’s high level comments on the UK can you maybe add some detail on recent activity and trends? In particular, I'm keen to hear about how capital financial flows in the UK are supporting or hindering our ability to decarbonise, and also our ability to diversify towards a more resilient energy mix.

    Tara Schmidt: Thanks, Jeavon. Yes, I mean, we are seeing significant opportunities to decarbonise in the UK towards net zero, but obviously in light of current events we do know that there are also a number of challenges, as Paul rightly noted earlier. So, maybe just starting with some of the challenges. We have seen significant cost reductions in low-carbon technologies over the past decade globally, and also here in the UK, numbers like 60% to 80% cost reductions in technologies like renewables. We're also seeing an uptick in the cost over the last year due to issues around supply chain constraints, and thinking about critical minerals strategy here in the UK. So, costs are going up for off-shore wind turbines, and costs have been going up for demand response, as well as potentially heat pumps. The cost for net zero transition is also going to potentially continue to rise the longer we wait. We know that already as we think about a disorderly transition. The Committee on Climate Change estimates that we'll need around £50 billion a year by the end of this decade for the UK's transition, and the cost could increase by an additional £15 billion a year increasing cost of capital if we have a disorderly transition, for instance.

    We also know the cost of doing nothing is rising as well as we think about energy security, and how we can continue to diversify, and improve our resilient energy mix. We've seen investments in net zero technologies rise by roughly a third since 2016 for the UK, but investment has been limited primarily to renewables. So, really if we're going to address a number of these challenges within the UK, we're going to have to see that same type of growth that we've seen in renewables expand across our economy as we think about net zero, because we know that it will require an entire re-wiring of all of our sectors of the UK economy to get to net zero. That includes investment in technologies like heat, electrification of heat, or decarbonisation of heat, and electrification of transport.

    Moderator: Thanks Tara. So quite a bit of uncertainty there and significant hindrances potentially but, in your opinion, what opportunities could lie ahead for the UK to advance investment in transition? But obviously accepting that we also have other pressing issues at hand, such as energy security, cost of living, supply chain constraints. What are the opportunities?

    Tara Schmidt: Yes, thanks Jeavon. Well, I think as Paul mentioned earlier and when you were chatting, you know, we do have the UK net zero strategy that's currently under review. And I think the key focus is really thinking about all of these crises at hand, energy, security, the cost of living crisis and the supply chain constraints as I mentioned, but really looking at the net zero strategy as the economic benefits from that. So, really being able to address things like energy security as we continue to diversify our energy mix for instance. So, the UK net zero strategy is currently under review, due to be out basically at the end of Q1, early Q2 next year, which will hopefully provide, I think as the UK government has suggested, a more holistic financial ecosystem for enabling net zero. That will entail looking at things like how do we continue to upscale private sector investment across the UK economy, not just on the supply side but also on the demand side as we think about energy efficiency, as we think about the technologies that will electrify heat and electrify transport as I mentioned.

    The other aspects maybe just to bring out as well as we think about the global financial system and the key role that the UK will play, we did see from COP26 the launch of the Global Financial Alliance for Net Zero, in which Lloyds was a founding member, and we're continuing to see progress. There have been challenges with GFANZ, you know, with US regulation and so on, but certainly we are seeing a lot of developments around GFANZ, thinking about things like credible transition plans and working with financial institutions as well as corporate institutions around their net zero targets and real action around the targets on that. So, certainly we are seeing a lot of opportunities on how we could potentially advance investments into net zero.

    Moderator: Thank you Tara. That’s great to hear. As I’m sure both of you can appreciate, as an economist, professionally, this has been one of the most challenging years I can recall, in the last two decades. However, I’ve got to say I keep positive during my regular interactions with our clients has been, despite everything else that’s going on, as I just mentioned, their unwavering interest in climate change. So if I may, I want to put a few questions to you now. Some of the most frequent questions I get asked from my clients. So, really these are to both of you. Firstly, what are the key trigger points for success factors that would increase or decrease your confidence that we're on track to avoid the worst impacts of climate change, what do you think?

    Paul McConnell: Look, this is a great question, okay. We see a lot of uncertainty as you pointed out in the market, you know, with technology, with geo-politics, but let's think about some of the things which could accelerate the energy transition and therefore see that we're meeting this climate challenge. COP27, the follow on from COP26 in Glasgow last year, this may be challenged with some issues around loss and damage but we could yet see some progress. We could see more nationally-determined contributions, greater, more ambitious targets for countries to reduce their emissions. We've got the mid-terms in the US coming up, we've got a G20 summit. All of these policy components could accelerate or may potentially slow climate action. So, we really need to look at these things quite closely. But we also need to think about implementation, right? It's all well and good having a net zero strategy and we've talked a little bit today about the UK providing more detail early next year, but we really need to see some of these policies be put into place. We need to see that build-out of technology, we need to see some of this industrial transformation start to take hold. I think once we start seeing those building blocks, that capital moving towards low carbon, then I think we can be more confident that the energy transition is underway and these targets, 2.2 degrees, 1.5 may well still be within reach.

    Moderator: Anything to add Tara?

    Tara Schmidt: Yes, I guess just from the UK lens as well, just building upon that, I couldn't agree more with everything that Paul has already mentioned. I think within the UK, we have been thinking a lot about just transition, really excited to see what comes from COP27 and thinking about just transition. Here in the UK, when we think about the net zero targets we're also thinking about the regional regeneration lens, thinking about green jobs, impact and the opportunities but also the gaps that will need to be addressed on things like electrification of heat and the training requirements around that. I think ultimately when we talk about triggers and success factors, I think we need to ensure that it's a just transition if we're going to be able to achieve net zero. While we do need to advance investments in the net zero technologies, if we push too far ahead without a just transition lens we may never get there. I think that's one of the things that's quite exciting also about the net zero review here in the UK is thinking about the economic benefits of net zero, and certainly there are a number of opportunities in thinking about, you know, greening our industrial heartlands for instance and the opportunities that could potentially present in the UK economy.

    Moderator: Tara, when you say just transition, I hear this quite a bit, can you just give us a couple of sentences on what that means to our listeners?

    Tara Schmidt: Yes, so just transition is really thinking not only about the environmental aspects of getting to net zero and the technologies around that, but also the social implications. So, things like levelling up, I guess as some have called it previously, or thinking about regional development opportunities, thinking about jobs, but also thinking about the cost of living crisis and how do we ensure just transition is going to be an affordable and resilient transition as well.

    Moderator: Thank you. That makes a lot of sense. I am quite glad you brought the word affordable then. So, another question I get commonly at the moment is, this transition is going to require significant investments in energy and transport infrastructure. What are the implications of higher global interest rates to this outlook?

    Paul McConnell: Look, we've done some work on the investment required to deliver low carbon, to deliver net zero, and there is no question, it is expensive relative to a base case view of the future, where we don't see much of a transition, but you have to offset this, I think, against some of the costs of not doing anything that Tara has spoken to. One of the interesting things, however, that we found was that moving to a lower carbon pathway isn't actually that much more expensive. There’s a bit of redistribution of funds, and a bit of divestment from, or moving capital away from fossil fuels and towards clean tech. However, having said all that, when we did a lot of this work earlier in the year, we were in quite a different world. Lower interest rates, the spectrum of inflation hadn't really reared its head so much. We are being asked when we talk to our clients this exact question, 'How much is it going to cost? Is the transition feasible in a, kind of, higher cost of capital environment?' I think, the higher cost of capital applies, not only to clean tech, but also to fossil fuels as well. One thing we do, however, know is that financing, actually, could be easier for greener technologies, and things like green bonds are available in order to push forward some of these cleaner projects.

    We are, as I said earlier on with the European approach to decarbonise, we are starting to see more funding being available, we're starting to see the inflation reduction act in the US, for example, direct capital towards clean tech, specifically, and away from fossils. So, I think, the current environment that we're in now does make things a little bit more challenging, relative to where we were, maybe, 6 or 12 months ago, but I think again, thinking about some of the reduction in costs that Tara has spoken to, I think the pathway is still relatively promising.

    Tara Schmidt: Yes, and just to add to that Paul, specifically the point on ESG financing, we've seen significant growths in ESG financing, and I think we will continue to see that through this challenging environment. We've seen significant growth in green bonds, as Paul has mentioned, as well as sustainability bonds, and sustainability-linked bonds, green loans, and sustainability-linked lending as well. So, really, what that entails is thinking about discounted financing for net zero projects, and for corporations and institutions that are basically looking to align to the net zero transition, and providing them with discounted financing if they do achieve their sustainability targets. So, I think we will see continued growth in that over the coming years as part of the energy transition, particularly in the challenging environment around interest rates.

    Moderator: So, a lot of change I’m hearing. What should companies expect, and prepare for in the short, and medium term? What do you think are the key things that should be on decision makers’ minds?

    Paul McConnell: Well, from my perspective, the big thing coming up is the winter. Gas prices are relatively low, they're certainly a lot lower than they were at the end of August. Storage is looking quite healthy in Europe, we have a lot of supply, and the winter hasn't really kicked in yet. But we don't know how cold it's going to be, we don't know what the progress of the war in Ukraine will be like, and we don't know whether or not we'll have, it's quite conceivable that we could have another energy shock over the next few months. But once we've got through this winter, and into next spring, into next summer, then we've got, of course, the following winter to come, and things could be as difficult, if not more difficult. So, I think, you know, we need to be moving ahead with this transition. We need to start to see those investments deliver. We need to start to reduce our dependence on imported energy, such that we can start to insulate ourselves from some of this commodity, price volatility that we've seen in the last few months. So, I think, it's actually seeing that progress, that deliverability, that implementation, I think, is what we need to look for.

    Moderator: Thanks, Paul.

    Tara Schmidt: Just adding to that, I mean, I guess looking at the UK lens, I think the Bank of England has used the analogy of walking the net zero tightrope. And then if we think about, as Paul rightly notes, over the next few winters, we've got a number of challenges to think about. The cost of living crisis, the energy security issues, supply chain constraints, and I'm sure Jeavon, you would add many more from the economics perspective as well. But as we walk on that tightrope, I think we all know the future that we want. We want a more sustainable, resilient economy, and to be able to mitigate the worst impacts of climate change on walking that net zero tightrope. And I think, ultimately, what is driving that is companies thinking about credible transition plans, thinking about tangible actions they can take to address the short-term crisis, but also thinking about long term plans for opportunity and growth.

    I think the 1 last thing I note, from the Lloyds Bank perspective, is we are investing significantly in the net zero transition. We recently launched our sustainability and ESG finance team, which is the centre of excellence looking at everything from, basically, we have people that have very different backgrounds, not just banking, but management consultancy, strategists, accountants, lawyers, and engineers, that are looking at how we can support our clients on their net zero journeys. We are also investing significantly in our technical capabilities around these net zero technologies, with the aim to become the UK's bank of choice for energy transition. While there are significant challenges ahead around the net zero transition, we have a lot of optimism on what the future can hold for a sustainable and resilient economy.

    Moderator: Thanks, Tara. That’s been excellent. Paul and Tara, I am really grateful for your time today. It is a really complicated area, and both of you really help my understanding tremendously. Many thanks and I look forward to crossing paths again soon.

    To our audience, thank you very much today for taking the time to watch this episode of Economic Pulse. I hope you found the session insightful and useful. If you have any questions for your speakers, please use the mailbox on the screen to reach out and speak to you soon.

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