## Energy Transition and Geoeconomic Fragmentation: Implications for Climate Scenario Design

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### Introduction — Context and the “Polycrisis”
- Definition quoted: “crises in multiple global systems become causally entangled in ways that significantly degrade humanity’s prospects.”
- Key shocks and policy responses:
  - Supply chain disruptions originating during the pandemic contributed to a resurgence of inflation.
  - Russia’s invasion of Ukraine (February 2022) and “weaponization of energy supply” renewed energy security priorities and affected climate mitigation policies.
  - European Commission’s REPowerEU plan aims to increase the share of renewable energy in final energy to 45 percent by 2030 (exceeding the 40 percent target previously under negotiation).
  - Europe’s liquefied natural gas (LNG) import capacity is expected to grow by 34 percent between 2022 and 2024.
- Central questions raised:
  - Structural implications of the polycrisis for energy and climate policies.
  - How to design climate-risk scenarios that accommodate this new reality.
  - The extent to which hypothetical transition scenarios (for example, NGFS) are questioned given growing prominence of energy security over climate mitigation.

### Climate scenarios and user needs
- Role and scale:
  - Climate scenarios depict plausible pathways under alternative socioeconomic, technological, and policy conditions.
  - IPCC Fifth Assessment Report (2014): 31 models and 1,184 scenarios.
  - IPCC Sixth Assessment Report (2022): 3,131 scenarios derived from 188 models.
- Use-case alignment:
  - Traditional use: informing climate policies.
  - Growing use: assessing alignment of government policies and private-sector strategies; demand from central banks, supervisors, financial institutions, and companies.
- Design considerations:
  - Time horizon and resolution must match use case: IPCC scenarios typically run in 5- to-10-year time steps to end-century; financial risk assessments require 1–5 year detail.
  - Key features to tailor: time horizon; geographical and sectoral resolution; modeling structure and variables; economic, energy, and climate policies; speed and form of transition.

### Implications of the polycrisis for decarbonization and the energy transition
- Broad impacts:
  - Increased likelihood of carbon lock-in in infrastructure and policy and higher probability of a less gradual and/or more “disorderly” transition.
  - Decreased likelihood of continuous cost reduction of low-carbon versus carbon-intensive energy observed in the past decade.
  - Interaction of geoeconomic fragmentation with intensified macroeconomic shocks and policy responses.
- Specific statistics and trends:
  - In 2022–23, the energy transition was anticipated to suffer a setback and possibly partial reversal as energy security regained prominence over climate objectives.
  - Prices of all major commodity groups remain above their 2015–19 average levels.
  - Aggregate energy investment trends:
    - Investment in unabated fossil fuel supply is set to rise by more than 6 percent in 2023, reaching an estimated $950 billion (IEA 2023a).
    - Capital expenditure forecasts for new oil and gas fields remain high in EMDEs, accounting for roughly 75 percent and 95 percent of energy industry investments by 2030 and 2050, respectively (IMF 2023b).
  - Net-zero target timing cited:
    - Net zero by 2050: European Union, Japan, South Korea, the United Kingdom, and the United States.
    - Net zero by 2060: China.
    - Net zero no later than 2060: Russia.
    - Net zero by 2070: India.
- Emissions trajectory and risk:
  - Net-zero pledges are often long-term and not always accompanied by concrete near-term commitments.
  - A concave emission reduction curve (“humped curve”) implies much higher cumulative emissions, raising the probability of a disorderly transition and increased physical risks (including higher likelihood of crossing climate tipping points).
- Industry behavior:
  - Despite increased renewable investment, strong investment in fossil fuels continues—consistent with a “symbiotic” relationship among energy sources.
  - IEA Net Zero by 2050 Roadmap: beyond projects already committed as of 2021, no new oil and gas fields can be approved and no new coal mines/extensions are required to achieve net zero CO2 emissions by 2050.
  - Oil and gas companies’ low-carbon investment remains an extremely limited share of overall capital expenditures; investment is increasingly anticipated for decarbonization of operations (for example, carbon capture, utilization, and storage) rather than diversification into power generation.

### Scenario-design and policy-relevant adjustments suggested
- Scenario features to better reflect the polycrisis:
  - Capture carbon lock-in: increase near-term GHG emissions, increase fossil fuel investment, delay climate policy development and implementation.
  - Make downward adjustments to renewable technology deployment and diffusion because of high policy rates and supply chain constraints on critical minerals.
  - Incorporate macroeconomic impacts into short-term scenarios: higher-for-longer policy rates, tightening credit standards, high inflation, reduced fiscal space.
  - Develop long-term scenarios reflecting emerging geoeconomic fragmentation and constraints to trade multilateralism.
- Focus of analysis:
  - Emphasize non-central (tail / heightened transition risk) pathways and channels through which the polycrisis affects climate-relevant variables.
  - Scenarios presented are hypothetical and do not reflect IMF expectations.

### Heterogeneous regional short-term impacts (selected)
- European Union:
  - REPowerEU (May 2022) builds on Fit for 55 and targets 45 percent renewables by 2030; faces supply security, slower fossil-fuel demand deceleration, and needs for flexibility in energy systems.
- United States:
  - Inflation Reduction Act (August 2022) aims to reduce GHG emissions by 40 percent by 2030 and disburses around $370 billion for energy security and clean energy measures (including carbon capture projects); includes a Methane Emissions Reduction Program.
- Asia:
  - Polycrisis drove up crude oil and natural gas prices, food inflation, and manufacturing costs; energy crisis may have derailed development progress, including access to affordable and clean energy.
- Central and Latin America:
  - Impacts vary between oil exporters and net importers; fuel pricing policy and competition for US LNG imports could create vulnerabilities; oil exploration increases in region (notably Brazil, Guyana, Suriname).
- Africa:
  - Polycrisis likely exacerbates energy poverty, constrains financial support for transition, harms electricity markets and renewable projects, and spurs mining investment for supply diversification.

### Carbon lock-in drivers and renewable prospects (Box 3 highlights)
- Investment and lock-in:
  - Investments in renewable energy have increased and now represent a 1.5-to-1 ratio with fossil fuels.
  - Large gap remains between current trends and investment required for the Net Zero Emissions by 2050 Scenario.
  - Renewable investments concentrated in China, European Union, Japan, and the United States.
  - Coal-fired power generation hit an all-time high in 2022 with rebound expected to persist in 2023; final investment decisions for unabated gas-fired power rose in 2022.
- Historic cost declines (2015–2020):
  - –56 percent for solar
  - –45 percent for wind
  - –64 percent for batteries
  - Capacity increases: +170 percent for solar and +70 percent for wind
- Sensitivity to higher interest rates (LCOE impacts cited from Schmidt and others 2019):
  - Solar photovoltaics LCOE would increase by 11 percent with interest rates in the 4 to 4.5 percent range, rather than close to zero.
  - Onshore wind LCOE would increase by 25 percent under the same interest-rate shift.
  - LCOE of a gas-fired power plant would rise by around 4 percent if interest rates were to rise from 3 percent to 7 percent.
  - LCOE of offshore wind and solar photovoltaic technologies would rise by more than 30 percent.
- Supply constraints for critical minerals:
  - Critical minerals include lithium, cobalt, copper, zinc, iron ore, aluminum, nickel, silicon, silver, platinum, palladium, manganese, graphite, rare earths.
  - Lithium demand rose by 300 percent between 2017 and 2022; cobalt demand by 70 percent; nickel demand by 40 percent.
  - Top three countries accounted for almost 90 percent of rare earths, graphite, and lithium supplies in 2022, and more than 60 percent of cobalt and nickel supplies.
  - Potential bottlenecks: copper, nickel, cobalt, lithium.
  - Material price surge since start of 2021 (accelerated since the Russian invasion of Ukraine) threatens the decades-long trend of falling costs for clean energy technologies.

### Macroeconomic, financial, and trade channels amplifying lock-in
- Monetary policy and macro shocks:
  - Massive and synchronized tightening of monetary policy in response to supply disruptions and war-related energy price surge.
  - Higher policy interest rates could reduce expected demand and productive investment, trigger capital outflows (especially in EMDEs), and hinder resources for the transition.
  - Historic monetary tightening has produced strains in the global financial system; tightening credit standards and decline in credit growth could dampen investment and innovation.
  - Higher interest rates favor oil majors and national oil companies because of large cash equivalents and long-duration fixed-rate debt at relatively low rates.
- Capital flows and fiscal policy:
  - Geopolitical tensions and misaligned climate commitments can reduce cross-border capital flows and raise borrowing costs.
  - Public debt expanded globally; increased military spending may reduce fiscal space.
  - Windfall taxes on renewable producers (example cited: 90 percent in Germany, temporary) can disincentivize renewables investment.
- Trade and industrial policy:
  - Friend-shoring and domestic content requirements can raise costs and delay technology diffusion.
  - Lack of cooperation on transition-critical minerals could constrain global decarbonization by raising prices and limiting access.

### Scenario-design improvements and modeling guidance (recommendations)
- Near-term updates and recalibration:
  - Regularly update model base years and near-term emissions trajectories to reflect post-2020 deviations and increased likelihood of disorderly transition.
  - Calibrate emissions between 2020 and 2023 to capture COVID-19 impact in 2020 and subsequent rebound.
- Capture carbon lock-in and fossil-fuel investment:
  - Reflect increased fossil energy investment since 2020 in historical periods and current policy assumptions.
  - Integrate exogenous investment paths toward fossil-fuel–based assets and properly vintaging fossil fuel–based assets (lifetime, retirement curves, capital and operating expenditures).
  - Incorporate fossil fuel producers’ economic and financial strategies (for example, strategic extraction, withholding exploration).
- Renewable and mineral constraints:
  - Adjust assumptions for slower renewable diffusion due to slower cost/efficiency improvement, constrained critical mineral supply, slowdown in investment from higher policy rates.
  - Explicitly model critical minerals: add supply curves and mineral trade; develop material sectors and link critical mineral supply and demand; where not possible, apply postprocessing feasibility checks.
- Macroeconomic and policy channels in short-term scenarios:
  - Adjust financial variable assumptions (short-term rates, risk premiums, lending conditions) for high inflation and high policy rates.
  - Reflect fiscal implications (higher deficits, constrained fiscal space) through macro variables and their effects on low-carbon investment.
- Trade, industrial policy, and geoeconomic fragmentation:
  - Adjust sectoral and bilateral trade flows, technology costs, and delays in technology transfer to reflect reduced cooperation and fragmentation (for example, Carbon Border Adjustment Mechanism, domestic content requirements).
- New scenario narratives:
  - Consider SSP3 (“Regional Rivalry”) and SSP4 (“A Road Divided”) in addition to SSP2 for narratives with resurgent nationalism, inequality, and mixed investment patterns.
  - Proposed new scenario: “Carbon Lock-in and Cascading Impacts” — narrative assumes increased fossil fuel assets result in carbon lock-in, higher transition and physical risks, tighter fiscal budgets, higher risk premiums, and supply chain pressures slowing technology diffusion.
- Modeling guidance:
  - Use computable general equilibrium models for sectoral granularity; ensure IAMs and energy models include detailed vintage and turnover parameters.
  - Even without explicit mineral modules, check feasibility of technology deployment against mineral supply constraints.

### Feedback effects between physical and transition risks (Annex 3 highlights)
- Overlapping transmission channels and feedback loops can create vicious cycles and amplify tail risks.
- Physical risk trends:
  - Increased frequency/intensity of hot extremes, heavy precipitation, marine heatwaves, agricultural and ecological droughts, higher proportion of intense tropical cyclones, reductions in sea ice, snow cover, and permafrost.
  - Many changes (ocean, ice sheets, sea level) are irreversible for centuries to millennia.
- Underestimation issues:
  - Physical risks are underestimated when tipping points, compound events, and recent climate variability (for example, El Niño onset) are not incorporated.
  - Example: as of October 23, 2023, Canadian wildfires had generated about three times as many emissions as Canada’s annual fossil fuel use—implications often overlooked in short-term scenarios.
- Economic and financial consequences:
  - Physical risks can increase food prices and inflation, tighten fiscal budgets, heighten risk premiums, and constrain supply chains.
  - Insurance market responses: large US insurers scaled back homeowner policies in vulnerable areas in 2023; ECB and EIOPA warned premiums are likely to rise and/or coverage to fall, widening the protection gap.
  - Potential credit risks from mismatches between long-term mortgages and annually renewed insurance policies.
- Research and scenario-design recommendations:
  - Integrate transition and physical risks coherently; incorporate tipping points, nonlinearities, aerosol dynamics, and geoengineering considerations.
  - Include recent climate variability and events in short-term scenarios.
  - Explore compounding risks and model chains of events (for example, drought amplifying flood impacts).
  - Account for heterogeneity in adaptive capacities across regions and temporal dynamics.

### Conclusions — Major findings and prioritized recommendations
- Major findings:
  - Post-COVID recovery and the Russian invasion of Ukraine materially weakened decarbonization momentum; geopolitical fragmentation and simultaneous crises increase risk of deviation from 1.5°C-consistent pathways and from countries’ own commitments.
  - Policy choices to replace Russian supply have increased carbon lock-in and inertia of fossil-fuel systems.
  - Renewables face headwinds: higher upfront capital intensity and sensitivity to high interest rates; geoeconomic fragmentation and critical mineral supply constraints; permitting and social constraints (“NIMBY-ism”).
  - Combined macroeconomic and geopolitical stressors (high inflation and policy rates; potential credit crunch; high public debts and fiscal deficits; trade disruptions; lower global growth) make the transition more disorderly, especially in EMDEs.
- Climate scenario deficiencies:
  - Current scenarios (including NGFS) have not fully incorporated short- and long-term implications of the polycrisis: carbon lock-in, delayed policy implementation, less optimistic renewable pathways, and macrofinancial effects.
  - Need to reflect geopolitical fragmentation, lower growth, and rising inequalities in narratives.
- Priority recommendations to upscale scenario design:
  - Adjust near-term emissions to reflect carbon lock-in and recent fossil investment.
  - Explicitly build in recent fossil energy investment and policy-development delays.
  - Consider less optimistic renewable pathways (downward adjustments on cost/efficiency improvements; supply chain constraints; slowdown in new investment).
  - Capture macroeconomic and macrofinancial implications in short-term scenarios (high inflation and policy rates, potential credit crunch, high public debts and fiscal deficits, trade constraints).
  - Develop new scenario narratives that incorporate geopolitical fragmentation, lower global growth, and rising inequalities.
  - Advance technical modeling capabilities (for example, fragmented commodity markets) and integrate interactions between physical and transition risks because a more disorderly transition implies higher peaking temperatures and higher physical risks with cascading economic impacts.

_Italic source: IMF staff (clnea2023003)._

### Introduction

### Introduction

### Context and the “Polycrisis”
- The global economic recovery from the COVID-19 crisis has been marred by the joint occurrence of several subsequent shocks that are partly interrelated, described in the literature as a “polycrisis” (definition quoted: “crises in multiple global systems become causally entangled in ways that significantly degrade humanity’s prospects”).
- Key shocks and responses noted:
  - Supply chain disruptions originated during the pandemic; while largely subsided, they contributed to a resurgence of inflation to levels not seen for decades.
  - Russia’s invasion of Ukraine in February 2022 and the associated weaponization of energy supply led to renewed prioritization of energy security, with mixed effects on climate mitigation policies.
  - Example policy reaction: the European Commission’s REPowerEU plan aims to increase the share of renewable energy in final energy to 45 percent by 2030, exceeding the 40 percent target previously under negotiation.
  - Europe’s liquefied natural gas (LNG) import capacity is expected to grow by 34 percent between 2022 and 2024.
- The polycrisis raises central questions:
  - What are the structural implications of the polycrisis for energy and climate policies?
  - How should the design of climate-risk scenarios accommodate this new reality?
  - To what extent are hypothetical transition scenarios (for example, those by the Network for Greening the Financial System [NGFS]) being questioned given growing prominence of energy security over climate mitigation?

### Climate Scenarios and Use Cases (Box 1)
- Climate scenarios depict plausible pathways for human and Earth system transitions under alternative socioeconomic, technological, and policy conditions.
- Historical scale of scenario databases:
  - IPCC Fifth Assessment Report (2014): 31 models and 1,184 scenarios.
  - IPCC Sixth Assessment Report (2022): 3,131 scenarios derived from 188 models.
- Scenario users and needs:
  - Traditional use: informing climate policies.
  - Growing use: assessing alignment of government policies and private sector strategies with emissions and temperature targets.
  - Increasing demand from central banks, supervisors, financial institutions, and companies to use climate scenarios to assess climate-related financial risks and opportunities.
- Scenario design considerations and time horizons:
  - IPCC scenarios usually run in a 5- to- 10-year time step through the end of the century and focus on energy system transition and emissions pathways.
  - Climate scenarios for financial risk assessment must align with business and investment cycles (usually one to five years) and require further short-term detail.
  - Key scenario features to tailor to use cases include time horizon; geographical and sectoral resolution; modeling structure and variables; economic, energy, and climate policies; and the speed and form of the transition.

### Implications of the Polycrisis for Decarbonization and the Energy Transition
- Broad impacts identified:
  - Increased likelihood of carbon lock-in in both infrastructure and policy and a higher probability of a less gradual and/or more “disorderly” transition.
  - Decreased likelihood of a continuous cost reduction of low-carbon versus carbon-intensive energy as experienced in the past decade.
  - Interaction of geoeconomic fragmentation with intensified macroeconomic shocks and policy responses.
- Specific observations and statistics:
  - In 2022–23, the energy transition was anticipated to suffer a setback and possibly partial reversal because energy security regained prominence over climate objectives.
  - Prices of all major commodity groups remain above their 2015–19 average levels.
  - Aggregate energy investment trends:
    - Investment in unabated fossil fuel supply is set to rise by more than 6 percent in 2023, reaching an estimated $950 billion (IEA 2023a).
    - Capital expenditure forecasts for new oil and gas fields remain high, especially in EMDEs, accounting for roughly 75 percent and 95 percent of energy industry investments by 2030 and 2050, respectively (IMF 2023b).
  - Net-zero target timing cited:
    - Net zero targets by 2050: European Union, Japan, South Korea, the United Kingdom, and the United States.
    - Net zero by 2060: China.
    - Net zero no later than 2060: Russia.
    - Net zero by 2070: India.
- Emissions trajectory concerns:
  - Net-zero pledges are often long-term (typically up to 2050 or 2060) and not always accompanied by concrete near-term commitments.
  - A concave emission reduction curve (a “humped curve” rather than a steady decline) implies much higher cumulative emissions and raises the probability of a disorderly transition and increased physical risks (including higher likelihood of crossing climate tipping points).
- Energy investment and industry behavior:
  - Despite increased renewable investment, strong investment in fossil fuels continues—consistent with a “symbiotic” relationship among energy sources.
  - The IEA’s Net Zero by 2050 Roadmap indicates that beyond projects already committed as of 2021, no new oil and gas fields can be approved for development, and no new coal mines or mine extensions are required to achieve net zero CO2 emissions by 2050.
  - Oil and gas companies’ low-carbon investment remains an extremely limited share of their overall capital expenditures; investment is increasingly anticipated for decarbonization of operations (for example, carbon capture, utilization, and storage) rather than diversification into power generation.

### Scenario Design and Policy-Relevant Adjustments Suggested
- The NGFS and the climate finance community should consider designing scenarios that better reflect current sources of uncertainty by:
  - Capturing carbon lock-in through an increase in near-term greenhouse gas (GHG) emissions, an increase in fossil fuel investment, and a delay in climate policy development and implementation.
  - Making downward adjustments to renewable energy technology deployment and diffusion as a result of high policy rates and supply chain constraints on critical minerals.
  - Incorporating macroeconomic impacts into short-term scenarios by considering higher-for-longer policy rates, tightening credit standards, high inflation, and reduced fiscal space.
  - Developing new long-term scenarios that reflect the emerging geoeconomic fragmentation and constraints to trade multilateralism.
- Focus of the note:
  - Emphasize implications of the polycrisis for the evolution of climate-relevant variables in different (potentially extreme) scenarios—as opposed to central projections.
  - Emphasize the channels through which the polycrisis affects the likely paths of those variables (the differential impact between before and after the crisis).
- Risk-management perspective:
  - The note focuses on future pathways belonging to non-central portions of the distribution of possible future outcomes (those most likely representing heightened transition risks); these scenarios are hypothetical and do not reflect the IMF’s expectations.

### Structure of the Note (as outlined)
- First section: elaborates on the main consequences of the polycrisis for the transition to a low-carbon economy.
- Second section: provides suggestions for the evolution of climate scenario design based on the first section’s analysis.
- Final section: reports authors’ conclusions and discusses areas for future research.

*Source: IMF staff.*

### 1. Total Oil and Gas versus Low-Carbon Capital Expenditure (Billions of US dollars)

### 1. Total Oil and Gas versus Low-Carbon Capital Expenditure (Billions of US dollars)

### Data scope and definitions
- Sources: International Energy Agency 2023a; Rystad; and IMF staff calculations.
- Note: Data only includes production capital expenditure.
- Definition: “Low-carbon capex” refers to capital expenditure in renewable power; grids; storage; carbon capture, usage, and storage; and energy efficiency.

### Capital expenditure in new oil and gas fields
- Sources: Rystad; and IMF staff calculations.
- Note: AE = advanced economies; EMDE = emerging market and developing economies.

### Skilled labor and project delivery constraints
- IEA (2023b) observation quoted: “Companies cannot respond to these market and policy signals without the skilled workforce needed to deliver these projects in the regions where they are being developed. Shortages of skilled labor across energy supply chains are already translating into project delays and impacting investment decisions in some sectors, such as oil, gas, and offshore wind.”
- Similar labor constraints are noted in the coal industry (Rutkowski and others 2022).

### Carbon lock-in and political-economy implications
- Carbon lock-in represents a major resource misallocation and diverts funds from decarbonization objectives.
- Dominant industries and coalitions (such as fossil fuel and other carbon-intensive sectors) have incentives to protect asset value (for example, via lobbying) against measures perceived as “stranding” them.
- Such protective actions can delay or weaken climate mitigation policies over time.

### Heterogeneous short-term impacts of the polycrisis on energy transition policies (Box 2)
- European Union:
  - REPowerEU initiative (European Commission 2022) adopted in May 2022 to reduce dependence on Russian natural gas and other commodities.
  - Builds on the Fit for 55 package (European Commission 2023) and includes additional actions to increase energy efficiency, diversify fuel supply (liquified natural gas, biomethane, renewable hydrogen), substitute fossil fuels by accelerating the energy transition, and increase renewable energy supplies to 45 percent by 2030.
  - New challenges relative to post-Paris Agreement years: supply security concerns, slower deceleration in fossil fuel demand, search for greater cost efficiency for renewable energy infrastructure and storage, and greater flexibility in energy systems.
- United States:
  - Inflation Reduction Act adopted in August 2022.
  - Aims at increasing investments to reduce greenhouse gas emissions by 40 percent by 2030.
  - Disburses around $370 billion for measures dedicated to improving energy security and accelerating clean energy transitions, including funding for carbon capture, utilization, and storage projects.
  - Includes a Methane Emissions Reduction Program.
- Asia:
  - Polycrisis has driven up crude oil and natural gas prices, food inflation, and manufacturing production prices (United Nations, ADB, and UNDP 2023).
  - Increasing electricity output while cutting coal and oil requires significant growth in renewable energy infrastructure paired with energy storage.
  - Energy crisis and increased commodity price volatility may complexify the transition agenda (S&P Global 2022).
  - Polycrisis appears to have derailed development progress in Asia and the Pacific, including for access to affordable and clean energy, with setbacks in access to affordable, reliable, and modern energy services (United Nations, ADB, and UNDP 2023).
- Central and Latin America:
  - Impacts uneven depending on whether economies are oil exporters (for example, Brazil, Colombia, Ecuador, and Venezuela) or agricultural exporters (for example, Argentina, Brazil, and Uruguay), which may benefit external accounts, versus net food and fuel importers (Central American and Caribbean countries) facing increased vulnerabilities.
  - Fuel pricing policy is likely to become a delaying factor in the current political context, especially if not targeted toward the most vulnerable social groups.
  - Increasing competition for US liquified natural gas imports may negatively impact the region, compounded by recurrent droughts hampering hydroelectricity production.
  - Oil exploration and increased oil production to address fiscal and external pressures point to a very large increase in oil production in the region (notably in Brazil, Guyana, and Suriname) (see IEA 2023e, p. 132; Flicking 2023).
- Africa:
  - Polycrisis likely to have stark implications for the energy transition by:
    - exacerbating the continent’s chronic energy poverty problem;
    - enhancing the lack of financial support for Africa’s energy transition;
    - harming African electricity markets and renewable projects as a result of rising commodity prices and interest rates;
    - spurring investment in Africa’s mining industry as a result of supply chain diversification (IMF 2023c; Auth and Moss 2022; Tollefson 2022; Wroughton 2022).

*Source: IMF Staff Climate Notes (excerpts and figures as provided).*

### Box 3. Recent Trends Are Likely to Increase the Degree of Carbon Lock-in in Infrastructure

### Box 3. Recent Trends Are Likely to Increase the Degree of Carbon Lock-in in Infrastructure and Policy

### Recent investment trends and lock-in risks
- Investments in renewable energy have increased and now represent a 1.5-to-1 ratio with fossil fuels.
- Large gap between current trends and the investment required to get on track for the Net Zero Emissions by 2050 Scenario in renewable energy deployment, energy efficiency, and electrification (IEA 2023e).
- Investments in renewable energy remain heavily concentrated in a handful of countries (China, European Union, Japan, and the United States).
- Lock-in developments:
  - Coal-fired power generation experienced an all-time high in 2022 with an intense rebound expected to persist in 2023; national decisions have slowed decommissioning and/or reopened mines (including in China, Germany, Italy, and the United States).
  - Final investment decisions for unabated gas-fired power generation rose in 2022 (primarily in China, the Middle East-Northern Africa region, Southeast Asia, and the United States).
  - Implementation challenges for structural reforms to reduce natural gas use, methane leakage, and scale renewables—especially in the European Union—are anticipated; the EU-U.S. Task Force on Energy Security (April 2022) to diversify gas supply via higher liquified natural gas and pipeline investment raises climate-related challenges because of the carbon content of liquified natural gas and buildup of import infrastructure.
  - Europe’s rush to secure supplies may trigger worldwide resource-grabbing and hoarding (including of liquified natural gas), crowding out some countries (including in South and Southeast Asia), pushing them back toward coal and causing blackouts, thereby spreading lock-in.

### Prospects for renewable energy and sensitivity to the current environment
- Historic cost declines between 2015 and 2020:
  - –56 percent for solar
  - –45 percent for wind
  - –64 percent for batteries
  - Capacity increases: +170 percent for solar and +70 percent for wind
- Signs that room for further cost reductions in solar and wind might be shrinking; prices for several major low-carbon energy technologies rose in 2021 and 2022 due to higher input prices for critical minerals, semiconductors, and bulk materials like steel and cement.
- Drivers increasing costs and risks for renewables:
  - Increase in energy prices since 2021 → higher inflation and real interest rates → stronger impact on renewable energy infrastructure because of higher elasticity with respect to interest rates.
  - Friend-shoring for inputs (for example, lithium) could reduce supply, raise costs, and increase investment needs.
  - Perception of higher risk by financial market participants could raise credit spreads and reduce profitability.
  - Supply gluts, declining profit margins, high commodity prices, and changing financing environments can create financial challenges across renewable sectors.
- Sensitivity of low-carbon vs. carbon-intensive technologies to interest rates (LCOE impacts):
  - Solar photovoltaics LCOE would increase by 11 percent with interest rates in the 4 to 4.5 percent range, rather than close to zero (Schmidt and others 2019).
  - Onshore wind LCOE would increase by 25 percent under the same interest-rate shift.
  - LCOE of a gas-fired power plant would rise by around 4 percent if interest rates were to rise from 3 percent to 7 percent.
  - LCOE of offshore wind and solar photovoltaic technologies would rise by more than 30 percent.
- Decarbonization in EMDEs requires a significant amount of debt financing (IEA 2021b); higher funding costs could be particularly detrimental.
- Other cost factors: permitting lags, transmission capacity, grid stability, removal of subsidies for renewables in many countries, and additional costs masked by LCOE (transmission, distribution, wholesale price volatility, market competition).

### Supply constraints for critical minerals and implications
- Critical minerals needed for the transition include: lithium, cobalt, copper, zinc, iron ore, aluminum, nickel, silicon, silver, platinum, palladium, manganese, graphite, rare earths.
- Expansion in supply could be insufficient to meet demand; supply must reach a multifold expansion for some minerals, straining existing supply chains.
- Geoeconomic fragmentation has led to a sharp rise in dispersion in commodity prices across regions, including critical minerals; intensifying fragmentation could disrupt flows, induce price volatility, and hinder the transition.
- Potential bottlenecks identified: copper, nickel, cobalt, and lithium are potential bottlenecks and are currently absent from transition scenarios despite their critical role.
- Material price surge since start of 2021 (accelerated since the Russian invasion of Ukraine) "threatens a decades-long trend of falling costs for clean energy technologies."
- Expansion of mineral production can be slowed by permit processes, environmental and social impact mitigation, local protests, and "NIMBY-ism."
- Reserves and processing concentration:
  - Relevant reserves of nickel, platinum, palladium in Russia; cobalt concentrated in the Republic of Congo.
  - Fragmentation and friend-shoring could reduce access to cheaper or more abundant sourcing.

### Geopolitical, macroeconomic, and financial channels amplifying lock-in
- Monetary policy and macro shocks:
  - Massive and synchronized tightening of monetary policy by most central banks in response to pandemic-related supply disruptions, war-related energy price surge, and broader price pressures.
  - High geopolitical and geoeconomic uncertainty and growing climate impacts on prices could make "higher-for-longer" interest rates more likely.
  - Higher policy interest rates could reduce expected demand and productive investment, trigger or amplify capital outflows (especially in EMDEs), and hinder channeling resources for the transition.
  - Historic monetary tightening has produced strains in the global financial system; tightening credit standards and a significant decline in credit growth could dampen productive investment and innovation.
  - Higher interest rates favor oil majors and national oil companies because they hold large cash equivalents and long-duration fixed-rate debt at relatively low interest rates.
- Capital flows and financial sector alignment:
  - Capital flows affected by geopolitical tensions; lack of alignment of climate policies and commitments of major banks and insurance companies with net-zero targets may prevent capital flows from supporting real-world decarbonization.
  - Greater geopolitical tensions between investor and recipient countries can reduce bilateral cross-border portfolio and bank allocation, cause sudden reversals of cross-border capital flows, and raise banks’ borrowing costs—reducing affected countries’ capacity to finance low-carbon investments.
- Fiscal policy reactions:
  - Public debt has expanded globally due to COVID-19 support measures and energy-price-related subsidies after the Russian invasion of Ukraine; increased military spending may reduce fiscal space.
  - Fiscal tightening could depress expected demand and lower productive investment, delaying decarbonization and producing path-dependency effects.
  - Windfall taxes on renewable electric power producers (for example, 90 percent in Germany, although set to be temporary) could disincentivize investment in renewables.
  - A global recession induced by tighter macro policies would lower expected demand and investment, potentially delaying decarbonization by several years.
- Trade, industrial policy, and geoeconomic fragmentation:
  - Heightened sensitivity of the energy sector to geostrategic factors may produce friend-shoring and industrial policies that alter supply chains and raise costs.
  - Trade-offs from policy measures (for example, firms investing in the United States may forfeit tax credits under the US Inflation Reduction Act if supply chains retain critical inputs from China).
  - Lack of cooperation on transition-critical minerals could hinder global decarbonization by constraining access and raising prices.
  - Cross-border spillovers of domestic fiscal policies can incentivize supply chain relocation for geopolitical reasons, provoke retaliation, and alter other countries’ climate policies.
  - A relative lack of decarbonization by large emitters or refusal to join global initiatives could discourage action by other countries because of concerns about burden sharing.

*Source: IMF | Staff Climate Notes — Box 3. Recent Trends Are Likely to Increase the Degree of Carbon Lock-in in Infrastructure and Policy*

### 1. Share of Top Three Producing Countries in Processing of Selected Minerals in 2022 (Percent)

### 1. Share of Top Three Producing Countries in Processing of Selected Minerals in 2022 (Percent)

### Overview
- Presents the share of the top three producing countries in processing of selected minerals in 2022, expressed in percent.
- The unit is a quantitative breakdown by country concentration in mineral processing for the year 2022.

### Data and Sources
- Sources cited in the unit:
  - Benchmark Mineral Intelligence
  - IEA analysis based on S&P Global
  - USGS 2023
  - Wood Mackenzie

*Source: clnea2023003 - 1. Share of Top Three Producing Countries in Processing of Selected Minerals in 2022 (Percent)*

### 2. Total Demand for Selected Minerals by End Use in the Net Zero Scenario, 2021–50 (Index, 100

### 2. Total Demand for Selected Minerals by End Use in the Net Zero Scenario, 2021–50 (Index, 100 = 2021)

### Polycrisis and macroeconomic context
- The polycrisis can produce interacting harms “greater than the sum of those the crises would produce in isolation” (Lawrence, Janzwood, and Homer-Dixon 2022).
- IMF’s global medium-term growth forecast declined from around 5 percent to 3 percent between 2008 and 2023, suggesting persistent downward structural forces on growth.
- Many climate scenarios (for example, IPCC/SSP-based scenarios) use optimistic growth assumptions and do not incorporate large-scale economic shocks or the economic impacts of climate change.
- Feedback effects between the financial system and the climate system imply climate risks are endogenous: financial institutions both suffer from and contribute to climate risks.

### Key empirical divergences and model weaknesses
- Models used in NGFS Phase III substantially underestimated near-term coal power capacity expansion:
  - Model-projected annual coal-fired power capacity additions between 2021 and 2025 range from 0–44 gigawatts across six NGFS Phase III scenarios.
  - Actual annual coal-fired power capacity additions between 2021–23 are between 46–52 gigawatts.
- LNG import capacity in the European Union and the United Kingdom will expand by 34 percent between 2021 and 2024.
- Mineral demand increases between 2017 and 2022:
  - Lithium demand increased by 300 percent.
  - Cobalt demand increased by 70 percent.
  - Nickel demand increased by 40 percent.
- Supply concentration in 2022:
  - Top three countries accounted for almost 90 percent of rare earths, graphite, and lithium supplies.
  - Top three countries accounted for more than 60 percent of cobalt and nickel supplies.
- Policy and domestic commitments coverage:
  - A total of 177 Parties have submitted their NDCs.
  - A total of 65 Parties submitted long-term strategies.
  - A total of 93 Parties, representing 97 countries, have communicated a net zero target.

### Recommendations for climate scenarios and modelling improvements
- Update and recalibrate model base years and near-term emissions trajectories regularly to reflect recent deviations (for example, post-2020 recarbonization) and increased likelihood of a disorderly transition.
- Capture carbon lock-in risks by:
  - Reflecting the increase in fossil energy investment since 2020 in historical periods and current policy assumptions.
  - Integrating exogenous paths of investment toward fossil-fuel–based assets where relevant.
  - Properly vintaging fossil fuel–based assets (including parameters such as lifetime, retirement curves, capital expenditures, operating expenditures) to capture transition costs.
- Incorporate fossil fuel producers’ economic and financial strategies into scenarios and models to reflect possible impacts on oil price and quantity dynamics (for example, strategic extraction, withholding exploration, selling at a loss).
- Adjust model assumptions to account for slower renewable energy diffusion due to:
  - Slower improvement in technology cost and efficiency.
  - Constrained deployment owing to limited critical minerals supply.
  - Slowdown in investment due to higher policy rates.
  - Higher upfront costs and greater sensitivity of renewable LCOE to interest rates (e.g., LCOE rises with interest rate increases as shown in Schmidt and others 2019).
- Explicitly model critical minerals:
  - Add critical mineral supply curves and mineral trade.
  - Develop material sectors and explicitly link critical mineral supply and demand sectors.
  - Where explicit modelling is not possible, apply postprocessing checks to assess whether technology deployment is constrained by mineral availability.
- Reflect policy implementation delays and asymmetric ambition:
  - Design scenarios with delayed implementation of NDCs in some jurisdictions (for example, delayed to 2025 or later) with potential resumption toward NDC/net zero pledges thereafter, but not necessarily by all jurisdictions.
- Account for monetary and fiscal effects in short-term scenarios:
  - Adjust financial variable assumptions (short-term rates, risk premiums, lending conditions) to reflect high inflation, high policy rates, and potential credit tightening.
  - Reflect fiscal implications (higher deficits, constrained fiscal space) through macro variables (fiscal balance, subsidies, taxes) and their effects on investment in low-carbon technologies.
- Incorporate trade and industrial policy responses:
  - Adjust sectoral and bilateral trade flows, technology costs, and delays in technology transfer and deployment to reflect reduced cooperation and trade fragmentation (for example, Carbon Border Adjustment Mechanism, domestic content requirements).
- Explore alternative Shared Socioeconomic Pathways (SSPs) and new scenario narratives:
  - Consider SSP3 (“Regional Rivalry”) in addition to SSP2, reflecting resurgent nationalism, regional conflicts, and limited global cooperation that hinder mitigation and adaptation; under SSP3 IAMs cannot achieve 1.5°C or even 2°C targets in many simulations.
  - Consider SSP4 (“A Road Divided”) as a less pessimistic alternative characterized by inequality and stratification, combined investments in both carbon-intensive fuels and low-carbon technologies; IAMs can sometimes achieve 2°C under SSP4 scenarios.
- Prioritize short-term implementable adjustments (for example, carbon lock-in, renewable prospects) while planning more technical work for complex items (for example, critical mineral supply, geoeconomic fragmentation, macroeconomic shocks, and policy responses).

### Modeling guidance and methodological notes
- Computable general equilibrium models can be used to add sectoral granularity; some models (for example, G-cubed, Economic Projection and Policy Analysis) already incorporate energy and environmental components.
- IAMs and energy models need detailed vintage and turnover parameters (lifetime, retirement curves, capital and operating expenditures) to track technology and capital stock turnover accurately.
- Even without explicit mineral modules, models should check the feasibility of projected technology deployment against known mineral supply constraints.

*Source: IMF staff note drawing on IEA 2023d and NGFS scenario analyses (IMF | Staff Climate Notes excerpt).*

### Conclusions

### clnea2023003 - Conclusions

### Major findings on the polycrisis and the low-carbon transition
- The post-COVID-19 recovery in many economies was accompanied by reduced attention to emission reduction objectives; the Russian invasion of Ukraine in 2022 further weakened policymakers’ determination to pursue decarbonization policies, amid increasing geopolitical fragmentation and multiple simultaneous crises.  
- The pullback on climate mitigation policies is material enough to drive a significant deviation of global GHG emissions from:  
  - the path necessary to keep end-of-century global average surface temperature increase below 1.5 degrees Celsius, and  
  - the path implicit in the sum of all countries’ own commitments.  
- The scramble to replace Russian supply has led to policy choices that increase carbon lock-in—raising the inertia of fossil-fuel–based energy systems and resisting broader adoption of alternatives.  
- Renewable energy faces headwinds that could slow or reverse historic cost declines (particularly for solar and wind), including:  
  - structurally higher upfront capital intensity and higher sensitivity to currently high interest rates;  
  - geoeconomic fragmentation and supply constraints on critical minerals; and  
  - administrative and social factors such as complex permitting and “NIMBY-ism.”  
- Combined macroeconomic and geopolitical stressors likely to make the transition more disorderly include: high inflation and policy rates; potential credit crunch; high public debts and fiscal deficits leading to downsized decarbonization policies; trade disruptions limiting technology diffusion; and permanently lower global growth with adverse effects on investment needs, especially in EMDEs.

### Climate scenario deficiencies identified
- Current climate scenarios (including NGFS scenarios) contemplate disorderly transitions but have not fully incorporated the short- and long-term implications of the current polycrisis.  
- Specific gaps include insufficient incorporation of:  
  - carbon lock-in from recent fossil energy investment;  
  - delayed development and implementation of climate policies;  
  - a less optimistic pathway for renewable energy (slower cost and efficiency improvements, supply chain constraints, slowdown in new renewable investment); and  
  - macroeconomic and macrofinancial effects of the polycrisis (high inflation and policy rates, credit constraints, high public debts and deficits, and constraints to trade multilateralism).  
- Scenario narratives need to reflect increasing geopolitical fragmentation, lower global growth over short, medium, and long terms, and increasing inequalities and stratification across and within countries.  
- More technical modeling work is required to capture structural changes (for example, modeling fragmented commodity markets) and interactions between physical and transition risks (see Annex 3 reference in source).

### Recommendations to upscale climate scenario design
- Adjust near-term emissions trajectories to reflect carbon lock-in and recent fossil energy investment.  
- Build in recent fossil energy investment explicitly and account for delays in climate policy development and implementation.  
- Consider less optimistic renewable energy pathways: downward adjustment on cost and efficiency improvements; incorporation of supply chain constraints; and slowdown in new renewable energy investment due to bottlenecks and a high-rate environment.  
- Capture macroeconomic and macrofinancial implications of the polycrisis in short-term scenarios: high inflation and policy rates, potential credit crunch, high public debts and fiscal deficits, and constraints to trade multilateralism.  
- Develop new scenario narratives that incorporate geopolitical fragmentation, lower global growth across horizons, and rising inequalities and stratification.  
- Advance technical modeling capabilities (for example, fragmented commodity markets) to better reflect the polycrisis implications.  
- Integrate interactions between physical and transition risks: a more disorderly transition implies higher peaking temperatures and higher physical risks, which can feedback into transition risks and amplify damages (heating/cooling demand shifts, power plant efficiency declines, water scarcity, agricultural productivity losses, supply-chain disruptions, inflation, lower labor productivity), with potential for cascading effects and irreversible losses if tipping points are exceeded.

### Annex 1: Natural gas lock-in literature highlights (implications for scenarios)
- Methane underestimation: anthropogenic fossil fuel sources’ contribution to total methane emissions has been underestimated in the range of 20–60 percent; current average leakage rates are estimated around 2 percent, while current super-emitters can lead this rate to an estimated 6–17 percent range. Methane’s global warming potential is up to 87 times greater than CO2 over the first 20 years after emission and up to 36 times greater in the first 100 years. Use of natural gas as a temporary substitute for coal may lead to additional short-term temperature increase.  
- Infrastructure lock-in: pipelines, LNG terminals, and gas-fired power plants have technical lifetimes spanning decades; if global energy infrastructure (as of 2018) operates as historically, the entire remaining carbon budget to limit warming to 1.5 degrees Celsius would be exceeded. Institutional protections (for example, legal protection of private property) make decommissioning after a fraction of technical life very challenging.  
- Caution on gas as a “bridge technology”: scenarios should carefully frame coal-to-gas switching assumptions—especially when new gas infrastructure is required—because lower-emission and lower-cost alternatives may exist.  
- Stranded asset risk: natural gas should be included in energy asset stranding assumptions given potential cascading effects on coupled sectors, including the financial sector; developing methane leakage regulations and policy actions (for example, COP26 Global Methane Pledge) could increase stranded asset risk.

### Annex 2: Preliminary recommendations on NGFS scenario updates
- Near-term and long-term NGFS scenario improvements that can be addressed with limited modeling changes include:  
  - Emissions: calibrate emissions between 2020 and 2023 to capture the COVID-19 impact in 2020 and the subsequent rebound.  
  - Fossil fuel consumption: adjust regional fossil fuel consumption to reflect responses to the Russian invasion of Ukraine and rising energy security concerns.  
  - Power sector investment: account for new investment in coal, gas, and nuclear power plants that may compete with renewables or become stranded assets.  
  - Energy trade and infrastructure: depict post-invasion changes in energy trade relationships and vintaging of newly developed infrastructure (for example, new LNG terminals built in Europe).  
  - Energy prices: keep energy prices up to date to reflect trends of increasing energy prices driven by growing demand, the Russian invasion of Ukraine, and climate conditions.  
- NGFS Phase III included six scenarios (Current Policies; Nationally Determined Contributions; Delayed Transition; Below 2°C; Divergent Net Zero; Net Zero 2050). NGFS Phase IV drops the Divergent Net Zero scenario and adds Low Demand and Fragmented World; Fragmented World builds on Divergent Net Zero with divergent policy implementation across countries and heterogenous sectoral actions.  
- Proposed new scenario (for short-term and long-term use): “Carbon Lock-in and Cascading Impacts” with narrative and assumptions:  
  - Narrative: current increase in fossil fuel assets results in carbon lock-in, higher transition and physical risks, tighter government fiscal budgets, higher risk premiums, and supply chain pressures that slow technology diffusion.  
  - Technology assumption: increase in near-term fossil fuel investment; slow deployment of clean energy technologies due to overcapacity and supply chain constraints.  
  - Policy assumption: failure to achieve or delays in climate commitments in some jurisdictions, higher peaking temperature and physical risks, tightening fiscal budgets from rising physical risks and slower growth, high inflation from supply chain constraints, and high risk premiums due to heightened risk perceptions.

*Source: IMF staff (Conclusions and Annexes from clnea2023003).*

### Annex 3. Feedback Effects between Physical and Transition

### Annex 3. Feedback Effects between Physical and Transition Risks

### Overview of dynamic relationship and relevance
- Transition and physical risks differ in their direct impacts on economic sectors, leading to potentially different indirect impacts and feedback effects.
- Transmission channels often overlap, meaning transition and physical risks may affect different sectors at the same time and create interacting effects that can gradually or abruptly turn into vicious cycles and destabilizing feedback loops that could trigger tail risks, shifting the likelihood of their occurrence (Coalition of Finance Ministers for Climate Action 2021).
- Acute and chronic physical risks are increasing in direct relation to increasing warming: increased frequency and intensity of hot extremes, heavy precipitation, marine heatwaves, agricultural and ecological droughts, increased proportion of intense tropical cyclones, alongside chronic changes such as reductions in poles’ sea ice, snow cover, and permafrost.
- Low-likelihood outcomes (such as ice sheet collapse or abrupt ocean circulation changes) and compound extreme events (such as concurrent heatwaves and droughts on a global scale) should not be overlooked and are part of physical risk assessment (IPCC 2021).
- Many changes (primarily those in the ocean, ice sheets, and global sea level) are deemed irreversible for centuries to millennia.

### Impact of transition scenarios on physical risks
- NGFS Phase III scenarios (released in October 2022) include macroeconomic damages estimates from global mean temperature change and damages from some extreme climatic events (tropical cyclones and riverine floods) (Richters and others 2022a).
- NGFS Phase IV scenarios enhance physical risk modeling by:
  - Considering temperature and precipitation variability in chronic physical risk estimates.
  - Expanding hazard coverage to add heatwaves and droughts to tropical cyclones and riverine floods.
  - Incorporating additional transmission channels (for example, impact of heatwaves on labor productivity, impact of droughts on crop yield).
- Physical risks can be underestimated because of:
  - Lack of consideration of tipping points.
  - Lack of accounting for simultaneous occurrence of different hazards and chains of events (for example, floods made more devastating by previous droughts).
  - Insufficient incorporation of recent climate variability, especially in short-term scenarios (the onset of El Niño will greatly increase the likelihood of extreme events, World Meteorological Organization 2023).
- Increasing physical risk implications for the economy include:
  - Food price increase and inflation because of physical risk.
  - Tightened fiscal budgets and heightened risk premiums because of the high perception of physical risks.
  - Supply chain constraints.
- Need to explore compounding risks from physical, macroeconomic, and sectoral drivers.
- Next-generation climate scenarios need to incorporate climate tipping points and nonlinearities in scenario design and implementation (Dietz and others 2021; FSB and NGFS 2022).
- “Upstream” effects: a failed or faltering low-carbon transition could further exacerbate climate impacts, especially as adaptation potential decreases leading to greater socioeconomic risks (IPCC 2022).
- Important research directions include exploring incorporation of climate change adaptation needs and heterogeneity in societies’ adaptive capacities and their temporal dynamics (Andrijevic and others 2023).
- Heterogeneity across regions: many EMDEs could have greater exposures to physical risks than advanced economies; delay in the low-carbon transition could further worsen vulnerabilities in EMDEs, including lowering capacity to adapt to climate change (IMF 2020, 2023c).
- Aerosols: regional estimates of climate risks generally do not sufficiently consider effects of aerosols, which have been a potent factor in climate extremes and have had a major cooling effect since the 19th century by reflecting sunlight (reducing global warming by 30–50 percent) (Persad, Samset, and Wilcox 2022). Omission implies a large underestimation of short-term climate risks in regions such as Southeast Asia and sub-Saharan Africa.
- Transition policies that reduce aerosol emissions (for example, targeting aerosols from fossil fuel plants or shipping) would generate large public health benefits through reduced air pollution but could have major local or global warming effects.

### Impact of climate change (physical risk) on transition risks
- The feedback loop from physical risk to transition risk is largely unstudied in current NGFS scenarios and most climate scenarios.
- Physical risk can affect transition risk through multiple channels:
  - Direct impacts on energy system and agricultural sector (temperature rise affects heating/cooling degree days and heating/cooling energy demand; temperature and precipitation changes impact electricity supply and crop yield).
  - Macroeconomic and macrofinancial implications (reducing fiscal space, slowing economic growth, disrupting supply chains, increasing inflation).
  - Interactions that can exacerbate each other, potentially leading to a more disorderly transition.
- Materialization of physical risks could complicate the energy landscape and energy security by affecting:
  - Carbon-intensive sources (for example, coal-fired power plants whose efficiency deteriorates due to heatwaves reducing availability of sufficiently cold water as a coolant).
  - Low-carbon sources (for example, droughts affecting hydropower generation) (IEA 2022c).
  - Critical mineral extraction and grid efficiency.
- Short-term scenarios often overlook large direct and indirect effects of climate change with implications for carbon budgets and decarbonization:
  - Example: as of October 23, 2023, wildfires in Canada had generated about three times as many emissions as Canada’s annual fossil fuel use—with implications for the country’s carbon budget and decarbonization pathway that are overlooked in short-term scenarios.
- Insurance and financial sector implications:
  - In 2023, large US insurance companies announced they would scale back homeowner policies in vulnerable areas nationally as a result of climate-related risks (floods, storms, fires), and some announced they would stop accepting new applications including all business and personal lines property and casualty insurance, citing growing climate-related risks (Eaglesham 2023).
  - ECB and EIOPA (2023) warned that with insurance claims rising, premiums are likely to rise and/or coverage to fall, thereby widening the protection gap; the public sector currently remains the holder of residual risk for large climate-related catastrophe losses.
  - Potential credit risk implications arise from mismatches between long-term mortgages and insurance policies that must be renewed on an annual basis.
- Geoengineering and transition scenario blind spots:
  - Geoengineering (for example, solar radiation management) is emerging as a prospective area of climate policy. Limited or unilateral deployment could have major consequences for the climate and the Earth system (for example, damage to the ozone layer, unintended changes in global precipitation patterns) and knock-on economic effects.
  - Debates and research on geoengineering, its risks, uncertainties, and governance implications should be incorporated in transition scenario considerations.

### Key research and scenario-design recommendations
- Integrate transition and physical risks in a coherent framework to capture overlapping transmission channels and feedback loops.
- Incorporate climate tipping points, nonlinearities, and second-round effects in next-generation climate scenarios rather than representing them in highly stylized ways.
- Include recent climate variability and events (for example, El Niño onset) in short-term scenarios to better capture likelihood of extreme events.
- Explore compounding risks from physical, macroeconomic, and sectoral drivers and model chains of events (for example, droughts amplifying flood impacts).
- Account for heterogeneity in adaptive capacities across regions and populations and their temporal dynamics; prioritize regions and populations with the most pressing need for increased adaptive capacity (Andrijevic and others 2023).
- Include aerosol dynamics and their interaction with transition policies when assessing short-term and regional climate risks.
- Better incorporate direct and indirect physical risk impacts on energy systems, carbon budgets, trade routes, insurance markets, and credit risk in transition scenarios.
- Consider prospects, risks, and governance implications of geoengineering in scenario development.

*Source: IMF staff.*

### References

### clnea2023003 - References

### Climate risk analysis and scenario frameworks
- Approaches to climate risk analysis in FSAPs: Adrian et al. 2022, “Approaches to Climate Risk Analysis in FSAPs.” IMF Staff Climate Note 2022/005.
- Scenario design and usage:
  - Moss et al. 2010, “The Next Generation of Scenarios for Climate Change Research and Assessment.” Nature 463: 747–56.
  - O’Neill et al. 2016, “The Roads Ahead: Narratives for Shared Socioeconomic Pathways Describing World Futures in the 21st Century.” Global Environmental Change 42: 169–80.
  - O’Neill et al. 2020, “Achievements and Needs for the Climate Change Scenario Framework.” Nature Climate Change 10: 1074–84.
  - NGFS publications: NGFS 2021; NGFS 2022a; NGFS 2022b; NGFS 2023a; NGFS 2023b.
  - Richters et al. 2022a, “NGFS Climate Scenarios Database: Technical Documentation V3.1.” and Richters et al. 2022b, “NGFS Climate Scenarios Data Set (3.3).”

### Energy transition, fossil fuels, and stranded assets
- Analyses of fossil fuel pathways, lock-in, and stranded assets:
  - Bertram et al. 2015, “Carbon Lock-in through Capital Stock Inertia Associated with Weak Near-Term Climate Policies.” Technological Forecasting and Social Change 90 (A): 62–72.
  - Seto et al. 2016, “Carbon Lock-In: Types, Causes, and Policy Implications.” Annual Review of Environment and Resources 41: 425–52.
  - Tong et al. 2019, “Committed Emissions from Existing Energy Infrastructure Jeopardize 1.5 °C Climate Target.” Nature 572: 373–77.
  - Kühne et al. 2022. “‘Carbon Bombs’ - Mapping Key Fossil Fuel Projects.” Energy Policy 166: 112950.
  - Godin et al. 2017. “Networks of Stranded Assets: A Case for a Balance Sheet Approach.”
- Oil majors, counter-shocks, and industry dynamics:
  - Basosi, Garavini, and Trentin, eds. 2019. Counter-shock: The Oil Counter-Revolution of the 1980s.
  - Alova 2022, “Oil Majors’ Slow Transition.” Nature Energy 7 (6): 472–73.
  - Blas 2023, “Exxon Has Way Too Much Cash Right Now.” Bloomberg News, April 28.
  - Bistline et al. 2023, “Emissions and energy impacts of the Inflation Reduction Act.” Science 380 1324-1327.

### Financial stability, monetary policy, and stress testing
- Central bank, supervisory, and IMF work on climate-related stress testing and financial stability:
  - Bank of England (BOE). 2022. “Results of the 2021 Climate Biennial Exploratory Scenario (CBES).”
  - Board of Governors of the Federal Reserve System. 2023. “Pilot Climate Scenario Analysis (CSA) Exercise: Participant Instructions.”
  - BIS 2022. “Inflation: A Look under the Hood.” In BIS Annual Economic Report, 41–73.
  - Financial Stability Board (FSB) and NGFS 2022. “Climate Scenario Analysis by Jurisdictions: Initial Findings and Lessons.”
  - IMF publications linking high inflation, interest rates, and climate/financial policies: IMF 2020; IMF 2022a; IMF 2022b; IMF 2023a; IMF 2023b; IMF 2023c; IMF 2023d; IMF 2023e.
- Monetary policy and climate:
  - Schnabel 2022, “A New Age of Energy Inflation: Climateflation, Fossilflation and Greenflation.” (speech, March 17).
  - Schnabel 2023, “Monetary Policy Tightening and the Green Transition.” (speech, January 10).
  - Schmidt et al. 2019, “Adverse Effects of Rising Interest Rates on Sustainable Energy Transitions.” Nature Sustainability 2 (9): 879–85.
  - Adrian 2023a, “Higher-for-Longer Interest Rate Environment is Squeezing More Borrowers.” IMF Blog, October 10.
  - Adrian 2023b, “Global Financial System Tested by Higher Inflation and Interest Rates.” IMF Blog, April 11.

### Geopolitics, energy security, and fragmentation
- Geopolitical drivers of energy markets and the transition:
  - Aiyar et al. 2023. “Geoeconomic Fragmentation and the Future of Multilateralism.” IMF Staff Discussion Note 2023/001.
  - EU-U.S. Task Force on Energy Security. 2023. “Progress Report and Outlook 2022-2023.”
  - European Commission 2022. “REPowerEU: A plan to rapidly reduce dependence on Russian fossil fuels and fast forward the green transition.”
  - Auth and Moss 2022, “How Russia’s Invasion of Ukraine Will Impact Africa’s Energy Transition.” Council on Foreign Relations blog, April 22.
  - Cárdenas et al. 2022, “Implications of the Russian War in Ukraine on Latin America’s Energy Sector.”
  - LaBelle 2023, “Energy as a Weapon of War: Lessons from 50 Years of Energy Interdependence.” Global Policy 14 (3): 531–47.

### Critical minerals, supply chains, and technologies
- Materials and supply risks for clean energy:
  - Boer, Pescatori, and Stuermer 2021, “Energy Transition Metals.” IMF Working Paper 21/243.
  - International Energy Agency (IEA) publications on minerals and demand: IEA 2023d, “Total Demand for Selected Minerals by End Use in the Net Zero Scenario, 2021-2050.”
  - IRENA 2023. “Geopolitics of the Energy Transition: Critical Minerals.”
  - McKinsey & Company 2022, “The Raw-Materials Challenge: How the Metals and Mining Sector Will Be at the Core of Enabling the Energy Transition.”
  - Hache and Louvet 2023. Métaux, le nouvel or noir.

### Climate impacts, tipping points, and adaptation
- Climate science and impacts informing economic assessments:
  - IPCC 2013; IPCC 2022; IPCC 2023 (Working Group contributions noted).
  - McKay et al. 2022, “Exceeding 1.5°C Global Warming Could Trigger Multiple Climate Tipping Points.” Science 377 (6611).
  - Dietz et al. 2021, “Economic Impacts of Tipping Points in the Climate System.” PNAS 118 (34): e2103081118.
  - Persad, Samset, and Wilcox 2022, “Aerosols Must Be Included in Climate Risk Assessments.” Nature 611: 662–64.
  - Richardson et al. 2023, “Earth Beyond Six of Nine Planetary Boundaries.” Science Advances 9 (37).

### Data sources, databases, and empirical studies
- Scenario and emissions databases:
  - Byers et al. 2022. “AR6 Scenarios Database hosted by IIASA.”
  - IIASA 2014. “IAMC AR5 Scenario Database.”
  - Richters et al. 2022b. “NGFS Climate Scenarios Data Set (3.3).”
- Empirical emissions and energy studies:
  - Chen et al. 2022b, “Quantifying Regional Methane Emissions in the New Mexico Permian Basin with a Comprehensive Aerial Survey.” Environmental Science & Technology 56 (7): 4317–23.
  - Schwietzke et al. 2016, “Upward revision of global fossil fuel methane emissions based on isotope database,” Nature 538, 88–91.
  - US Geological Survey (USGS). 2023. “Mineral Commodity Summaries.”

*Source: clnea2023003 - References*

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### Document identifiers and notes on the page
- Energy Transition and Geoeconomic Fragmentation: Implications for Climate Scenario Design
- IMF STAFF CLIMATE NOTE 2023/00
- 3

*Source: clnea2023003 - 48. https://doi.org/10.1038/s41558-018-0293-8*

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