20th century conversations about sustainability were often framed as «economy versus the environment». Many people would have agreed, back then, that it was important to protect the environment, but when push came to shove, economic factors like jobs, profits and shareholder value were limiting decision makers’ green ambitions. In today’s business world, hanging on to this outdated worldview is a recipe for disaster. In this Topic Brief, Professor Rolf Wüstenhagen explains why.

For more than a century following the industrial revolution, we have created wealth by burning fossil fuels. In all these years, there was a positive correlation between economic success (measured, for example, in terms of GDP) and carbon dioxide emissions. When scientists started warning that emitting greenhouse gases causes global warming, policy makers and corporate decision-makers were reluctant to take ambitious steps, as this seemed to go hand-in-hand with lower profits, or, worse still, an outright recession. But now, two fundamental changes indicate a complete reversal in the GDP-CO2 relationship.

The atmosphere is no longer a free garbage can

First, it is becoming increasingly clear that the costs of climate change can no longer be considered to be somehow “external” to corporate balance sheets or national accounts. Extreme weather events like the Australian bushfires in early 2020 are an illustration of the very real costs of climate change. For successful climate change mitigation, more and more countries are therefore internalizing the cost of emissions, thereby moving closer to the polluter-pays-principle.

The atmosphere is no longer a free garbage can, and companies that fail to reduce their emissions will have to foot the bill. In some jurisdictions, policymakers are still reluctant to adjust prices to environmental realities. But even there, more and more companies are preparing themselves for a carbon-constrained world, knowing that not preparing for the inevitable would be imprudent.

This is now being acknowledged by high-profile figures in the investment world. Larry Fink, the founder and chief executive of Blackrock, the world’s largest asset management firm, recently wrote to investors: “The evidence on climate risk is compelling investors to reassess core assumptions about modern finance.” And Mark Carney, previously governor of the Bank of England and now UN special envoy on climate finance, put it even more bluntly: “Companies that fail to respond to climate change will go bankrupt.”

Solar and wind have rapidly become the world’s cheapest energy sources

The second aspect that has changed the equation is the fundamental shift in relative costs of renewable and non-renewable energies that occurred over the past decade. In the United States, wind and solar power are now 69% and 88% cheaper than a decade ago. Similar trends can be observed around the world. In contrast, the cost of fossil-fueled and nuclear power generation tends to be increasing and now exceeds the cost of renewables in many countries. The cost curves of different energy technologies have reached a tipping point, implying that while in the early 2000s, investors would still have had to choose between reducing emissions and making profits, the clean solution is now increasingly the competitive solution, too.

Some observers point out that while wind and solar have become cheaper, their production profile also fluctuates with the weather. So building up a reliable electricity system with high shares of renewables requires complementary investments in storage or other sources of flexibility. These solutions, similar to solar and wind a decade ago, are now also progressing on the technology learning curve. Battery storage, in particular, is benefiting from the convergence of the electricity system and the transport sector: With the rise of electric mobility, car companies have started ramping up battery manufacturing capacities. This will inherently lead to lower cost, which can also make stationary battery storage more affordable. Furthermore, the electric cars themselves can serve as sources of flexibility in the system. When people drive to work and their car is connected to the grid during the day, the car’s battery can absorb some of the excess production of solar power on their employer’s roof, giving them an emissions-free ride home.

The question is not if clean energy will shape our future, but how fast

Some observers point out that while wind and solar have become cheaper, their production profile also fluctuates with the weather. So building up a reliable electricity system with high shares of renewables requires complementary investments in storage or other sources of flexibility. These solutions, similar to solar and wind a decade ago, are now also progressing on the technology learning curve. Battery storage, in particular, is benefiting from the convergence of the electricity system and the transport sector: With the rise of electric mobility, car companies have started ramping up battery manufacturing capacities. This will inherently lead to lower cost, which can also make stationary battery storage more affordable. Furthermore, the electric cars themselves can serve as sources of flexibility in the system. When people drive to work and their car is connected to the grid during the day, the car’s battery can absorb some of the excess production of solar power on their employer’s roof, giving them an emissions-free ride home.

With all the new technological opportunities for decarbonization of the energy and transport sectors and their favorable economics, the question is no longer if clean energy will shape our future, but how fast. This, in fact, turns out to be no trivial question, as three main tasks remain to be addressed: cognitive inertia, social acceptance, and climate resilience.

The first task is rooted in the nature of human psychology. We are creatures of habit, and do not easily give up long-held beliefs. Overcoming cognitive inertia is therefore the prime task for any executive trying to take advantage of the opportunities of decarbonization. Accepting the new realities has turned out to be challenging for many incumbent firms in the electric utility sector as solar power occurred on the fringes of their radar screen, and their peers in the automotive sector seem to have had similar struggles with the rise of electric mobility. Even where forward-looking CEOs are now working hard to reposition their firms, they may still face pockets of resistance within their organization. Armadas of engineers have built their careers around fossil-fuel related technologies, and will not easily let go of the skills and manufacturing excellence that they are proud of, even if deep inside they realize the time has come to move to new pastures. As Peter Drucker once put it, “culture eats strategy for breakfast”, so the importance of changing people’s minds inside the company and among its external stakeholders can hardly be overestimated.

The second task is social acceptance. Companies will only succeed in growing the market share of innovative low-carbon solutions if they convince their customers to tag along, and the same is true for political leaders with regard to their voters. There are two common traps here – first, engineering-driven companies might lack awareness for changing customer needs, and then be caught by surprise if a shiny new technological solution fails to be picked up on the market. Second, customers are human beings, too, and as such they might be just as prone to inertia as the companies. So understanding customers’ needs, and helping them to walk the talk, is an important ingredient of any low-carbon strategy. Similarly, policymakers should not mistake public sentiment for addressing the climate challenge for a guarantee that those same voters will also enthusiastically support implementation of low-carbon solutions. The rich literature on social acceptance of wind energy is a case in point here – implementing such projects requires careful local leadership, and is supported by appropriate levels of procedural and distributional justice.

The third and final task is to build climate resilience. Building up a cleaner energy and transport infrastructure is essential if we want to limit the consequences of global climate change. Given the time lags in the climate system, though, there is a component of change that is already inevitable. Designing resilient infrastructures is key to manage the physical risks that emerge from climate change. Railways are good for low-carbon travel, but they are also exposed to extreme weather events such as landslides or flooding. And then there is the financial dimension of carbon risk, too. As Mark Carney and others have repeatedly warned, the stability of financial markets might be at risk because of a looming carbon asset bubble due to overvalued fossil fuel companies. If large investors do not act fast enough on reducing their exposure to carbon risk, the repercussions would not be limited to the fossil fuel sector, but felt across the entire economy.

Therefore, acting now on clean energy is the ultimate path towards securing tomorrow’s freedom. It makes good business sense to invest in renewables. It is the right thing to do for future generations. But above all, failing to do so in a timely manner will severely constrain our degrees of freedom in the years to come.

Prof. Rolf Wüstenhagen