Climate and security trade-offs: Transatlantic, industrial and trade policy in the green transition

Earlier this month, Ditchley Foundation held its most recent conference focused on the topic of climate change and the ongoing energy system transition, "Climate and Security Trade-Offs: Transatlantic and Industrial and Trade Policy in the Green Transition."

Assembled in the historic—and now tastefully digitalized—library at Ditchley Park (in the United Kingdom), more than 30 international participants from across government, industry, academia and civil society gathered to explore topics surrounding the global energy transition and its anticipated impact on trade, national security, public policy and the fabric of the transatlantic alliance.

Ditchley Foundation and Canadian Ditchley Foundation lead conferences aimed at building new common ground and addressing some of the world's most complex geopolitical problems. The observations and commentary offered here reflect the writer's personal impressions of the discussion and should not be understood or interpreted as the official viewpoint of either the Ditchley Foundation, the Canadian Ditchley Foundation nor any of the conference participants.

Canada is looking good

The timing of this conference, focused as it was on the topics of climate change, trade and security trade-offs, was perfect: immediately after the U.S. federal election and prior to the launch of the 29^th United Nations Climate Change Conference (COP29) in Baku, Azerbaijan. In addition, as it turned out, almost immediately after the results of the U.S. election became clear, the coalition government of Olaf Scholz in Germany collapsed, plunging Europe's leading industrial economy into political uncertainty. In this international context Canada, such as it is, appears relatively predictable and stable.

Although Canada currently enjoys a minority parliament at the federal level and may potentially see a federal election called at any time, Canada's reputation in the world as both a safe, stable place to invest and as a global leader in the response to climate change remains remarkably firm.

Canada and the US have a deeply entwined trade and investment relationship. Indeed, the vast majority of Canada's imports and exports travel north-south across the American border and the cultural, social and political linkages between our two nations are deep and highly multifaceted.

Despite this, and despite the not infrequent adoption of populist, American-style rhetoric by Canadian politicians of all stripes, the likelihood of wholesale policy changes on trade, climate or economic openness in Canada, such as those promised by the incoming American administration, is low. Canada is an open, trading nation—still open for business, governed by the rule of law, generally committed to addressing climate change and, in many other key respects that matter to global business, delightfully boring.

Security is not independence

One of the most crucial themes from the Ditchley conference this year was the emphasis on the staggering complexity and interwoven nature of world trade.

All major powers do rely, at least to some extent, on one another for key components and inputs to their economy. As one speaker put it, "security isn't independence" and, despite all the rhetoric, the recent populist trends toward nativist protectionism and mercantilist trade policies will not enhance the national security of any nation state actor nor the resiliency of national economies.

As proven out many times over the course of the 20^th century, nation states who wish to "go it alone" in their economic policy generally end up with lower GDP per capita, a smaller economy and significantly reduced soft and hard power on the global stage. This is truer today than ever before.

If we do indeed move toward a world with higher tariffs and decreased international trade and investment, living standards will fall for virtually everyone.

In the context of efforts to reduce global climate change and mitigate its worst effects—a universal human challenge which can only be met through rapid innovation and investment at historic scale across virtually every sector of the economy—the cost of global economic fragmentation and a decline in trade and cooperation now would be catastrophic.

Solar is eating the energy system

In 2011, an essay by Marc Andreessen captured the business world's imagination. Titled "Why software is eating the world," it argued that the business world was undergoing a dramatic and broad technological and economic shift to a scenario where software companies were poised to take over large swathes of the economy.

The remarkable and continuing exponential decline in the cost-per-watt of solar energy, and the comparable decline in energy storage costs-per-watt-hour—not unlike the ongoing cost decline in computational power known as "Moore's Law"—are now rapidly disrupting energy systems around the world.

Declining exponential cost curves are difficult for people to comprehend. We tend to overestimate change in the near term and underestimate changes over the long term. They are also brutally hard for policy makers and investors in large, capital assets to plan for. In combination with the deep electrification and broad decarbonization of all industrial sectors now underway (e.g., HVAC system electrification, sustainable aviation and carbon-free smelting technology adoption) the rapid and accelerating decline in solar and energy storage costs are causing change across all sectors of the economy.

Plan for sweeping change and accelerating price disruption across the energy systems and related energy applications.

From the mid-1970s to the early 2020s, cumulative shipments of photovoltaics increased by a factor of over one million. In other words, they doubled 20 times. Over the same period, solar cost-per-watt declined by a factor of 500.^[1]

Figure 1: Learning curve for solar panels. This data is expressed in US dollars per watt, adjusted for inflation. Cumulative installed solar capacity is measured in megawatts.^[2]

Swanson's Law, the observation that the price-per-watt of solar photovoltaic modules drops roughly 20 per cent for every doubling of cumulative shipped volume, has held true since first being applied to the photovoltaics industry in the mid-1970's and, more importantly, it still holds true today (see Figure 1). As importantly, a similar "experience curve" analysis for lithium-ion battery costs has also held true: lithium-ion battery cell costs fall by 28 per cent for every cumulative doubling of units shipped.

Analogous declining cost curves also apply across numerous other technologies deemed crucial to the energy transition—wind generation, air source heating and cooling, non-chemical battery storage technologies, hydrogen and non-fossil transportation fuels.

What this means, effectively, is that the energy transition train has already left the station. Even if U.S. federal government policies with respect to renewables and the green transition were to reverse course, it would appear that the price superiority of cleaner energy technologies will win the day.

An excellent case in point, covered in detail recently by the Financial Times^[3], is the rapid green transition which has occurred in Pakistan—where expensive, dirty and unreliable grid-power is rapidly being replaced by commercial, industrial and residential consumers with cheap, efficient and reliable solar power—using equipment imported primarily from China.

Similar trends are being seen across the developing world—and in islands and so-called 'grid-edge' scenarios in the developed world—essentially, wherever traditional energy resources are expensive and/or unreliable. It is often said that innovation happens from the edge in.

A possible U.S. CBAM

As importantly, and despite campaign rhetoric, it appears unlikely that the incoming U.S. administration will want to entirely dismantle the sweeping industrial policy put in place by the previous administration to subsidize an ambitious decarbonization of the world's largest economy—the Inflation Reduction Act ("IRA"). Nearly 80 per cent of IRA credits pass through to Republican-held districts in the United States—which is why 18 Republican congressmen recently declared that they are opposed to a wholesale repeal of the IRA.

One of the most surprising observations made at Ditchley was the possibility, some say likelihood, that the U.S. may in the near future enact legislation akin to the Carbon Border Adjustment Mechanism ("CBAM") now being put in place by the European Union. A CBAM is a carbon tariff on carbon-intensive products, such as steel, cement, electricity, agricultural products and manufactured goods, imported into the European Union. Launched as part of the European Green Deal, the European CBAM comes into effect in 2026 with reporting obligations already having started in 2023.

The European CBAM is a cause of some consternation for certain carbon heavy and/or coal reliant economies, such as South Africa and China, and will result in changes to overall global trade patterns on that basis. That said, certain other countries, such as low-net-carbon sub-Saharan exporters in Africa, see the European CBAM mechanism as a positive thing which will give them a trade advantage going into Europe. The most surprising take away for this writer from the conference was the possibility that a U.S. CBAM style mechanism (rebranded to appeal to U.S. voters) is likely—even in the context of the incoming administration.

For Canada, which is already well set up to enact CBAM-type legislation with its current federal carbon pricing rules and blessed with vast clean energy resources, this could represent a significant market opportunity.

Gifts from China

One item that is clear to most observers is that the People's Republic of China now has a very significant market position in three of the key components necessary to facilitate the decarbonization of the world's energy systems: solar panel manufacturing, lithium battery manufacturing and EV manufacturing.

Indeed, the "New Three" has been a buzzword in Chinese manufacturing for well over a decade—highlighting the country's strong commitment to solar cell manufacturing, battery manufacturing and EV manufacturing. China currently represents more than 80 per cent of global solar cell exports, more than 50 per cent of lithium-ion battery exports and more than 20 per cent of electric vehicle exports. In 2023, Chinese-owned companies produced 93 per cent of all the world's solar cell polysilicon.

Whether this level of market concentration is seen as a good thing or a bad thing really depends on your perspective.

The fact is that, for obvious strategic reasons,^[4] China has acted decisively to launch and develop various clean energy technologies and related tertiary industries giving it domestic control over tremendous power generating capacity—resources that are not reliant on strategically vulnerable imported fuel inputs. To accomplish this, for decades Chinese central, state and municipal governments have used a combination of direct and indirect subsidies, zero and low-cost debt, technological support and industrial policy guidance to attract and support renewable energy champions.

The result has been a massive expansion in supply that, in turn, has helped drive down the cost of renewable energy technologies for consumers all around the world. Chinese solar module manufacturing capacity reached roughly 1,000 gigawatts (GW) in 2023—five times that of the rest of the world combined.^[5] The country can now produce more than twice as many solar modules as the world installs each year.

The result has been fierce competition among renewable energy equipment manufacturing titans and, arguably, a boon for the rest of the world. Just as Germany's pioneering launch of its Energiewende in the late 1990's can be credited with setting the world on course to see a rapid uptake and correspondent price decline in wind and solar energy, China's uptake of the New Three since the early 2000's could, potentially, be credited with saving the world. Irrespective of whether the West's heavy reliance on Chinese made materials pertaining to the energy sector spells pending doom or imminent salvation for the world, it was noted that virtually everyone at the Ditchley Conference had on their person a smart phone …most likely made in China.

Supply chain concentration reporting

The concern that Western governments might now be or become overly reliant on Chinese made materials as they undertake the energy transition was not fully resolved. There is a concern both with over-reliance for key industry technologies on any foreign power, and a more basic concern with respect to unfair industrial subsidies and the impact that they have on domestic industries. At least one economist at the Ditchley conference posited for consideration the idea that, given the gravity of the situation now facing humanity, we might consider "filling our boots" and encouraging China to continue subsidizing the energy transition for the rest of the world.

A broader concern with respect to trade with non-liberal and/or non-democratic countries (the so-called 'CRINKs', among others) was also expressed. That said, strategic industry supply concentration—think Taiwan and semi-conductors, or Europe and its dependence on Russian oil and gas—does undoubtedly represent a significant risk of exposure across innumerable industries for the world's advanced economies. It also represents a significant political concern as reliance on strategic resources controlled by other nations invariably influences freedom of policy maneuver at the highest levels of government.

Given the critical nature of the challenge at hand for humanity, the risk of key industry concentration is a matter which merits further examination and research. At a minimum, there is a compelling case to be made for widely available supply chain concentration risk reporting mechanisms across critical industry sectors serving the world's economies—particularly those which relate to climate action.

Conflict spells climate disaster

One chilling observation made toward the end of the conference discussion was the fact that national security concerns and the exigencies of armed conflict will almost invariably trump broader concerns over climate and sustainability. Furthermore, climate change itself is increasing the risk of armed conflict across the regions of the world which are most vulnerable to its effects. In the Middle East and North Africa, for example, prolonged drought and unpredictable weather patterns are making armed conflict more likely.

Conversely, and as one might expect, warfare itself is a major cause of both direct and indirect GHG emissions.^[6] These factors make dialogue and the cessation of hostilities, even the smallest localized conflicts, is crucially important to everyone.

Paths forward

Despite the almost incomprehensible scale of the challenge facing current generations, the overall consensus from this month's Ditchley conference was surprisingly upbeat. What is clear is a vast majority of the world's scientists and senior political leaders recognize the correlation between continued fossil fuel reliance and the damage being done to the world's climate systems.

What is also clear is that the ship is already turning. Renewables and climate-friendly technologies already make economic sense across most economic sectors, and the costs associated with them are very likely to continue to decline exponentially in the coming decades as adoption rates go up. Solar power is the world's fastest-growing source of energy. The International Energy Agency (IEA) projects that 2024 global investment in energy, including fuels and infrastructure, will exceed $3 trillion for the first time this year. Of that total, $2 trillion will be directed toward clean energy technologies.^[7]

When faced with a common threat, we humans can sometimes rise above our baser instincts. The classic examples given are humanity's response to the threat of ozone depletion, with CFCs phased out almost entirely after the adoption of The Montreal Protocol in 1987, and the more gradual phase out of leaded gasoline between the mid-1970's and 2021.

Other less well-celebrated examples include literally thousands of bilateral and multilateral freshwater cooperation treaties, many of which had actually resolved longstanding armed conflicts, hundreds of transboundary fishery accords, the Convention on International Trade in Endangered Species of Wild Fauna and Flora and, of course, the vast multilateral endeavor to develop and manufacture highly effective vaccines for COVID-19 in record time—which saved untold millions of lives.

The key takeaways from Ditchley for this writer were simple: we can and are currently solving climate change, but success is not assured. To succeed, we must continue to cooperate internationally, find common cause with those whom we might otherwise distrust and rely on openness and continued dialogue to continue to find win-win solutions to a shared threat.