Diversification and cooperation in a de-carbonizing world: Climate strategies for fossil-fuel dependent countries

Countries’ attempts to tackle climate change will depend on their circumstances and coal-fired_power_plant_lundrim_aliu_world_bankcapabilities.  Among the most challenging, will be how fossil fuel–dependent countries (FFDCs) do so, given their economies are the most dependent on fossil-fuel income and carbon-intensive industries. These countries represent almost one-third of the world’s population. They are themselves responsible for roughly 20 percent of global greenhouse gas (GHG) emissions but are home to over 80 percent of emissions embodied in known fossil fuel reserves. Many also have foundational systems built on the back of (expected) fossil fuels and related value chains and are, therefore, at risk as the global low-carbon transition gets fully underway.

A new book “Diversification and Cooperation in a Decarbonizing World – Climate Strategies for Fossil Fuel–Dependent Countries” takes stock of what the decarbonization of the world economy means for FFDCs and explores how they can prepare for a future of permanent decline in global fossil fuel demand. This book is particularly relevant today, as countries respond to the COVID-19 crisis which offers once-in-a-generation moment for countries to shape sustainable and resilient growth pathways.

A composite indicator identified the countries least prepared for a low-carbon transition (see fig 1). These include Iraq, Libya, Venezuela, Equatorial Guinea, Nigeria, Iran, Guyana, Algeria, Azerbaijan and Kazakhstan. The Gulf Cooperation Council countries and Russia are borderline cases; often equally exposed, but benefitting from greater resilience thanks to their more complex economies.

This indicator and the book draw attention to the more vulnerable FFDCs, such as small oil and gas producers in sub-Saharan Africa, North Africa, Latin America, and the Middle East, that have not yet diversified their exports or undertaken a structural transition towards knowledge-intensive, low-carbon economic growth. Many also have to deal with widespread poverty, conflict and violence, have few options to attract investors and finance, and are among the most vulnerable countries to the impacts of climate change.

Countries’ Preparedness for a Low-carbon Transition
Figure 1 – Countries’ preparedness for a low-carbon transition

Uncertainties related to policy action in the rest of the world, consumption choices in developing countries, and technology tipping points complicate their decision making and requires broad scenario planning. Robust transition risk management strategies towards sustainable and resilient growth calls for FFDCs to apply two broad strategies.

First, diversification:
In the past, diversification efforts in resource rich countries traditionally focused on moving down the value chain to energy-intensive and polluting industries. This generated short-term export revenues and helped manage volatility in energy prices. But it also increased their dependency on carbon-intensive economic activities, and hence their exposure to the low-carbon transition in the rest of the world.

Another diversification pathway, emphasized in the book, is to support a broader diversification of wealth (assets) to pave the way for the productive and competitive economies that are also more flexible and resilient in the decarbonizing world. Countries whose income depends on narrow range of assets, such as fossil fuel reserves and emission intensive industries, need to build a more balanced portfolio of produced, human and natural capital.  They can do so by investing more in education and innovation, ecosystems services, and boosting their social capital and institutions.

Second, through climate cooperation:
Diversification alone is unlikely to trigger a low-carbon transition. Worse, climate action in net fuel importing countries could lead to so-called “dirty” diversification with the relocation of emission-intensive industries to FFDCs.

To decarbonize the world economy, domestic climate policies in FFDCs would be needed. They would help diversify assets and contribute to economic diversification. And they would protect FFDCs against the potential impacts of border taxes or broader trade sanctions that the rest of the world may decide to implement against countries with insufficient climate policies.

However, these policies have short-term costs and risks, and policymakers may find them hard to justify and implement. Solutions to this challenge include creative cooperative instruments, such as wellhead taxes and preferential trade agreements or wholesale conditional financial and technology transfers. These approaches could incentivize and facilitate climate cooperation from FFDCs, and also enable a more comprehensive structural transition than a retail, project-by-project, climate finance approach.

For both of these strategies, FFDCs will need to develop and implement plans that account for a just transition for affected communities particularly in the coal-dependent regions who will be the first affected by a low carbon transition, including through re-training, re-tooling and targeted social protection.

Modelling simulations show that if fuel importers and exporters together apply innovative cooperative strategies, most oil and gas rich countries can have sufficient revenues and incentives to make the transition to a low-carbon economy without sacrificing living standards, and have the resources needed to discover new drivers of sustainable development while supporting the people negatively affected by the transition.

Going forward
This book identifies strategies for FFDCs that strike a balance between managing their traditional, carbon-intensive assets and shaping the transition to sustainable growth models relying on a much broader portfolios of assets and technologies. These strategies could enable FFDCs to create economies that are not only less exposed to declines in fossil fuel demand but also better able to prosper in a cleaner, more sustainable and resilient twenty first century.