Action taken on ESG, the green transition, energy, and the circular economy in the next few years will shape the climate and world events for the rest of the century. However, companies faced with troublesome near-term financial situations and investors coping with soaring inflation and rising interest rates are less likely to have these issues at the front of their minds.
At the same time, governments are focused on the cost-of-living crises and international geopolitics when they must propel the green transition and act radically to combat climate change.
So, why is the green transition under threat?
The green economy has been hit by rising material prices and transport costs. The increasing cost of PV-grade polysilicon pushes up the price of solar cells, and a higher cost of steel hurts the wind turbine industry. This is naturally impacting a variety of industries. However, the renewables industry’s dispersed supply chains make it particularly vulnerable to rising logistics costs.
This is one of several bottlenecks in the rollout of renewables and other sustainable technologies. Another is a lack of underlying infrastructure. For example, we are far off from having enough batteries to store the energy generated by renewables. In addition, continent-spanning high voltage direct current (HVDC) power lines, which are necessary to transport electricity to where it is needed, are still in the planning phases. This is a result of the slow diffusion of new technology and has occurred throughout history, such as during the advent of electrification. New technology adoption has to be accompanied by systematic changes (in this case, batteries and power lines) and this creates a lag between innovation and implementation, slowing down the expansion of renewables.
In a time of macroeconomic and geopolitical turmoil, the inertia to change can be all the stronger. This manifests itself in an unfair advantage that incumbents have in the energy transition. Oil majors and established utilities expanded during a period of more relaxed regulation, and existing procedures are embedded in the highly regulated industry. In addition, energy technology is often self-reinforcing due to high upfront costs. This results in ‘technological lock-ins’, meaning that the combination of money invested and knowledge accumulated prevents change.
BP CEO Bernard Looney believes this explains why helping ‘greening companies’ to transition is vital as “you simply cannot scale enough green companies in the world fast enough, quick enough to solve this problem.” This is partially because numerous startups that develop technology to help lower carbon emissions will not make it past initial commercialization due to limited early cash flow, a period known as the ‘valley of death’. In fact, knowledge spillover, a term that describes attaining knowledge developed by another party, is preventing the development of green technologies in the first place. This is because firms and investors worry that this intellectual property is harder to gatekeep, thus putting any investment they make at risk.
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What must governments do?
In the face of macroeconomic turmoil and strong headwinds, governments must help the private sector power the radical shift required. Policy support is therefore needed. There are a variety of levers, such as:
- Technology-push measures to ensure money for innovation continues.
- Demand-pull measures to help the formation of new markets and limit the advantage of incumbents.
- Systematic instruments such as infrastructure investment to prevent bottlenecks in the rollout.
The private sector alone can often only deliver incremental improvements. A radical change such as overhauling steel production requires long-term risk-taking, and governments need to have a favourable policy agenda to address this.