Managing the net-zero transition: Actions for stakeholders

The net-zero transition: What it would cost, what it could bring

(224 pages) (PDF-2 MB)

The transition to net zero will require economies and societies to make significant adjustments (see sidebar, “Our research methodology: Sources, scenarios, limitations, and uncertainties”). Many of these adjustments can be best supported through coordinated action involving governments, businesses, and enabling institutions, and by extending planning and investment horizons. This action would need to be taken in a spirit of unity for two key reasons: first, the universal nature of the transition means that all stakeholders will need to play a role. Every country and sector contributes to emissions, either directly or indirectly, through its role in global production and consumption systems. Second, the burdens of the transition will not be evenly felt, and the costs will be much more difficult to bear for some stakeholders than for others. This is all the more challenging because contributions to emissions have not been even across stakeholder groups. Thus, without a real effort to address these effects in a spirit of fairness, it appears unlikely that the most affected stakeholders would be either able or willing to do their share to advance the transition.

The following three categories of action stand out:

• Catalyzing effective capital reallocation and new financing structures, including through scaling up climate finance; developing new financial instruments and markets, including voluntary carbon markets; deploying collaborations across the public and private sectors; and managing risk to stranded assets
• Managing demand shifts and near-term unit cost increases for sectors through building awareness and transparency around climate risks and opportunities, lowering technology costs with R&D, nurturing industrial ecosystems, collaborating across value chains to reduce or pass through cost increases from the transition, and sending the right demand signals and creating incentives for the transition
• Establishing compensating mechanisms to address socioeconomic impacts, through economic diversification programs, reskilling and redeployment programs for affected workers, and social support schemes

Our research methodology: Sources, scenarios, limitations, and uncertainties

We assess the net-zero transition along two dimensions: sectors and geographies. For the first, we examine energy and land-use systems that account for about 85 percent of global emissions: power, mobility (in particular, road transportation), industry (steel and cement production), buildings, agriculture and food, and forestry and other land use. We also looked at fossil fuels that supply energy to many of these systems. For the geographic dimension, we analyze effects in depth for 69 countries, which make up about 95 percent of global GDP.

We chose not to develop our own transition scenarios and rely instead on widely used scenarios created by other institutions. Specifically, we analyze potential effects under the Net Zero 2050 scenario defined by the Network for Greening the Financial System (NGFS). This hypothetical scenario mirrors global aspirations to cut emissions by about half by 2030 and to net zero by 2050 (exhibit). It reaches net-zero CO₂ emissions by 2050 for the economy as a whole; this means there are some low residual gross CO₂ emissions in hard-to-abate sectors and some regions that are counterbalanced by CO₂ removals. We chose to work with the NGFS scenarios because they cover all major energy and land-use systems in a coherent manner, provide regional granularity, are designed for use in risk and opportunity analysis, and are becoming the standard scenarios used by financial institutions, regulators, and supervisors.

In some cases, as a counterfactual for comparison, we also use the NGFS Current Policies scenario. This scenario projects the greenhouse gas emissions that would occur if only today’s mitigation policies remain in place (based on an NGFS assessment of policies as of the start of 2020), and it anticipates a little over 3°C of warming by 2100. The comparison allows us to account for how other factors such as GDP growth or population growth could affect the economy between now and 2050. We also collaborated with Vivid Economics to use the two NGFS scenarios to generate more granular sector variables where needed (for example, sales of new automobiles), in a manner that was based on and compliant with the NGFS scenarios. In such cases, we still refer to the specific sector variable as being based on the relevant NGFS scenario.

We performed the analysis as follows. First, we used the NGFS scenarios and downscaling by Vivid Economics to quantify changes in important variables in each energy and land-use system (for example, changes in power production by source). The downscaling was done to provide sectoral or technological granularity where not available from NGFS. We used this to assess changes in demand and then assessed the implications for capital stock and investment, producer and consumer costs, and employment based on information about decarbonization technologies and their capital and operating costs, labor intensity, and effects on value chains. Where possible, we used region-specific costs and labor assumptions, as well as expected technology learning curves over time, based on McKinsey analysis.

Limitations of our approach and uncertainties. We recognize the limitations of the NGFS scenarios, as with any transition scenario, given that this is an emerging field of research. First, while some variables are explored at the sector level, the scenarios often do not provide enough detail to explore how different types of activities will be affected, thus requiring downscaling to achieve the necessary sectoral granularity. Second, the models underpinning the NGFS scenarios may not capture important dynamics or constraints within a sector. For example, the model we used favors more economy-wide use of biomass in energy and industry (for example, hydrogen production) than may be considered feasible in other sector-specific decarbonization pathways. Third, although the models do capture ongoing learning and technological innovation, they may fail to sufficiently anticipate the emergence of disruptive technologies that may change decarbonization pathways and lower cost trajectories faster than anticipated. Fourth, while some NGFS scenarios have begun to incorporate damages from physical risks in the economic modeling, further work is needed to fully integrate physical risks into the decarbonization pathways. As a result, we have focused here on scenarios that do not incorporate physical risk. This approach also allows us to focus our analysis on the effects of the transition alone. Finally, the scenarios reflect climate policies and technological trends in place before the COVID-19 pandemic and climate negotiations and pledges at COP26 in Glasgow in November 2021.

Our analysis largely consists of an analysis of first-order effects. Various uncertainties could influence the magnitude of outcomes highlighted here. While some of these factors could result in lower outcomes than those sized in this research, some factors suggest that additional costs and effects will likely occur as the transition unfolds. By the same token, the costs of physical climate risks could likely prove higher than those described here.

Key uncertainties include the following:

• Warming scenario and emissions pathway. A higher warming scenario (for example, 2.0°C) may lead to smaller transition effects than a 1.5°C warming scenario, given the lower degree of emissions reduction and deviation from today’s production and consumption patterns it entails.
• Sectors’ decarbonization actions and activity levels. Because the focus of our work is assessing the nature and magnitude of economic shifts and not identifying decarbonization actions, we used a prespecified net-zero scenario from NGFS. It is feasible that an alternate technology mix could result in lower costs and different shifts than those described here, and that further technological innovation could result in a different pathway with lower costs. It is also feasible that the path the world undertakes to decarbonize is different from the one described here. For instance, an alternate scenario may consist of substantially more use of carbon capture and storage (CCS) technologies and a focus on decarbonizing the hydrocarbon value chain. For example, this could happen if capture costs fall, regulatory frameworks are put in place to incentivize CCS use, and markets mature for recycled CO₂ as a material feedstock.
• Magnitude of direct and indirect socioeconomic effects. Some effects could be larger than described here, for example, if executing the transition is more complex than the scenario here suggests, and additional capital spending is needed to maintain flexibility and redundancy in energy systems. If supply of key materials or low emissions of sources of energy do not keep up with demand, this could result in shortages and price increases, which we have not considered in our quantification. Higher-order effects could magnify risks and increase costs, particularly in the short term. For example, depending on how the transition is financed, the effects on the overall economy could be substantially higher than sized here. Finally, effects could also be larger under an abrupt or delayed transition.
• Economic and societal adjustments needed for the transition. Costs and investments could be higher than sized here, for example to implement social support schemes to aid economic and societal adjustments. Similarly, additional costs may arise from delays, setbacks, and urgently needed adaptation measures, particularly if restricting warming to 1.5°C proves not to be possible. For our analysis, we quantify the scale of first-order effects and describe qualitatively the adjustments needed.

Aspects we did not cover. Topics we did not cover include the likelihood, validity, and comparative costs associated with various decarbonization scenarios; the comparative merits of different emissions-reduction technologies; constraints to implement and deploy decarbonization technologies (for example, scaling up supply chains); the actions needed to drive and incentivize decarbonization; quantification of higher-order economic effects of the transition, including on output, growth, value pools, valuations, trade flows, and human well-being: relative costs and merits of decarbonization and adaptation; and impacts that could result from physical climate hazards. We use benchmarks from the external literature and our past research to describe these latter possibilities. As discussed above, our analysis here represents first-order estimates. Fully quantifying the costs of rising physical risks and the transition is complex. It would require estimating impacts from rising physical risks and the cost of adaptation actions, building robust estimates of the impact of the net-zero transition on the economy that takes into account the higher-order effects described above, and doing so over time and while grappling with the various uncertainties described previously.

As these actions are undertaken, individual leaders will need to both consider risks and opportunities to their organizations and to their stakeholders, and determine the role they can play in supporting the necessary adjustments for all. We consider more detailed actions and the role of stakeholders below.

Companies can consider integrating climate considerations into their strategies and their decision-making frameworks. Companies have begun to develop comprehensive plans for achieving net-zero emissions and to integrate those plans into their strategies, combining elements of what might be called “offense” (such as entering new markets, funding R&D, and participating in innovation ecosystems) and “defense” (divesting businesses and retrofitting high-emissions assets to lower their emissions). As they embark on this journey, they can consider the following steps:

• Articulate and communicate a coherent case for change and upskill employees to help drive their organizations toward net-zero goals while also supporting broader economic and societal adjustments. As they initiate action, most CEOs will want to communicate a coherent case for change and take visible ownership of the sustainability agenda.
• Develop ongoing capabilities to make granular, holistic, and dynamic assessments of transition-related risks and opportunities in order to capture shifts in regulations, investor preferences, consumer behaviors, and competition. To stay abreast of new developments and emerging possibilities, organizations are likely to need new capabilities, data, infrastructure, and talent. A key part of this will also be better tracking of scope 1, 2, and 3 emissions, including through the use of digital tools to increase transparency of emissions in companies' own operations and in their supply chains.
• Define decarbonization and offsetting plans and update them as competitive, financial, and regulatory conditions change. This would include scope 1 and 2 emissions (with priority given to “no regret” actions such as improving energy efficiency and making decarbonization investment with positive returns). Where feasible, needed, and material, and depending on the nature of their operations, businesses can expand these plans to include scope 3 emissions.
• Create a portfolio of agile business strategies consistent with these decarbonization plans and with the risks and opportunities emerging in a net-zero economy. They can then put these plans in place as conditions change and opportunities arise. For companies, repositioning themselves could involve investing in new physical assets and reallocating capital, redesigning products, or building new low-emissions businesses.
• Integrate climate-related factors into key business decisions for strategy, risk management, finance and capital planning, R&D, operations (including supplier management and procurement), organizational structure and talent management, pricing, marketing, and investor and government relations.
• Consider if and where to take a leadership position in the company’s industry and its ecosystem of investors, supply chains, customers, and regulators.

Financial institutions can support large-scale capital reallocation, even as they manage their individual risks and opportunities. In the near term, they will need to consider assessing and disclosing their risks and measuring and committing to reduce their financed emissions. Over time, they will need to translate these commitments into actions that lower emissions. Relevant practices for financial institutions to consider include the following:

• Rethinking conventions for risks and returns. Some decarbonization projects are likely to have longer-than-normal payback periods. This possibility may compel financial institutions to adjust their criteria for which projects they finance.
• Assessing and disclosing climate risks. For example, various regulators and supervisors already require banks to conduct climate-risk assessments, and more are planning to start these assessments.
• Measuring and reducing financed emissions. Financial institutions are increasingly making pledges to align their portfolios with 1.5°C or 2.0°C warming targets or to achieve net-zero financed emissions by a certain date. They have started translating these commitments into targets for sectors and geographies. Given that emissions ultimately are from counterparties, financial institutions may find it helpful to support the transition plans of those counterparties—for instance, by offering new financial solutions, advising them on emissions-abatement methods, and introducing partnership opportunities.
• Over time, translating these commitments into actions that lower emissions, including expanding the range of climate-finance products and services (for example, funding for low-emissions power projects, new financial instruments to support negative emissions or nature-based solutions, and well-governed voluntary carbon markets).

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Governments and multilateral institutions could consider the use of existing and new policy, fiscal, and regulatory tools to establish incentives, support vulnerable stakeholders, and foster collective action. Public-sector organizations have a unique role in managing uneven effects on sectors and communities. Among other options, they could consider the following:

• Assess exposure to risks and opportunities, develop decarbonization plans, and create net-zero strategies (similar to businesses). This would include governments bringing climate considerations into decisions about such matters as urban planning, infrastructure development, and tax and subsidy regimes in an effort to anticipate future dynamics, as well as efforts to increase awareness of and transparency about climate risks and opportunities. One major adjustment that governments may need to make is developing new low-emissions industries as demand wanes for fossil fuels and emissions-intensive industries.
• Use policy measures and regulation to encourage decarbonization investment across sectors (for example, consider where and how to best use subsidies, grants, demand signals, and carbon taxes, to name a few). They can also play a role in accelerating research and development that would lower technology costs.
• Governments could establish multilateral and government funds to support low-carbon investment and manage stranded-asset risk.
• Institute reskilling, redeployment, and social-support programs for workers and manage negative effects on lower-income consumers.
• Collaborate with other stakeholders to drive collective action. For example, governments can catalyze private-sector action to build new low-emissions industries in various ways; strategies might include setting road maps and convening stakeholders.

Enabling institutions such as standard setters, industry groups, and civil-society coalitions will be critical in coordinating action across sectors and geographies. Although individual actions by companies and governments can support a wide range of stakeholders during the transition, these actions may not be enough to meet all stakeholder needs. The pace and scale of the transition means that many of today’s institutions may need to be revamped and new institutions created to disseminate knowledge, support capital deployment, manage uneven effects, and organize collective action. Enabling institutions could play valuable roles in developing and enforcing governing standards, tracking, and market mechanisms (for example, related to the measurement of emissions or climate finance), convening stakeholders and facilitating collaboration (for example, to arrange collective investment or organize the build-out of infrastructure), and giving a voice to vulnerable workers and communities.

Individuals will need to manage their own exposure to the transition and can play powerful roles as consumers and citizens. They can begin by continuing to learn about the effects of both ongoing climate change and the net-zero transition that they may experience as consumers or workers. The goal of net-zero emissions can be reached only if people adopt new behaviors and consumption patterns, such as switching to electric vehicles and renovating or retrofitting homes for energy efficiency. Civic discourse has an important role to play: an informed, engaged public that recognizes the imperative for a net-zero transition could spur decisive and transformative action on the part of government and business leaders.

The economic transformation required to achieve net-zero emissions by 2050 will be massive in scale and complex in execution. The transition would bring substantial shifts in demand, capital allocation, costs, and jobs, which will be challenging to a wide range of stakeholders, not least because they will be distributed unevenly. Yet the costs and dislocations that would result from a more disorderly transition to net-zero emissions would likely be far greater, and the transition would prevent the further buildup of physical risks. The findings of this research serve as a clear call for more thoughtful and decisive action, taken with the utmost urgency, to secure a more orderly transition to net-zero by 2050. It is important not to view the transition as only onerous; the required economic transformation will not only create immediate economic opportunities but also open up the prospect of a fundamentally transformed global economy with lower energy costs and numerous other benefits—for example, improved health outcomes and enhanced conservation of natural capital. Actions by individual companies and governments, along with coordinated action to support more vulnerable sectors, geographies, and communities, could help support the needed economic and societal adjustments. The key issue is whether the world can muster the requisite boldness and resolve to broaden its response during the upcoming decade, which will, in all likelihood, decide the nature of the transition.