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A year marked by tighter financing conditions and geopolitical disruptions ended with a COP28 conference that delivered some major agreements but often seemed to lack practical measures. Uncertainty will continue into 2024, when investors and other market participants will have to cope with ongoing pressures, notably related to the climate finance gap.

What We're Watching

A new operating environment defined by higher-for-longer interest rates and tighter financing conditions could further challenge companies' and countries' climate mitigation and adaptation efforts. These conditions put climate finance at risk—particularly in emerging economies where the financing needs are barely fulfilled and where access to capital is more difficult.

As these conditions continue, climate change adds another layer of uncertainty to the outlook for the global economy—and our economic research shows it will continue to affect output, dampen growth, and disrupt supply chains due to the variety of paths global warming can take.

As this year's climate momentum culminates with the United Nations' annual climate conference in Dubai, public- and private-sector stakeholders are seeking solutions to the climate crisis. At COP28, countries agreed on "transitioning away from fossil fuels in energy systems" and to set a "new collective quantified goal on climate finance." Yet, S&P Global Ratings witnessed the extent to which participants struggled to provide more details and timelines for these declarations and others.

What We Think And Why

Both mitigation and adaptation are essential in reducing the expected impact of climate change on humans and their environment, according to the U.N.'s Intergovernmental Panel on Climate Change.

Our analysis shows that progress in decarbonization has been slow. The scopes 1 and 2 greenhouse gas emissions didn't reduce from 2016-2021 for a universe of more than 13,000 companies across private-sector industries in over 100 geographies.

Industries are approaching the decarbonization challenge in differing ways and will likely see varying outcomes.

For example, there is no quick fix to decarbonize complex and hard-to-abate sectors like chemicals. Our research shows that chemical manufacturing's medium-term decarbonization targets are unlikely to materially affect companies' cost structures but could imply more significant disruptions after 2030. In our view, the sector's credit risks are currently manageable under existing regulatory policies. And decarbonization could ultimately create new markets and applications for some chemicals.

Meanwhile, companies that have made ambitious decarbonization commitments may need to utilize technologies like carbon capture and storage, carbon dioxide removal, and the use of carbon credits. As solutions continue to evolve, we find that companies that can understand and manage potential technical challenges associated with these technologies are likely to be better placed to deliver the most efficient solutions, limiting financial costs and reputational risks.

Our research also shows that if global warming does not stay well below 2 degrees Celsius by 2050, up to 4.4% of the world's GDP could be lost annually if adaptation isn't adopted, disproportionally affecting developing economies. We find that lower-income countries are 4.4 times more exposed to climate risks than their wealthier peers.

For example, our research finds that without adaptation to climate change, as many as 20 of Mexico's 32 states face high exposure to water-related stress by 2050--up from around 11 today. Our scenario analysis covering various levels of exposure to this physical climate risk also shows that the Mexican states facing the greatest risk may experience decreased economic growth.

What Could Go Wrong

With slower economic growth and higher financing costs, priorities might shift away from tackling climate change. This means some countries and businesses are more likely to fall behind in their transition if they reduce their climate-mitigation efforts. At the same time, policymakers could consider more constraining climate regulations on certain sectors, including stricter industry norms or sanctions. Failure to comply with these could pose significant business risks and future liabilities. We think that the visibility and materiality of such risks remain challenging to foresee.

Global, extreme weather conditions will continue to increase and influence credit fundamentals. Extreme weather and natural disasters could disrupt supply chains and dampen growth. The adaptation gap could widen due to tighter financing conditions. We could see credit quality deteriorate for sovereigns and governments if worsening physical risk exposure and a lack of resources erode our view of their fiscal performance, economic strength, and growth prospects. For corporate entities with exposure to physical risks, a lack of insurance or changing liability landscape could make these risks more financially material to creditworthiness.

Writers: Molly Mintz and Joe Maguire