Climate change threats global development – what's the role of carbon pricing?

We know that the impacts of climate change have the potential to revert decades of efforts to end poverty. The most vulnerable have been – and will be increasingly – hit the hardest by droughts, floods, and more intense and frequent climate change-led disasters. Without urgent action, climate impacts could push more than 100 million people into poverty by 2030 already. Furthermore, risks posed by climate change permeate into broader areas, such as climate-led migration, infrastructure investments, and ultimately, global development.

Businesses and infrastructure investments will be inevitably impacted by climate change. Impacts will include: reduced revenues due to operational disruptions and decrease in business activities; increased maintenance costs of damaged infrastructure; shortening of assets‘ lifetime and decrease in value; and, as more infrastructure is damaged and regulations / technology standards evolve, a substantial increase in insurance premiums and retrofitting costs. As result, businesses indebtedness and need for additional capital will increase.

Given this scenario, financiers, insurance providers and investors are becoming more and more risk adverse to financial losses coming from increasingly frequent extreme weather events - making it more difficult to raise the long-term finance necessary to keep operations, test new technologies and update industrial parks.

Not surprisingly, extreme weather events, natural disasters and failure of climate-change mitigation and adaptation ranked in the top 5 risks for business leaders in the newest World Economic Forum report, as these are seen as complex risks that cascade through complex and interconnected systems, rather than conventional risks, easily isolated and managed with standard risk-management approaches. Once again, businesses in least developed economies might face skewed challenges, only accentuating existing global development inequality.

To address the global development risks posed by climate change, a major technological shift leading to a substantial reduction in the global greenhouse gas (GHG) emissions will be necessary. In parallel, the substantial global economic and development distortions - that lead to inequality-  do not enable the technological and financial transfers needed for a sustainable and equitable global economy. This brings us to a fundamental question:  when climate change only imposes an additional threat of unseen scale, how can we change the economic status-quo?

Global investment as high as US$2.7 trillion annually will be needed by 2030 and switching to a low-carbon economy will require an additional US$600 billion per year, or almost 1% of global GDP. These numbers largely surpass expected public expenditure available in a scenario of increasingly budget-constrained economies.

As we respond to that challenge, carbon pricing can play a crucial role in enabling the technological and financial transfer necessary to a low-carbon global economy. Back in 2012, carbon markets – mostly the Kyoto Protocol and the EU Emissions Trading System (ETS) – topped up US$176 billion in value or almost a third of the incremental investment needs suggested by 2030. On one side, only a portion of those resources resulted in technological and financial transfers to reduce GHG emissions (a large portion of the value came from secondary market transactions with market players aiming at cost hedging and/or arbitrage opportunities), on the other hand, compliance companies (over 11 thousand under the EU ETS alone) have significantly changed their business models, finding ways to reduce costs and increase revenues opportunities under the new economic environment. Also, financial institutions have developed tailored financial products, including sophisticated capital market and derivatives, to support the investment needs and innovation that came along the carbon market.

The main outcomes from those markets were that: (i) international cooperation to reduce emissions is possible (about 8 thousand emission reduction projects from all continents were registered under the Kyoto Protocol’s Clean Development Mechanism (CDM), while the single EU ETS covered GHG emissions from several sectors in 31 countries, representing about 45% of the block’s total emissions), and (ii) carbon markets can trigger swift response from private sector, who will ultimately lead the transition to a low-carbon economy.

As assessed in the World Bank's State and Trends of Carbon Pricing report, today, 47 carbon pricing mechanisms are implemented by 67 countries and subnational jurisdictions, who account for half of the global GDP. Combined, these mechanisms cover over 15% of global GHG emissions. The substantial increase in these mechanisms and in global GHG coverage (fourfold and threefold, respectively, in the past decade) corroborates that carbon pricing is no longer seen as a robust climate mechanism only, but also, it represents an efficient fiscal tool for governments to raise revenues, and it spurs technological innovation.

In light of the substantial investment needs for the transition to a low-carbon economy, carbon markets result in significant cost saving opportunities and the associated resource mobilization. With a global carbon market, nations seeking GHG emission reductions, have the flexibility to source these where it is most cost effective to do so (rather than within national borders). Under that scenario, cost saving opportunities can reach US$115 billion annually in 2030 and almost US$4 trillion in 2050.

While global carbon market addresses the urgency and the scale of the climate challenge in an effective manner, resulting resource flows around the globe will also allow for the technological and financial transfers needed to the reduce today’s global development inequality.

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Alexandre Kossoy

Senior Financial Specialist

Climate Change Group – World Bank

With over 25 years of experience, Mr. Alexandre Kossoy is engaged in the high-level political dialogue on climate policy with public and private sectors, mainly in Latin America. He has leading roles in the activities of the Carbon Pricing Leadership Coalition (CPLC) and Climate Action Peer Exchange (CAPE) in the region.

In addition, Alexandre has led the publication of the World Bank annual flagship report on climate and carbon pricing – State and Trends of Carbon Pricing – since 2010. Among other activities and responsibilities, he is a member of the advisory council in the Brazilian Emissions Trading System simulation, and he has been actively involved in the design and implementation of innovative financial instruments related to climate and carbon finance, including the World Bank carbon neutral program, the design of green and the carbon-linked bonds, and the structuring of carbon-guarantee products. 

Before joining the World Bank, Mr. Kossoy was in the private sector, working in a variety of positions for international private sector companies such as Rabobank, Pepsico, and Monsanto.   

Mr. Kossoy holds a Bachelor’s degree in Agricultural Engineering from the University of Sao Paulo and a Master’s degree in Environmental Engineering Sciences from the Israel Institute of Technology.