The Economic Opportunities and Challenges of the Net-Zero Transition

By: John A. Lanier

In January, McKinsey & Company released a sweeping report that explores what a successful net-zero transition would entail. The report makes it clear that decarbonizing our economies is a worthwhile endeavor, but it also highlights the challenges inherent in making the shift. One particular challenge - ensuring that low-emission supply of energy matches shifts in demand - may prove to be make-or-break when it comes to solving the climate crisis.

Of all of my five-year-old son’s toys, two are my favorites. I don’t mean that I like it when he plays with these particular toys - I mean that I enjoy playing with them! Both are similar, in that they are elaborate self-contained marble mazes. One is a cube, and a more advanced one is a sphere (I am including the links not so you will buy them, but so that you can see what I am talking about). In each case, you have to carefully rotate the game so that the marble follows the three dimensional track to the end. Any slight twist or turn the wrong way and the ball will fall off the track, forcing you to go all the way back to the beginning. Going too fast can cause you to fail, as can going too slow in some parts. Reaching the end requires skill and focused attention, especially for the more advanced toy, and it is incredibly satisfying to solve these challenges.

The Mother of All Reports on the Net-Zero Transition

I thought of these games when I read one particular quote from a report recently. Here it is: “Rapidly scaling up demand for low-emissions assets and other products needed for the transition without corresponding scale-up of supply could lead to supply shortages, price increases, and inflation. As already noted, a mismatch or mistiming between the ramping down of high-emissions activities and the ramping up of low-emissions activities could create energy price volatility and issues with reliability that may result in a backlash that delays the transition. Conversely, the risk exists that stakeholders maintain two parallel energy systems in a manner that is inefficient and not cost-effective. Thus the transformation of the energy system needs to be carefully managed.”

I’m going to spend some time unpacking this quote, but I will start by sharing where it comes from. A couple of months ago, the global management consulting firm McKinsey & Company released an incredibly comprehensive report titled, “The Net-Zero Transition: What It Would Cost, What It Could Bring.” In the report, McKinsey examines the wide range of impacts that would come from the economies of the world decarbonizing such that humanity successfully stays below the 1.5 degrees Celsius goal of the Paris Climate Agreement. Stated more simply, they explain what it would look like, economically speaking, if humanity successfully solves the climate crisis over the next three decades.

When I say the report is comprehensive, I mean it. It has six separate sub-reports that discuss various aspects of the global transition to net-zero greenhouse gas emissions. For instance, one talks about the economic sectors that will be particularly impacted by this shift. Another talks about how the transition will play out in different countries and regions. My quote above comes from the sub-report that focuses on what would change economically in a net-zero transition. As that report summarizes at the top, “A net-zero transition would entail a significant and often front-loaded shift in demand, capital allocation, costs, and jobs.”

The Net-Zero Transition Will See Massive Economic Shifts

Feel free to spend as much time as you like with McKinsey’s work. For my purposes though, I want to explore what these shifts will look like against the backdrop of the first quote I provided. To me, it is the make-or-break question on if we will achieve the goals of the Paris Climate Agreement. Let’s start with a closer look at the first part of the quote: shifts in demand.

It’s common sense - decarbonizing the economy means that the market must pivot away from demanding high-emission goods and services toward demanding low-emission goods and services. In their report, McKinsey projects that, by 2050, successful decarbonization will see demand for oil production volumes fall 55%, demand for natural gas production volumes fall 70%, and demand for coal production volumes essentially disappear. While demand for these sources of energy falls, demand for things like renewable energy sources, battery-electric vehicles, low-emission steel production, and low-emission agricultural products will grow dramatically. All told, the shifts in demand are projected to require a cumulative capital outlay on physical assets of $275 trillion from now to 2050. In other words, that’s the price tag to finance a successful net-zero transition.

It’s a big number, for sure, but as with any good investment, the world should see a positive return on this one. First, this investment would mitigate the worst impacts of climate change, saving millions of lives and trillions of dollars. Further, as the McKinsey report projects, the transition would yield a net-gain in jobs of 15 million. Sure, many jobs will be lost in the transition (especially in the fossil fuel sectors), but they are more than made up for in other sectors. The report also highlights the efficiency gains and economic growth opportunities that can come from the increased demand for low-emission products. There will be economic losers for sure, but I think the report conclusively shows that it will be very good for the economies of the world to successfully decarbonize.

Avoiding a Pitfall that Could Derail the Net-Zero Transition

We need to circle back to that quote now, as it observes a pitfall that might derail a successful transition. If demand shifts in the direction of low emissions but supply lags behind in making a parallel shift, the result could be undersupply, price increases, and inflation (which is all on the minds of many people today). Certainly, businesses around the world have a responsibility to make the supply pivot happen. Just as critical, and I would argue even more critical, is the role that governments will play on the supply-side of the net-zero transition. We will need both carrot and stick policies to shift the supply-side of our economies towards decarbonization, which might look like tax incentives for renewable energy (a carrot) and a price on carbon for high-emission forms of energy (a stick).

Moreover, as the quote goes on stating, the balance of the supply shift will be important. It not only needs to match demand shifts overall, but it also must see a smooth and orderly pivot from high-emission activities to low-emission activities. Much as I wish it were otherwise, our economies could not handle it if all coal-fired power plants were closed tomorrow. That fact doesn’t mean coal has an economic future, however. It just means that we need to have meaningful plans in place to guide the supply-side transition. By analogy, an airplane can’t land by nose-diving into the ground, but neither can it fly forever. A good pilot has a plan in place for making a smooth landing.

Or we can come back to my son’s toys. To me, the net-zero transition looks a whole heck of a lot like a marble maze, and we have a ticking clock we need to beat. We can’t rush it, or we will fail. We can’t wait too long or we will run out of time. Sudden twists and turns won’t work either. To navigate this maze, we need urgency that is matched by thoughtfulness and care. But if we can make it to the end in time, it will be to the world’s great benefit. And it will be so incredibly satisfying to solve this challenge.