Fossil fuel phase-down pledge at COP28 could create just transition problem: Fitch

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Ratings agency says narrow focus on unabated fossil fuels could create equity issues for emerging markets where decarbonisation challenges persist

Fitch Ratings said a commitment on the reduction of unabated fossil fuels at this year’s COP meeting can raise significant ‘just transition’ issues due to global disparities in access to decarbonisation technologies and transition capital.

A phase-down or altogether phase-out of ‘unabated’ fossil fuel capacity, broadly defined as capacity where carbon is not captured and stored at source, would favour countries that have already made headway in building capacity to abate fossil fuel-related emissions, primarily developed economies. This capacity could enable the continued use of fossil fuels in these areas, whereas unabated emissions in emerging markets would need to be addressed.

This highlights the importance of growing access to transition capital and finance across emerging markets in the wake of COP28.

Policy support mechanisms are one of the main advantages for developed markets and wealthier developing markets in an unabated fossil fuel phase-down scenario. In addition to the greater prevalence of carbon pricing (which creates downwards pressure on emission levels), developed markets generally already incentivise the adoption of abatement technologies through tax benefits, subsidies and other similar means. The absence of such incentives in emerging markets reduces the speed and degree of ease at which decarbonisation is able to occur.

Risk is another important factor for emerging markets in terms of decarbonisation. Investors continue to view many emerging markets as high-risk for a variety of reasons, ranging from high political and regulatory uncertainty to broader concerns, such as credit, currency and liquidity risks. These factors ultimately affect access to capital, which in turn limits emerging markets’ ability to decarbonise their economies, including by reducing unabated fossil fuel emissions through, still nascent, expensive carbon management technologies such as CCUS or Direct Air Capture (DAC).

According to BMI’s Infrastructure Key Projects Database, almost 95% of carbon capture projects, planned or under construction, are located in either Europe or North America with the UAE standing out as a notable exception to this trend.

There are also unique challenge surrounding the early retirement and phase-out of coal-fired power plants in emerging markets, especially in Asia-Pacific.

These challenges highlight the important role of collaboration in addressing decarbonisation, including through the use of blended finance and other innovative structuring solutions. As climate-related private capital flows to emerging markets greatly lag behind estimated needs, strategies to encourage additional investment to emerging markets could help alleviate just transition concerns, particularly if these countries are to support a commitment to reduce unabated fossil fuel emissions at COP28.