Ministries of Finance need to jointly manage four sources of risk from climate change: physical risks; risks of overcapacity and stranded assets as carbon-intensive industries decline; risks of potential shortages from the delayed establishment of alternatives; and the risk of a disorderly transition driven by economic and political shocks, investor uncertainty, and mismanagement.
MoFs can use analytical tools and policy mechanisms to help understand and manage these risks, but more work needs to be done. Of the four risks, that of a disorderly transition is particularly dangerous and poorly understood.
- Of the four risks (physical risk, stranded assets, shortages, and disorderly transition), disorderly transition risk is the least understood, and possibly the most dangerous. Fear of disorder can drive investor and policy decisions that significantly increase costs and reduce economic growth, even if the disorder-related shocks never materialize. Similarly, uncertainty can drive investment and policy decisions that lead to disorderly transitions.
- While economic analysis and modeling, including scenario analysis, sectoral models, macroeconomic models, and tax and policy mechanisms, can help the management of all four risks, there are significant gaps in the analytical tools and policy mechanisms required to manage disorderly transitions.
- Active management of the transition at a national and global level can create significant economic value globally by increasing confidence, lowering the cost of investment, and avoiding volatility that reduces economic growth.
- Clear and transparent plans and targets, an accelerated transition, and robust, credible, and viable mechanisms are needed to manage transition relevant shocks—whether they are technological, economic, political, or resource-driven.
To manage risks and reduce the impact of uncertainty during the transition, setting credible targets and sticking to them reduces one major source of uncertainty and volatility for all sectors. Beyond that, the first step should be to identify sectors, technologies, and regions where a mismatch between phasing out and phasing in alternative energy sources would have major economic impacts, and those that are highly susceptible to mismatches. Here, additional policy responses may be useful.
Keywords
physical riskrisk managementstranded assetstransitionuncertainty
