Abstract: Despite the agreement reached at COP27 on the establishment of a loss and damage fund, opinions on many climate issues remain divided. More in-depth research is needed to answer the following three questions. First, which is the best method for achieving net-zero emissions—central planning, market-based mechanisms, and/or corporate self-discipline? Second, how to balance energy supply and energy security during the transition of the power system? Third, how to ensure a fair and just low-carbon transition?
COP27 closed on November 20 with a breakthrough agreement to provide “l(fā)oss and damage” funding for vulnerable countries hit hard by climate disasters. It is an important manifestation of inclusive growth.
Progress was made at COP27 but fell short of expectations judging by the response from the media and the scientific community, reflecting varied and often conflicting concerns compounded by an increasingly complex international landscape.
Measures to deal with climate change are still under study. Although a certain degree of consensus has been reached, opinions remain divided over many issues. Beyond the main content of COP27 which can be found in the newspapers, a lot of issues were discussed during and after the high-level and side sessions. For these issues, it is not yet possible to form a written consensus, let alone a consensus on policy moves.
Therefore, the end of COP27 is only the start of further study on sustainable development and climate actions, which can support decision-making and facilitate progress at COP28 next year.
Next, I would like to discuss three issues.
Ⅰ. CENTRAL PLANNING, MARKET MECHANISMS, OR SELF-DISCIPLINE? ANALYSIS OF THREE APPROACHES TO NET ZERO EMISSIONS
There are three main approaches to dealing with climate change, reducing carbon emissions, and achieving net zero emissions.
Approach One: Central planning. Construct an indicator system to encourage local governments, enterprises, and consumers to act.
Approach Two: Market-based mechanisms to achieve net-zero emissions. Some sessions at COP27 discussed the establishment of carbon markets and the role of carbon prices.
It is generally agreed that the funding gap to be bridged to achieve net zero emissions is huge no matter what calculation method is adopted, which means that incentive mechanisms are needed to attract massive investment. The so-called market-based approach emphasizes the incentive mechanisms, that is, rewards and punishments. Incentives can affect carbon allowances, which are linked to the carbon allowance market (called the carbon emission market in China) and voluntary carbon markets, and thereby can guide investment.
However, some argue that carbon emissions and climate change represent a market failure caused by externality and doubt whether a market-based approach could fix a market failure.
Approach Three: Corporate self-discipline. All important companies should make commitments to net zero emissions according to industry-specific timetables and roadmaps. Once a promise is made, it should be kept in good faith and fully implemented.
Financial companies are a very important part because the commitment of financial enterprises not only involves their own net zero emission goals but also determines whether they can mobilize sufficient funds for the transition towards a net zero emission economy.
Some people extend the scope beyond enterprises by arguing that non-governmental organizations, local governments, and other entities apart from the central government should also make commitments. But they are different from enterprises, and even when commitments are made, the mechanisms required to implement them will be very different.
So far, many companies and financial institutions have made commitments to climate change. However, what mechanism should be relied upon to respond to climate change needs further discussion. We can mobilize all types of entities and combine various forces from government planning, market-based mechanisms, and corporate self-discipline. It is necessary to have a sober understanding of each approach's pros and cons, feasibility, and implementation prospect. It is also necessary to have a clear judgment on the specific division of labor and the implementation priority of different measures.
As a country transitioning from a centrally planned economy to a market economy, China has a deep understanding of the advantages and disadvantages of central planning. A central planning-based approach needs to be implemented through an indicator system, which must be built upon solid data to accurately reflect the reality, but too often these data are subject to artificial distortion. In addition, the government must decompose the overall indicators into regional or sectoral components, but such decomposition might deprive the indicators of their flexibility by leaving no room for adjustment. In this case, once certain indicators exceed the target, the government may take tougher measures, such as power cuts, causing a lack of resilience in the economy and dissatisfaction among various parties that weakens their willingness to respond to climate change. China experienced this kind of situation in the autumn of 2021. For certain industries, power cuts could be dangerous. For example, explosions may occur when some chemical reactions encounter a power outage midway. Therefore, authorities should pay enough attention to avoid such situations.
The market-based approach is open to questions, too. Europe has been attaching great importance to "cap and trade", i.e. capping the total emissions and trading the emission permits, but the carbon price is not always stable. In addition, some large emitters may buy allowances under the counter, thereby weakening their motivations to cut carbon emissions. These practices in the carbon market cause concern about "greenwashing."
Therefore, the government should have the ability to manage carbon market prices. The IMF suggests that carbon markets in different regions set minimum prices that change with the timetable. The instability of carbon allowance prices is also related to the amount of free allowances issued during the transition, as too many allowances would lead to low prices. In short, in the market approach, the issuance of carbon allowances and the control of the total amount of carbon allowances will have a great impact.
At present, a large number of companies around the world have made commitments that they will follow a certain roadmap and timetable to achieve net zero emissions, but we hope that more companies can follow in their footsteps. The international community doesn’t see enough Chinese companies joining in. A group of financial institutions joined the Glasgow Financial Alliance for Net Zero, reviewing their existing financing process and making commitments regarding future financing. However, these practices can also be controversial and require further research.
There is a view that, from the perspective of microeconomics, an enterprise is a combination of factors such as capital, technology, management, and talents to complete a certain job. Among these factors, capital will be translated into specific equipment, processes, and talents, etc., which means that the combination of factors suitable for one goal may not necessarily be suitable for other goals. For example, the combination of factors in the field of fossil energy, including raw materials, talents, technology, etc., may not be suitable for new energy. Therefore, as much as we hope that fossil energy producers can invest in and transit to new energy, that’s not how companies operate. For some enterprises, after being in existence for several years, the market demand for their products disappears, so the existing combination of factors may disintegrate (the enterprises go out of business). And new combinations of factors will emerge in the market to undertake new development directions.
Therefore, to resolve the debate on "what method to rely on" during the COP27, more research is needed.
II. INCREASING INSTALLED CAPACITY OF RENEWABLE ENERGY AND PUSHING FORWARD STABLE AND SAFE TRANSITION OF THE POWER SYSTEM
Among the relationships between energy supply and energy security, the most important one is the relationship among power supply, power security, and transition of the power system. In the future, energy demand will be largely manifested as power demand, and many industries will seek to transition from fossil fuels to electricity, preferably green and zero-carbon electricity. This requires the transformation of the power industry, including a large amount of investment and technological development.
Recently, geopolitical conflicts have exacerbated the global energy supply, forcing some countries to return to fossil fuels. In response, there were calls for COP27 to propose a ban on coal mining, and a halt to financing for new oil and gas projects, but both proposals might be a bit controversial.
At present, the most important task is to significantly increase installed capacity of solar and wind power, or renewable energy in a broad sense, along with peak-load units and energy storage capacity. Given the intermittency of new energy generation, we should ramp up backup capacity, which means that we need to install more peak-load units and energy storage units, to ensure adequate power supply during different periods of time. Compared with peak-load units, energy storage may seem to be greener. But both pumped storage hydropower and electrochemical energy storage mode are more or less constrained by geographical conditions or technological levels, which requires further research and development. Therefore, we still need more peak-load units. Going forward, with the development of energy storage technology and the rise in installed capacity of renewable energy, China will be more capable of adjusting new energy power, and at that time, peak-load units can be phased out.
While increasing installed capacity of renewable energy, we should also put efforts on constructing and transforming the power grid, upgrading power dispatching ability, and reforming the pricing mechanism. These upgrades aim to pave the way for gradually phasing out fossil fuels, ensure the transition of the power system while avoiding power rationing, and prevent shocks due to the efforts to fight climate change.
Overall, during COP27, some people believed that the world failed to meet expectations in terms of reducing the use and exploitation of fossil fuels, which was debated a lot and calls for more research and discussions.
III. ADDRESSING THE FINANCING GAP OF DEVELOPING COUNTRIES AND REALIZING JUST LOW-CARBON TRANSITION
To cope with climate change and realize a low-carbon transition, we should emphasize fairness and justice, which poses the most difficult question: who should take care of the funding gap faced by emerging markets and developing countries. The COP27 reached an agreement to establish a loss and damage fund. But the scale of the fund is not clear yet, and it is expected to account for only a small share of fund for just transition globally.
In the current process of low-carbon transition, although certain developed countries started early in emission reduction, the fight against climate change in the future largely depends on whether emerging markets and developing countries can reduce their emissions. These countries will need lots of funds to upgrade their equipment and develop technologies. By any account, the finance gap is huge. In this case, it is difficult to mobilize capital. While many financial institutions have made promises to provide funds, from the perspective of microeconomics, most of them only serve as intermediaries who use clients’ money for investment or wealth management. Therefore, without enough incentives, financial institutions cannot use their clients’ money at will based on merely a promise.
To deal with such a yawning funding gap, we can consider the following two measures: first, we could foster controllable connectivity between carbon markets to enable developed countries to purchase carbon allowances, carbon offsets, or carbon credit from other markets so as to direct some financing into those countries . Second, we can utilize border adjustment tax to help developing countries and emerging markets to reduce emissions. The EU put forward the Carbon Border Adjustment Mechanism (CBAM) that levies taxes on carbon-intensive products from developing countries. I think the tax revenue should be returned to the carbon markets of developing countries to help them reduce emissions and protect forests and land. In other words, we need to work out feasible ways to direct funds from developed countries to developing countries. Hence, the issue of just transition requires the financial sector and the academia to provide policymakers with workable methods.
This article is the transcript of Zhou Xiaochuan’s speech at the 2022 Bund Summit on December 10th. It is translated by CF40 Secretariat and has not been reviewed by the speaker. The views expressed herewith are the speaker’s own and do not represent those of CF40 or other organizations.
