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S&P Global Ratings views climate change as a megatrend that has the potential to reshape markets for decades to come--considering the realities of climate physical risks, the need for adaptation and resilience, and the implied investments in transition to stabilize the climate. Leaders at CERAWeek discussed how emerging and established geopolitical headwinds are likely to weigh on the pace of the transition as countries consider their energy security and the affordability of transition solutions.

What We're Watching

As the Paris Agreement celebrates its 10th anniversary, while some progress has been made, the global economy is still far behind the original ambition. Global greenhouse gas emissions reached new highs in 2024, rebounding from emissions reductions realized during the pandemic slowdown.

The target to achieve net-zero emissions by midcentury is not on track--despite significant cost reductions in renewable energy. In fact, the 1.5-degree Celsius carbon budget (the targeted temperature limit of warming above preindustrial levels) has already been almost entirely emitted into the atmosphere.

The energy trilemma of affordability, security, and sustainability is increasingly coming into focus. Most countries have committed to keep global warming well below 2 degrees Celsius by the end of this century compared with preindustrial levels, as per the Paris Agreement. But these commitments are under pressure from rising power demand in both developed and emerging economies and the expected exponential growth in data centers for AI. At the same time, geopolitical uncertainties have reinforced many governments' needs for reliable energy sources.

These three factors will likely evolve at different paces across regions. Against this backdrop, we are closely watching headwinds--including diverging political priorities, the fragmentation of the Washington consensus, and the lack of climate adaption and transition support for low- and middle-income countries.

At the CERAWeek by S&P Global conference in Texas this week, leaders discussed how national security is driving the current geopolitical environment and affecting energy policies and the race for technological innovation. The transformation of the energy mix needed to support the climate transition will take more time--making resilience and adaptation investments critical to face increasing risks from physical climate risks. But while climate and energy financing is waiting to be released and capital is available, policy uncertainties may hold this funding back even as the world prepares for a warmer future.

What We Think And Why

Balancing the energy trilemma is complicated, and a wider array of geopolitical issues adds to the complexity. Countries are confronting competing priorities amid an evolving political landscape defined by tighter fiscal constraints, a cost-of-living crisis, and looming trade wars. Policymakers across the world are increasingly focused on energy security, economic competitiveness, and defense spending.

Overall, the multiplication of priorities in a more challenging fiscal environment is already affecting the amount of public funds available or allotted to fund the energy transition. Uncertainties in the stability of climate policies are also affecting transition investment decisions, which need long-term predictability.

S&P Global Ratings assesses climate change as a megatrend that could have a material impact on the creditworthiness of issuers and debt instruments. Megatrends typically have regional or cross-sector implications, have the power to transform societies and economies, and create financial, economic, and environmental risks and opportunities. The impact of climate transition risk on our credit ratings has been limited so far due, in part, to how policymakers have balanced their climate transition ambitions against the social and economic costs--and how policy predictability may evolve in different regions.

Policies designed to mainly further climate goals are increasingly under the microscope. The U.K.'s backtracking on heat pump targets (citing affordability reasons) and the EU's decision to ease emission rules for combustion engine cars are recent examples of the challenges balancing climate objectives with the realities of the market.

In the U.S., recent actions have resulted in the U.S. exiting the Paris Agreement, ceasing new offshore wind developments, and challenging SEC climate disclosure rules. While we can't rule out some reduction in subsidies, we don't expect at this stage a complete reversal of Inflation Reduction Act policies.

Prioritization of domestic or national priorities is another headwind for transition. The multiplication of trade barriers and restrictions on green technology imports and exports will likely slow down the diffusion and adoption of transition technologies and increase their cost, at least in the short term.

These dynamics are likely to heighten the risk of rising costs of physical climate impacts and exacerbate the climate financing gap in low- and middle-income countries, including for adaptation. These are not only the countries most exposed to physical climate risks and the least prepared to adapt, but they also have their own economic goals and population drivers, which will require ever-increasing energy demands. We view this as a critical issue that heightens long-term social and environmental risks for local and global financial stability.

Despite enhanced climate finance targets agreed upon at COP29, the competing industrial policies to attract investments in developed economies, growing constraints on public finance, and the risk of relative deprioritization of development policies in the U.S. and globally are pressuring the amount of funds available for climate finance in developing economies.

What Could Change

Important factors that are likely to play out unpredictably include the recent escalation in trade tariffs, the pace of development and deployment of clean tech, and the impact of AI.

Some green technologies such as solar, wind, and electric vehicles have achieved scale with price and market competitiveness and disruption in some markets. But more clean technologies alongside more energy supplies overall will be required to meet the increased demand. This could mean that all sources of energy will continue to grow in the coming decade--resulting in an "energy addition" as much as an energy transition.

While renewables will continue to grow, the world will still need to rely on traditional fossil fuels (with gas playing a critical role in the transition and the role of nuclear becoming more prominent over the longer term). AI could be disruptive itself, speeding the development of clean tech in some instances or causing wider economic disruptions.

Regardless of these uncertainties, we believe the cost of climate change impacts will continue to rise in the near term. Countries are facing rising costs of physical climate impacts (including wildfires and heat and water stress), which could be exacerbated if progress on emissions reductions slows in the longer term. Our research shows that if global warming doesn't stay well below 2 degrees Celsius by 2050, up to 4.4% of the world's GDP could be lost annually, absent adaptation.

We think it will be key for governments and businesses to give increasing attention to adaptation and resilience measures as these risks increase in likelihood.

Writer: Molly Mintz