In partnership with Continuum Economics


COVID-19: the green recovery at risk

Rebuilding better post-COVID-19, and especially rebuilding greener, has been presented as an opportunity by most international institutions, especially the EU. The economic case for a green recovery is based on job creation and ultimately cheaper energy costs, with few disputing its validity. Yet the fiscal burden of addressing the COVID-19 crisis has meant that by end-2020, less than half of the Paris Agreement’s signatories had delivered on its core provisions - to raise the ambition of their contributions towards achieving the goal of limiting the global average temperature increase to 1.5 degrees above pre-industrial levels. Prospects of a post-COVID-19 green recovery have dimmed for five reasons:

  1. The COVID-19 recession has made fossil fuels cheaper
  2. Investment in clean technologies is costly, especially at a time when a COVID-19-driven drop in demand bites
  3. Protectionism in raw materials that are essential to green technologies could rise
  4. 50% of EM (emerging markets) which converged towards DM (developed markets) incomes over the last decade will diverge in 2020-22, and an environment/inequality trade-off becomes a salient political issue in EM
  5. Beyond China’s rhetoric of net-zero carbon emissions by 2060, it approved more new coal power plants in H1 2020 than any year since 2015.

One year into COVID-19, while a global, if uneven recovery is underway, there is little evidence that it is primarily green, quite the contrary. From the beginning of the pandemic to January 2021, G-20 nations dedicated almost USD 240 billion of recovery funds towards supporting fossil fuel energy compared to USD 180 billion for clean energy, most of which was accounted for by the US and UK. In 2020, while COVID-19 had the benefit of reducing global emissions by more than 7% through a one-off, involuntary reduction in economic activity, this pace of reduction is required on a yearly basis until 2030 to keep within reach the Paris agreement’s commitment of limiting the global average temperature increase to 1.5 degrees above pre-industrial levels. The challenge is not small. The case for a green recovery has been made ad nauseum; hence it is only reiterated briefly here. The economy would benefit in the short term through the creation of many high-paying jobs in clean-energy infrastructure, wind and solar facilities, electric vehicle charging stations, hydrogen production plants, and in new programmes to retrofit buildings for energy efficiency. Better still, over the long term, all of these investments should result in lower energy costs (the costs of clean-energy technologies have already been falling rapidly), more resilient energy systems, and a healthier population. McKinsey finds that the speed of decarbonisation depends on the availability of mature technology and the ability to scale supply chains, implying this speed will be sector-specific, with power and transportation the fastest, while agriculture and industry will lag.

Aon insights

The shift in oil majors divesting their large oil and gas projects in favour of wind, solar and electric production has been well documented as the industry makes a concerted move towards greener investments/projects. The market has a growing appetite for this type of risk as it too is keen to play its part in the energy transition. Following the divestiture of assets, we have seen an uptick in second-tier firms acquiring these assets and looking to protect their investments in certain countries. Large private pension and hedge funds have also moved into the green energy space with significant investments in emerging economies’ power purchase agreements (PPAs). As much of the world emerges from COVID 19’s stranglehold, there has been an increase in the renegotiations of PPAs and new opportunities arising in emerging markets. Political risk can protect investors and typically comes as arbitration award default cover. There is still interest in the market for oil and gas projects, and political risk cover can protect both the assets used in the extraction/production and the investments in these projects. Sarah Taylor Head of Political Risks and Structured Credit Global Broking Centre, Aon

On the upside, the EU’s determination to push through its green agenda, China’s commitment to achieving net-zero carbon emissions by 2060, and new US President Joe Biden’s strong endorsement of climate change mitigation create a global high-level coalition that has a chance to deliver on climate change.

Even poorer countries like Egypt, Pakistan, Bangladesh, and Vietnam have pledged to ensure a green recovery. Perhaps the most striking evidence of the green agenda taking over in EM comes from Russia, which has long been a laggard in the environmental space. Following the May 2020 environmental disaster at Norilsk in Russia’s far north, where millions of tonnes of oil were spilt into the ecosystem, causing billions of dollars in damage, both the government and corporations have started to put ESG standards on the agenda. An Arctic plan was released in 2020, and senior Kremlin official Anatoly Chubais, who is an effective administrator, has been appointed the Green Tsar.

After the Norwegian sovereign wealth fund banned investment into companies with poor ESG scores in October, some of Russia’s blue-chip companies lost up to a third of their shareholders, prompting Norilsk Nickel to invest USD 3 billion in a clean-up operation and to plan for more. Since then, Russian companies have started hiring sustainability officers and attempting to go green to attract investment.

Still, there are five causes for concern in 2021. First, the COVID-19-induced recession means that fossil fuels have become relatively cheap, providing less incentive to transition to green energy. While carbon allowance prices have rebounded since their early drop at the start of the pandemic, they are still well below the USD 50-100/ton mark, which is needed to bring forward the massive low carbon investment required for mitigation. At the same time, oil majors have come to recognise the benefits of long-term stability of cash flows from renewables, which are reflected in BP’s plans to add 50 gigawatts of renewable energy capacity by 2030. Renewables provide a hedge against oil price volatility and a response to pressures from institutional investors for environmental, social, and governance (ESG) standards. Yet funding a shift to green technologies is costly. This second cause for concern is illustrated by South African state electricity provider Eskom, whose management has announced that solar power generation is affecting its costs and efficiency as well as its revenues, forcing it to make changes to its structure. Overall, while the costs of green technologies are gradually moderating, it is hard for companies to find the resources to devote to clean technologies when they are fighting the economic consequences of a pandemic, and fossil fuels remain a convenient, cheaper option.

Figure 1 Global energy-related CO2 emissions by sector


Source: Continuum Economics, IEA

“The COVID-19-induced recession means that fossil fuels have become relatively cheap, providing less incentive to transition to green energy. ”

Aon insights

COVID-19 has proved to be a destructive catalyst for less resilient and more rigid business models within the energy and power sectors, and an enabler of the pre-existing trend towards decarbonization. It has reinforced the realisation that the energy transition must be driven as much by the energy community as consumers – underpinned by strong government incentives. However, the roadmap will have significant shaping costs, and it will be important to measure its impact across various stakeholders, including communities. Investment, and who will cover the costs, will be an important item on the agenda. While a complete shift away from fossil fuels is unlikely in the short-term, rising levels of low carbon intensity oil and gas production and more robust transition supply chains are on the horizon. Refineries are already considering a switch to renewable hydrogen to produce heat, increase integration with petrochemicals for the materials of the transition, and produce fuels to support increasingly efficient engines. While the pandemic may have stalled some of the momentum apparent in the transition, there is inevitability in the direction of travel. Luis Fragoso Deputy Director Energy and Power Aon

Figure 2 The COVID-19: winners and losers

Source: Continuum Economics, Bloomberg

Note: Comparisons are 4Q - 4Q. Pre-Covid-end 2019. India data for fiscal year.

Third, a green recovery requires imports of specific raw materials for batteries and other clean technologies. While COVID-19 protectionism is more evident with respect to vaccines and food, it could also apply to the raw materials for a green economy, especially raw materials for batteries. The risk of expropriation looms large in EMs and Continuum Economics' Country Insights model captures it through its Political Interference risk icon, pointing to two countries that are particularly likely to disrupt the supply of green raw materials. The model classifies Bolivia, which has a quarter of the world’s lithium deposits, and the Democratic Republic of Congo, which dominates cobalt production, as presenting very-high political interference risk, as the risk of expropriation in both countries is real. While Russia, which produces cobalt, nickel, and graphite, is only ranked as having medium-high risk of political interference, recently the risk of expropriation has increased given President Vladimir Putin’s rising protectionism in general. Similarly, while China’s political interference risk is ranked medium-high, its production of graphite, lithium, cobalt, and nickel could become a political weapon in the post-COVID-19 context. While Indonesia, which is the world’s largest producer of mined nickel, presents medium political interference risk, it has a history of asset nationalisation in the mining industry, which suggests caution. Finally, as the second-largest lithium producer, Chile is another country on the list of green raw material producers, though it is not covered in the Country Insights model. While it presents a low risk of expropriation in general given the historic behaviour of its governments, a recent increase in social instability should be monitored closely.

Fourth, 2020 data reveal the fiscal and growth costs created by COVID-19, which are overwhelming the poorest EMs, while China and the US are recovering swiftly. According to the IMF, over 50% of the EMs that were converging towards DMs per capita incomes over the last decade are expected to diverge over 2020-22 due to COVID-19. This trend represents a threat to mitigation goals. As we have noted before, increased perceptions of a trade-off between mitigation and income inequality accelerated by COVID-19 are likely to mean that there is declining buy-in from EMs for mitigation, with fears of civil unrest amongst the factors holding it up. Out of 160 countries tracked by the Climate Vulnerable Forum’s Climate Survival Leadership Barometer, in 2020, 87 countries promised but failed to submit stronger Nationally Determined Contribution targets. Especially if vaccines do not make it to large parts of the EM universe in H2 2021, climate change mitigation could end up being delayed until 2022-23 for lack of resources. And DMs are unlikely to make income transfers to EMs to finance their mitigation, as DMs fast recovery has been engineered through an unsustainable explosion of DM debt, which reduces their ability/willingness to fund EM mitigation. The fifth concern is China’s commitment to its net-zero carbon emissions goal by 2060. Investments in the Belt and Road Initiative are a good gauge of the direction of Chinese investment allocation, bearing in mind that these investments as a whole have dropped 54% y/y in 2020. While renewable power accounted for the bulk of China’s Belt and Road Initiative in 2020 at 57% of investments, rising from 38% in 2019, coal investments took up a larger portion of China’s USD 20 billion total of energy investments from 15% in 2018 to 27% last year. Within China itself, there also seems to be a mixed investment profile, whereby China installed 120 gigawatts of wind and solar power in 2020, nearly four times the UK’s installed capacity, but it also approved more new coal power plants in H1 2020 than any year since 2015, based on the fact that coal is a cheap source of energy and one that fulfils China’s concern with national security. In Continuum Economics' view, the technological change that underpins green industries is not happening fast enough to displace coal. Even in the EU, McKinsey estimates that from now until 2030, 75% of abatement would be achieved by expanding mature and early-adoption technologies such as heat pumps in buildings, heat cascading in industry and electric vehicles, but continued innovation and scale effects will be important to drive down transition costs. This brings us back to the challenge of climate change mitigation for EMs at large: what coal represents is fast and easy real GDP growth rates, which EMs are not entirely keen to jeopardise in the short run, especially not after the shock of a pandemic. Yet China is central to the mitigation agenda, both as it has accounted for two-thirds of growth in emissions in the past two decades and on the basis of its demonstration effect for other EMs. In that perspective, the champions of a green global economy will have to be patient, as China works its way through a long transition.

About the map and the methodology