Understanding the social risks posed by climate transition requires discipline, nuance and a systematic approach.
The concept of a “just transition” has gained ground among responsible investors concerned about the economic consequences of the social risks that countries face in moving from fossil fuels to alternative energy sources. These risks are particularly high in emerging markets (EMs). How can investors systematically measure them?
Put simply, a just transition entails transitioning from fossil fuels in a way that is mindful of the economic impacts and not disruptive of the social fabric of economies.
The consequences of a mismanaged transition may be significant in coal- or oil-exporting countries, especially those with relatively undiversified economies. As demand for these commodities declines, such countries may face more significant transition risks. Governments may face fiscal and debt challenges that pressure their sovereign credit ratings. Worse, economic privation and civil unrest may lead to political instability and even regime change.
In developing a systematic approach to assessing these risks, it helps to focus on the sector at the center of most transition strategies: energy production, particularly coal (the most carbon-intensive fossil fuel). This has the added advantage that coal transitions already under way—such as those of Germany, Poland, the UK and the US—provide policy lessons and examples of pitfalls to avoid. These can be a useful lens through which to analyze how EMs are managing their just transitions.
Policy Lessons: Learning from Experience
Policy lessons show, for example, that a holistic and integrated government planning process is necessary, focusing on workers’ welfare, economic diversification, and social and environmental preservation. Without the help and commitment of national and local governments, a just transition is unlikely to succeed.
Planning is essential, but the reality is that macroeconomic preconditions such as existing levels of industrialization and access to infrastructure matter hugely in government efforts to diversify coal regions. Also, prevailing labor market protection and social security networks are crucial in protecting workers during their transition into alternative employment. In that context, the locations of coal mines are important too, as diversification in very remote areas (where many EM mines are situated) is difficult.
Relative Transition Risks and Specific Vulnerabilities
Informed by past policy lessons, we created a Just Transition Index (JTI) that scores countries across a range of key indicators. The scores are intended to capture a country’s overall level of macroeconomic development and the locations of its mines, the make-up of its labor and energy markets, government policy commitment to a just transition, and the ability to finance it.
Some indicators are relatively easy to measure quantitatively (such as a country’s level of development, exposure of its labor market to coal, and government budget capacity), while others (for example, coal mine locations and government commitment to reform) are harder to quantify.
For this reason, we opted for a qualitative index to score each country from –2 to 2, where the lowest numbers represent the most risk (Display). The JTI provides a guide not only to countries’ overall relative risk (contained in their score averages) but also specific vulnerabilities (individual factor scores).
