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Financing a Net Neutral Economy

The Paris Climate Agreement marks a turning point in the fight against climate change, as the pledge to keep temperatures from rising more than 2℃ above pre-industrial levels means that countries and companies can no longer conduct business as usual. While the Paris Climate Agreement has ushered in a new era of environmental regulations, it has also created an economic “catch-22” for banks and other financial institutions: moving investments away from the fossil fuel industry fast enough to satisfy the restrictions brought about by the Paris Climate Agreement, without throwing the economy into a recession. 

The potential for recession is due to a phenomenon called the carbon bubble. The carbon bubble is the large amount of money invested in fossil fuels via oil and gas companies, the transportation sector, the agriculture sector, and other high-carbon industries. Initially, economists theorized that environmental regulations would stop oil companies from using their full reserves, leaving these unused assets to depreciate in value. While this depreciation might seem on the surface to be detrimental only to oil companies, in reality it could cause energy exchange companies to rapidly lose 40-60% of their stock values, resulting in a global economic recession.

How, then, can the world divest from carbon heavy industries fast enough to save the earth, but slow enough to avoid a global recession? At first, it seemed like banks and other financial institutions were the issue, and they were therefore the main target of potential solutions. But fortunately, the rapid advancements of the renewable energy industry and a change in consumer values have allowed free market forces to naturally divert money away from fossil fuel investments.

When the phenomenon of the carbon bubble first entered the academic sphere in 2011, the thought was that it would take decades of slow, controlled, divestment to avoid bursting the carbon bubble. And, even with this controlled divestment, certain countries would inevitably face consequences. The United States and Russia were to be hit the hardest, followed by certain countries in Western Europe—specifically Britain, France, and Belgium—due to how they had tied their pension funds to the petroleum and natural gas industries, and thus leading the initial solution to avoid bursting the carbon bubble to focus on maintaining the value of fossil fuel investments. While certain parts of this plan, such as the focus on carbon capture technology, certainly have their place in the transition to a net zero economy, this initial plan failed to view renewable energy as an economically viable solution.

For all the initial concern over the divestment away from the fossil fuel industry, the movement away from these investments has begun to pick up naturally. This movement is partially due to the effects of climate change becoming increasingly visible. With water levels continuing to rise and forest fires devastating countries and ecosystems, the need for change has become more urgent. Additionally, when viewing the situation from a financial perspective, the effects of climate change are causing assets like real estate holdings to depreciate, making investing in climate friendly companies a smarter option.

The movement away from fossil fuels isn’t only to mitigate the loss of value in fossil fuel reserves.. Many financial giants are investing in green technologies to take advantage of the current transitioning economy.  According to BlackRock, an investment management firm, consumers value sustainability and are looking to invest their money in institutions whose values match their own. With this moral shift, banks are choosing to move away from their investments in fossil fuels so as to appeal to this new brand of consumers. Many banks, including Santander, Bank of America, and Morgan Stanley are going even further in their efforts by pledging to be carbon neutral by 2050. 

Another key turning point in the transition to net zero-financing has been the COVID-19 pandemic. The pandemic has increased attention to natural disasters, like forest fires, furthering the high valuation of sustainability in business practices. Additionally, with the beginning of the pandemic bringing historically low (and at one point negative) oil prices, banks have begun to more comprehensively assess the risk involved in fossil fuel investments. The pandemic has also brought a large share of problems, though. With government budgets being used to mitigate the devastation caused by COVID-19, governments may choose not to aid financial institutions in their divestment through government subsidies. Some governments are implementing strategies to tie COVID-19 relief and fossil fuel divestment together such as conditional bailouts, but governments historically tend to put environmental priorities on the backburner during economic crises. While there are still challenges in the movement away from fossil fuel investments, the shift in consumer valuation and visibility of climate change has given banks the opportunity to naturally divest from the carbon bubble, hopefully smoothing the transition to the net zero economy that is sure to come in the future.

Sources

Bank of America matches efforts by Morgan Stanley, JPMorgan Chase with net-zero financing goal.(n.d.). https://www.marketwatch.com/story/bank-of-america-matches-efforts-by-morgan-stanley-jpmorgan-chase-with-net-zero-financing-goal-11613074045#:~:text=public%20policy%20efforts.-,Bank%20of%20America%20joins%20Morgan%20Stanley%20and%20JPMorgan%20Chase%20as,net%2Dzero%2Dfinanced%20emissions.

The Carbon Bubble: The financial risk of fossil fuels and need for divestment. (n.d.).

    https://www.cbd.int/financial/doc/carbon-bubble.pdf

 

McGrath, M. (n.d.). Carbon ‘bubble’ could cost global economy trillions. BBC News.

 

Harvey, F. (n.d.). What is the carbon bubble and what will happen if it bursts? The Guardian

 

Larry Fink’s 2021 letter to CEOs. (n.d.). https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter

 

Financing a Net-Zero Economy: Measuring and Addressing Climate Risk for Banks. (n.d.).https://www.ceres.org/resources/reports/financing-net-zero-economy-measuring-and-addressing-climate-risk-banks

 

Accelerating the transition. (n.d.). Financing a Net-Zero Economy: Measuring and Addressing Climate Risk for Banks. (n.d.). https://www.ceres.org/resources/reports/financing-net-zero-economy-measuring-and-addressing-climate-risk-banks

 

The net gains of net-zero. (n.d.). Financial Times. https://www.ft.com/partnercontent/lloyds-bank/the-net-gains-of-net-zero.html

 

How can sustainable finance support the road to net-zero? (n.d.). https://www.ey.com/en_us/financial-services/how-can-sustainable-finance-support-the-road-to-net-zero

 

Dimmelmeier, A. (n.d.). The Role of Economic Ideas in Sustainable Finance: From Paradigms to Policy

    [Unpublished doctoral dissertation].

 

Tett, G. (n.d.). Wall Street’s new mantra: green is good. Financial Times.

Houlder, V., & Livsey, A. (n.d.). Lex in-depth: how carbon prices will transform industry. Financial Times.

 

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