Powering Net Zero Commitments

Creating A Low Carbon Economy Is Cheaper Than Climate Change Costs

Given the summer of wildfires, floods and extreme heat in Europe, the financial and human costs of climate change have become increasingly stark. The European Central Bank released a new report which reaffirms the stark consequences of inaction or delays on climate change.

Companies and banks in the eurozone risk financial instability and economic loss, according to the central bank, as it released the results of its first economy-wide climate stress test. The stress test is part of a major effort by policymakers to support the world’s transition to a net-zero carbon world.

More frequent and severe natural disasters could shrink the region’s economy by 10% by the end of the century. This is if no new climate change mitigation policies are introduced. By comparison, the cost of transition would only account for 2% of gross domestic product.

“The short-term costs of transition pale in comparison with the costs of unfettered climate change in the medium to long term,” the report published on Wednesday stated.

The European Central Bank utilised data collected from 1,600 banks and 2.3 million companies operating in the eurozone to analyse the impact of three outcomes on the economy.

The first sees an orderly transition which contains global warming to 1.5 degrees Celsius compared with the preindustrial era. The second is a “disorderly transition” in which countries delay action till 2030, causing them to make costly and abrupt changes to contain global warming to 2 degrees Celsius. The third is the hothouse world, which involves no further action to mitigate climate change, which would result in the costs from natural catastrophes being extremely high.

European Union nations have already agreed to lower their collective greenhouse gas emissions by 55% from 1990 levels by 2030, with a path of becoming carbon-neutral by 2050.

The European Central Bank has made climate change one of its major focuses, with an aim to influence financial regulation and monetary policy. However, it is still a hotly contested topic whether central banks should play an active role in tackling climate change through policies such as altering the composition of asset purchases to exclude oil companies.

In July, the European Central Bank justified incorporating climate change into its monetary policy framework by stating that  “climate change and the transition towards a more sustainable economy affect the outlook for price stability.”

Under the orderly transition path, eurozone companies would have less profitability, slightly more leverage and a higher risk of default over the next 4 or 5 years due to the costs of complying with green policies such as replacing technologies and carbon taxes. However, the benefits of the transition would kick in.

In comparison, the disorderly transition would cause a company’s profitability to drop more than 20% by 2050 and its probability of default could rise more than 2%. In the hothouse world where no climate action is taken, profitability would take a 40% hit and the probability of default would rise 6%.

Banks across the eurozone could have a similar exposure to the costs of transition, however, their exposure to physical risks can greatly vary, according to the report. In southern European nations such as Spain, Portugal and Greece, where the risk of extreme wildfires and heat waves are higher, climate change is a “major source of systemic risk”, the central bank was quoted saying.

As previously reported by The New York Times

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