Co-authored by Noah Gordon, Acting Co-Director, Sustainability, Climate, and Geopolitics program, Carnegie Endowment for International Peace
This article is part of our COP28 series. Learn more about CATF at COP28.
A series of geopolitical and economic crises – from the COVID-19 pandemic and its economic repercussions, to emerging and worsening conflicts – have constrained governments’ abilities to prioritize or execute climate action. A resurgence in coal use in Europe and a global race to secure oil and gas resources have demonstrated that, even as climate action becomes ever more urgent, geopolitical and economic security remain the priority.
As the world convenes in Dubai for COP28, countries will join the conference amid a different era from many of its predecessors; those who saw post-Cold War global peace, peak globalization and supply chain efficiency, unprecedented low-interest rates coinciding with technology readiness, and the apex of multilateralism. Even so, emissions have risen more than 70% since the first COP (Conference of the Parties) took place in Berlin in 1995, all while clean energy and climate policy have evolved at unprecedented levels. It is clear that climate action must adapt to and prepare for geopolitical disruption, rather than remaining a separate and, in many cases, competing priority. In fact, foreign policy and economic policy are increasingly inextricable from climate policy. The world is changing rapidly and there are four geopolitical trends shaping the future of climate action that policymakers must take into account.
The first key trend is industrial de-specialization, as countries attempt to compete in every stage of technology value chains, rather than just those in which they have a comparative advantage. The COVID-19 pandemic’s disruption of global supply chains, the rise of new competitors, and protectionism have all contributed to new industrial strategies that prioritize domestic control over supply chains. For products critical to national security and health, this is sensible: reliable access to goods from surgical masks to semiconductors is essential and cannot be left to vulnerable global supply chains. But the benefits of sure access come at the expense of capital efficiency, and this push is already affecting the clean energy sector.
A wave of new industrial policies across regions — including the Inflation Reduction Act in the United States, the Net Zero Industry Act in the European Union, major new investments into solar and hydrogen production in India, and increasing industrial investment across regions — intends to localize or in some cases re-shore clean energy production. Other countries, including Indonesia and Zimbabwe, have similarly implemented export restrictions on critical commodities. With traditional centers of innovation trying to revive manufacturing competitiveness and new innovation centers rising elsewhere, this push has broadened the scope of competition and embraced protectionism. The drive toward industrial policy signals and turn away from comparative advantages and efficiencies gained from global supply chains — and push to control technologies’ full value chains, from research and innovation to manufacturing and deployment — has been spurred by an increasingly fierce technological competition, and perhaps a hangover from China’s capture of the solar and battery industries.
Governments face a catch 22 and have ushered in an era of globalization light. Competitiveness and supply chain security are critical, but protectionist trade measures and redoubled investments outside of countries’ comparative advantages have the potential to raise the costs of transition everywhere, as research has shown. For example, the United States and Europe are unlikely to be able to compete with other regions to manufacture clean technologies as efficiently and cheaply as possible. And without those cheaper goods, the clean energy transition will become far more costly and slower: solar energy’s successes would not be possible without China’s inexpensive manufacturing capacity coupled with German incentives, and supply chain decoupling may prevent the same rapid cost declines in other key technologies. Investing in rivaling that capacity—rather than into innovation and development of complex technologies that will change rapidly, eschewing value capture by manufacturers — may fail to create cost-competitive products and has the potential to deploy capital inefficiently by duplicating efforts at a time when financing is most critical and scarce. Now, Europe, for instance, faces a tough choice between top speed decarbonization through open trade — allowing citizens to continue buying inexpensive Chinese and other importers’ EVs — and using trade measures or local content rules to protect its industry. For example, manufacturers are already concerned about a drop in demand for aluminum. Either choice risks eroding support for the low-carbon transition, and next year, more countries will have to choose between despecialization and efficiency.
Cost of capital
The second is the rising cost of capital. The era of cheap money came to an end in 2022, as high inflation returned due to insufficient supply as the world emerged from the pandemic and a surge in food and fuel prices. Central banks responded by hiking key interest rates hiking key interest rates in rich countries to levels not seen since before the 2008-09 financial crisis. In October 2023, the US federal funds rate was over 5.3%, while European Central Bank rates were over 4%. This signals significant headwinds for clean energy investment in advanced economies, and even further complicates investment prospects in emerging markets.
The 2010s were characterized by massive cost improvements for low-carbon technologies. The cost of solar power declined by 89% in the 10 years from 2009-2019, thanks to, overwhelmingly, economies of scale and innovation through scaled deployment, along with continued R&D. This same recipe promises to deliver continued cost improvements across clean technologies over the next decade. Cheap debt over the past decade turbocharged both innovation and deployment levels, driving rapid cost reductions.
With rising interest rates and competing spending priorities such as security and defense, fiscal headroom for government investment — which has been one of the key catalysts of deployment and innovation — is dwindling. Moreover, the cost of capital is becoming an obstacle to project development and thus deployment in the first place. This is particularly true for renewables like wind and solar; while their fuel is “free”, all the cost is in the upfront investment, meaning they are more capital intense than fossil fuel fired electricity generation like a gas plant. The latter buys fuel over time, lowering upfront capital expenditures — and thus the impact of the cost of debt — at the expense of higher operating costs. Higher interest rates will thus have an outsized effect on renewables compared to fossil fuels. Consider an increase from 5% to 7% in the cost of capital of utility-scale solar compared to a natural gas combined cycle plant: the levelized cost of electricity (LCOE) for solar would increase by 22.2 per cent but the gas plant’s LCOE would increase by only 5.6 per cent.
The cost of capital is an even bigger hurdle for developing countries whose currency is not accepted as a safe asset globally, and where investors assess additional regulatory and political risk. IEA data on 2021 show that the cost of capital for a new solar project in the U.S. or Europe was around 3-4%, compared to 9-10% in India. Rising interest rates in the U.S. also increase the cost of dollars in other currencies, which is painful for governments and firms in emerging markets who have borrowed in dollars. It becomes harder for them to pay back their debts at a time when there is a need for huge new capital investment. Geopolitical turmoil that raises interest rates–raises the cost of building new things–is bad news for a clean energy sector that the world needs to build out at unprecedented speed.
Shifting centers of geopolitical gravity
The third trend is shifting centers of geopolitical gravity. In a new age of power politics and multipolarity, the world is increasingly divided geopolitically and economically, putting into question the post-World War II multilateral system that has evolved to be seen as an instrument for driving climate action. New fault lines emerged between advanced economies and emerging markets, over financial transfers and what kind of technologies should be part of the transition, and new regional blocs and alliances are taking shape, creating a new set of narratives.
For example, Iran, Saudi Arabia, the United Arab Emirates, Argentina, Ethiopia, and Egypt have been invited to join the BRICS coalition, the formation of which began in 2008 to counter the Western-led G7. Now these six countries will be joining Brazil, Russia, India, China, and South Africa in what Reuters called “a push to reshuffle the World Order”. The growth of the BRICS coalition is one of many signs that the current multilateral system is evolving, and the center of gravity in geopolitics and on climate is shifting away from the West. Incidentally, Egypt has just hosted COP27, the UAE is up next for COP28, Brazil in 2030, while India and Brazil hold the G20 presidency in 2023 and 2024, respectively. Talks on which country will host COP29 have stalled over geopolitical division auguring future challenges to the consensus-based approach.
At COP27 in Egypt, developing countries gave a clear voice to their needs, including new timeframes beyond 2050 for decarbonization, putting energy security and energy access first, welcoming industry along with international and national oil companies to the table, and creating space for new technologies such as carbon capture and storage for industrial decarbonization and nuclear. These trends are likely to continue; in his letter to delegates ahead of COP Dr. Sultan Al Jaber, COP28 President, laid out four paradigm shifts focused on fast-tracking the energy transition with a comprehensive solutions set, elevating adaptation, fixing climate finance through fit-for-purpose international financial institutions, which include the Bretton Woods multilateral banks, and an inclusive COP that also involves the business and industry community.
Diversifying perspectives on climate will drive a more globally equitable approach to tackling the issues. Analysis has shown that over 90% of the research on the African energy transition was published after the 2015 Paris Agreement, and 60% was published between 2018 and 2021. And research has focused on a limited sub-set of African countries and technology pathways. This suggests that African countries could have entered the Paris Agreement with a limited knowledge base to inform their standing and the first nationally determined contributions (NDCs) commitments. A change to that paradigm should be welcome.
More fluidity in the international system will require countries to be more flexible in their approach, calling for smarter actors to push the limits of multilateralism. However, that does not necessarily mean that climate action will stall. It could, rather, advance through different fora and in different constellations, depending on the issue. In fact, climate emerges as a rallying factor — as it has under the Global Methane Pledge, with more than 150 countries having signed up to collective reduce methane emissions 30% by 2030.
A refocus on security
The fourth trend is a refocus on security – both of energy supplies and against other major powers. The conflict in Ukraine coupled with a global investment crunch has scrambled fossil fuel markets since 2022, with the G7 boycotting Russian oil and placing a price cap on shipments carried with Western financial and maritime services. The gas price spikes have also disrupted shipments of key ingredients for fertilizer, forcing countries to prioritize food security over long-term decarbonization plans.
It is against this background that the US government makes decisions like loaning $100 million to Indonesia for a new oil refinery, or approval new oil drilling projects in Alaska–and those are just examples from one country. In a quest to diversify away from Russian gas, European governments have pursued liquefied natural gas options. By the end of 2024, import capacity is expected to expand by 34% compared to 2021, mainly through additional floating storage and regasification units and expansion of existing facilities. Middle Eastern producers, Norway, and the US have become core suppliers. Coal production and consumption was up in 2022, but fell again in 2023, with Germany re-starting individual units, demonstrating volatility. Fossil fuel subsidies rose by $2 trillion to reach $7 trillion in 2022, and upstream oil and gas investment is expected to rise by 7% in 2023, reaching 2019 levels at a time when the world urgently needs to cut unabated fossil fuel consumption to reach its climate goals.
A refocus on security leads countries to turn to whatever seems most secure – and for policymakers in, say, Beijing or India, clean energy technologies can be a much safer bet than relying on constant shipments of foreign hydrocarbons. There’s been a record investment in clean energy to more than $1.7 trillion in 2023–that’s more than the $1 trillion being invested in fossil fuels this year. With the goal to keep greenhouse gases out of the atmosphere, clean energy additions are not happening fast enough. At the moment, concerns about energy security are boosting investment in all sorts of secure supply, whether Chinese-produced EVs that reduce reliance on oil imports, US LNG that replaces Russian pipeline gas, or US-produced batteries that are supposed to be built without Chinese minerals.
Taken together, these four trends paint a dim picture of the year ahead for climate action. But trends are not destiny. What policymakers at COP28 and – perhaps more importantly – what those focused on geopolitics and economics that stay home must realize is that foreign policy and economic policy are climate policy. We can no longer draw a line between climate and security. By understanding climate and decarbonization as a key piece of other priorities, policymakers can not only make climate action far more resilient to geopolitical trends, but also shape those trends to climate’s benefit, without sacrificing security or competitiveness.