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The world is beginning what S&P Global defines as a multidimensional transition: "a multispeed, multifueled, and multi-technology transition with different road maps and end points for different countries." In S&P Global Ratings' view, companies' and governments' readiness to address these risks and opportunities may become even more challenging to overcome in an environment of intensifying geopolitical fragmentation, slower growth, and tighter financing conditions.

What We're Watching

As extreme weather conditions and worsening physical climate risks continue to increase and influence credit fundamentals, companies and countries alike are experiencing a confluence of challenges—culminating in tradeoffs between energy affordability; resilience and security; decarbonization efforts; and climate adaptation needs—in approaching and accelerating a multidimensional transition to a low-carbon global economy.

Decarbonization needs to take place at a global scale, but has so far failed to happen in companies across most sectors—and will require a broad range of solutions to overcome rising and ranging risks that could result in significant disruption. Our research shows that in a slow transition scenario, up to 4.4% of the world's GDP could be lost annually (absent adaptation) by 2050 if global warming does not stay well below 2 degrees Celsius, compared with preindustrial levels.

Investment in, access to, and utilization of renewable energy powered by hydrogen, wind, solar, and other sources is beneficially growing. Notably, renewable electricity generation may now be cheaper than power from fossil fuels. But while this green energy growth is expanding the global energy mix, demand is also increasing—and these green investments aren't yet demonstrably replacing fossil fuels or diminishing dependencies on them, and as such not yet altering the profitability of or access to financing for the oil and gas sector. Additionally, we see capital flows currently strongly favoring renewable power generating assets (namely wind and solar) with less focus on, for example, transmission and storage. The dislocation between policy intent and current investment is likely to result in integration bottlenecks and dysfunction in energy markets, unless market design evolves quickly.

How both public- and private-sector market participants respond to evolving regulations, adopt new technologies, and adapt to disruptive business models amid the transition will shape the breadth and depth of change required (across industries, supply chains, and customer bases, among others) to limit the potential dramatic consequences of climate change.

What We Think And Why

Climate change is a growing risk factor—and credit risk is higher in an abrupt transition. Because implementing comprehensive and coordinated climate policies and strategies remains challenging for countries and companies, divergences in actions across regions and/or industries could reshuffle sector-specific competitiveness.

The potential for negative implications across supply chains could result in weakened business positions or profitability for certain players or prompt ongoing regulatory adjustments that reduce stability, affect visibility, or jeopardize investment decisions. Borrowers managing a multidimensional transition may see credit risks become more material from the costs of decarbonizing their assets, the requirements of regulatory changes, and the uncertainty surrounding the longer time horizon discouraging some market participants from acting more imminently.

Physical climate risks may see some borrowers experience higher costs from any extreme weather events' direct damage to assets and returning their business operations to normal after disruptions from heat waves, floods, storms, wildfires, and other hazards. Corporates may also see physical risks impact their access to key inputs, costs, and availability of insurance against such events, with some markets already seeing coverage withdrawn. From an adaptation perspective, sovereigns and governments in localities with worsening physical risk exposure (along with a lack of resources, capacity, or support to adapt) that could see credit quality deteriorate may require support from developed economies and a combination of public and private funding to finance their needs and support their fiscal performance, economic strength, and growth prospects.

The hardest-to-abate sectors face particularly challenging decarbonization-related credit risks, but these higher carbon-emitting sectors have yet to feel significant credit pressure. We believe disclosure and transparency by companies about their chosen emissions-reduction solutions—and how they are planning for the associated risks—will better enable analysis of how companies might meet their decarbonization commitments and mitigate some credit risks. In the end, decarbonization could create new markets and applications for some sectors.

What Could Change

Balancing decarbonization with the increasing demand for key commodities may prove more difficult in the near-term amid ongoing credit headwinds and geopolitical uncertainty—especially as the costs of the energy transition continue to tighten in 2024.

Market participants are concurrently confronting still-higher-for-longer interest rates, tighter financing conditions, and heightened uncertainty about the payoff of prioritizing the transition above competing priorities (including trade frictions, spending constraints, and access to liquidity) in a more fragmented and disrupted world.

Increased geopolitical fragmentation may majorly challenge countries' willingness and abilities to address climate change if their focus shifts towards energy security. Because physical climate risks are global in nature, addressing them requires global coordination—with consideration to support adaptation in, and the multidimensional transition for, developing and lower-income countries, which are 4.4x more exposed to climate risks than their wealthier peers but lack the financial flexibility to address such challenges. Many are primarily focused on energy affordability.

But on the brighter side, we believe the climate policy paradigm has evolved to a more constructive macroeconomic transition model where green growth and a sustainable environment can coexist—under which ensuring that the benefits are shared equitably across the global landscape is critical for success. Developing technologies and the adoption of artificial intelligence at low costs and at scale will enable solutions to advance the transition under this framework.

Writer: Molly Mintz