Editing IPCC:AR6/WGIII/Chapter-15 (section)

=== 15.3.3 Fossil Fuel-related and Transition Finance ===

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As called for by Article 2.1c of the Paris Agreement and introduced in [[#15.3.1|Section 15.3.1]] , achieving the goal of the Paris Agreement of holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels requires making all finance consistent with this goal. Data on investments and financing to high GHG activities remain very partial and difficult to access, as relevant actors currently have little incentive or obligations to disclose such information compared to reporting on and communicating about their activities contributing to climate action. Further, the development of methodologies to assess finance for activities misaligned with climate mitigation goals, for hard- and costly-to-abate sectors such as heavy industries, as well as for activities that eventually need to be phased out but can play a transition role for a given period, remain work in progress. This results in limited empirical evidence to date.

In modelled pathways that limit warming to 1.5°C (&gt;50%) with no or limited overshoot, however, make it clear that the share of fossil fuels in energy supply has to decrease (see Chapter 3). For instance, the International Energy Agency (IEA) Net Zero by 2050 scenario relies on halting sales of new internal combustion engine passenger cars by 2035, rapid and steady decrease of the production of coal (minus 90%), oil (minus 75%) and natural gas (minus 55%) by 2050, and phasing out all unabated coal and oil power plants by 2040 ( [[#IEA--2021b|IEA 2021b]] ). To avoid locking GHG emissions incompatible with remaining carbon budgets, this implies a rapid scaling down of new fossil fuel-related investments, combined with a scaling up of financing to allow energy and infrastructure systems to transition ( ''hi'' ''gh confidence'' ).

The IEA provides comprehensive analyses of global energy investments, estimated at about USD1.8 trillion a year over 2017–2019 ( [[#IEA--2019a|IEA 2019a]] , 2020a), and expected to reach that level again in 2021 after a drop to about 1.6 trillion in 2020 ( [[#IEA--2021c|IEA 2021c]] ). Energy investments represent about 8% of global GFCF ( [[#15.3.2|Section 15.3.2]] .1). In the power sector, fossil fuel-related investments reached an estimated USD120 billion yr –1 on average over 2019–2020, which remains well above the level that underpin the IEA’s own Paris-compatible Sustainable Development Scenario (SDS) and Net Zero Emission (NZE) scenarios. The IEA observes a similar inconsistency for supply-side new investments: in 2019–2020 on average yr –1 , an estimated USD650 billion were invested in oil supply and close to USD100 billion in coal supply. These estimates also result in fossil fuel investments remaining larger in aggregate than the total tracked climate finance worldwide ( [[#15.3.2|Section 15.3.2]] .2). For oil and gas companies, which are amongst the world’s largest corporations and sometimes government owned or backed, low-carbon solutions are estimated to represent less than 1% of capital expenditure ( [[#IEA--2020b|IEA 2020b]] ). As discussed in the remainder of this chapter, shifting investments towards low-GHG solutions requires a combination of conducive public policies, attractive investment opportunities, as well as the availability of financing to finance such a transition.

In terms of financing provided to fossil fuel investments, available analyses point out a still significant role played by commercial banks and export credit agencies. Commercial banks provide both direct lending as well as underwriting services, the latter facilitating capital raising from investors in the form of bond or share issuance. Available estimates indicate that lending and underwriting extended over 2016– 2019 by 35 of the world’s largest banks to 2100 companies active across the fossil fuel lifecycle reached USD687 billion yr –1 on average (Rainforest Action Network et al. 2020). Official export credit agencies, which are owned or backed by their government, de-risk exports by providing guarantees and insurances or, less often, loans. In 2016–2018, available estimates indicate the provision of about USD31 billion yr –1 worth of fossil fuel-related official export credits, out of which close to 80% was for oil and gas, and over 20% for coal ( [[#DeAngelis--2020|DeAngelis and Tucker 2020]] ).

Finance for new fossil fuel-related assets lock in future GHG emissions that may be inconsistent with remaining carbon budgets and, as discussed above, with emission pathways to reach the Paris Agreement goals. This inconsistency exposes investors and asset owners to the risk of stranded assets, which results from potential sharp strengthening climate public policies, that is, transition risk. As a result, a growing number of investors and financiers are assessing climate-related risks with the aim to disclose information about their current level of exposure (to both transition and physical climate-related risks), as well as to inform their future decisions ( [[#TCFD--2017|TCFD 2017]] ). Reporting to date is, however, inconsistent across geographies and jurisdictions ( [[#CDSB%20and%20CDP--2018|CDSB and CDP 2018]] ; [[#Perera--2019|Perera et al. 2019]] ), with also a wide variety of metrics, methodologies, and approaches developed by commercial providers that contribute to disparate outcomes ( [[#Kotsantonis--2019|Kotsantonis and Serafeim 2019]] ; [[#Boffo--2020|Boffo and Patalano 2020]] ). Further, as developed in [[#15.6.1|Section 15.6.1]] , there is currently not enough evidence in order to conclude whether climate-related risk assessments result in increased climate action and alignment with the goals of the Paris Agreement ( [[#The%202°%20Investing%20Initiative%20and%20Wüest%20Partner--2020|The 2° Investing Initiative and Wüest Partner 2020]] ).

As developed in [[#15.6.3|Section 15.6.3]] , the insufficient level of ambition and coherence of public policies at national and international levels remains the root cause of the still significant misalignment of investment and financing compared to pathways compatible with the Paris Agreement temperature goal ( [[#UNEP--2018|UNEP 2018]] ). Such lack of coherence includes low pricing of carbon and of environmental externalities more generally, as well as misaligned policies in non-climate policy areas such as fiscal, trade, industrial and investment policy, and financial regulation ( [[#OECD--2015b|OECD 2015b]] ), as further specified in the sectoral Chapters 6 to 12.

The most documented policy misalignment relates to the remaining very large scale of public direct and indirect financial support for fossil fuel-related production and consumption in many parts of the world ( [[#Bast--2015|Bast et al. 2015]] ; [[#Coady--2017|Coady et al. 2017]] ; [[#Climate%20Transparency--2020|Climate Transparency 2020]] ). Fossil fuel subsidies are embedded across economic sectors as well as policy areas, for example, from a trade policy perspective, in most countries, import tariffs and non-tariff barriers are substantially lower on relatively more CO 2 intensive industries ( [[#Shapiro--2020|Shapiro 2020]] ). Available inventories of fossil fuel subsidies (in the form of direct budgetary transfers, revenue forgone, risk transfers, or induced transfers), covering 76 economies, indicate a rise to USD340 billion in 2017, a 5% increase compared to 2016. Such trend is due to slowed down progress in reducing support among OECD and G20 economies in 2017 ( [[#OECD--2018b|OECD 2018b]] ) and to a rise in fossil fuel subsidies for consumption in several developing economies ( [[#Matsumura--2019|Matsumura and Adam 2019]] ), which, in turn, reduces the efficiency of public instruments and incentives aimed at redirecting investments and financing towards low-GHG activities.

As a result, the demand for fossil fuels, especially in the energy production, transport and buildings sectors, remain high, and the risk-return profile of fossil fuel-related investments is still positive in many instance ( [[#Hanif--2019|Hanif et al. 2019]] ). Political economy constraints of fossil fuel subsidy reform continue to be a major hurdle for climate action ( [[#Schwanitz--2014|Schwanitz et al. 2014]] ; [[#Röttgers--2018|Röttgers and Anderson 2018]] ), as further discussed in [[#15.5.2|Section 15.5.2]] . and Chapter 13.

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