• New initiatives by governments are likely to be limited in 2022, as high energy prices and insufficient international funding for developing countries will limit overall progress.

• The focus will shift increasingly to implementing existing pledges. Important legislation to watch include the Build Back Better plan in the US and the EU’s Carbon Border Adjustment Mechanism (CBAM).

• The pool of climate financing will continue to grow, although new EU regulations will lead to stricter accounting rules on what is considered “green”.

• Natural disaster risk will remain elevated and unpredictable, with governments and businesses increasingly prioritising climate risks, in addition to decarbonisation.

Last year was a critical one in climate change policy. In November the COP26 conference represented the first opportunity for countries to submit enhanced pledges around emissions cuts since the 2015 Paris Agreement. These pledges (known as nationally determined contributions, or NDCs) fell far short of the collective ambition needed to keep overall global warming to below 2°C by 2100, although they achieved modest progress in some technical areas. The UN requested that countries revise their NDCs and return with greater ambition at the COP27 conference in Egypt in November 2022. However, the impediments to progress at COP26—insufficient agreement on funding for developing economies, and policymakers’ concerns around costs to government and household living standards—are unlikely to have abated significantly by COP27. We expect any increase in the ambition of NDCs to be minor.

Governments will focus on meeting existing commitments rather than making new ones

Oil and natural gas prices reached multi-year highs in 2021, amid surging demand and supply-chain bottlenecks due to the pandemic. The increased price of energy has become a major political issue in advanced and emerging economies alike. Although we forecast that prices will largely stabilise in 2022, they will remain elevated, making cost-of-living concerns a higher priority for policymakers globally, rather than ambitious new climate policies.

Many of the largest carbon-emitting nations must still implement new policies to meet the pledges they have already made. The EU’s “Fit for 55” plan will move from the proposal stage to legislation. Most notably, it includes the CBAM, which will introduce a border tax on imports for goods produced through high-emissions activities. Other advanced economies, including the UK and Canada, have mooted enacting their own version of the CBAM, which will probably be compatible with the EU model. Many of the proposed versions are technically complex, potentially requiring exporters to report on emissions added at each step of the manufacturing process, similar to a value-added tax (VAT). Rules finalised at COP26 codifying an international system of carbon offsets and credits also make it more likely that the CBAM will inform international supply-chain decisions as countries develop a more integrated carbon emissions market. The European Commission hopes to begin a transition period in 2023 with full implementation by 2026, making 2022 a critical year in developing the policy.

The progress of the Biden administration’s signature Build Back Better social spending bill in the US will also be crucial, as it includes more than US$500bn in incentives for households and businesses to adopt green energy and electric vehicles. Although this has been watered down by a Democratic senator, Joe Manchin (the Senate’s swing vote, who represents coal-rich West Virginia), it still represents the centrepiece of Joe Biden’s climate agenda. The failure of Build Back Better would undermine action internationally, as the world’s second-largest emitter (after China) will be necessary for any global solution.

The fastest-growing emitters, China and India, are unlikely to change their policies significantly. Despite promising to reach net zero by 2070 at COP26, India has yet to formally submit a revised NDC to the UN, while China’s commitment to continue building new coal-fired power plants throughout the 2020s—the policy contributing the most to carbon emissions—is unlikely to be reversed amid rising energy costs.

With COP27 taking place in a developing country, the issue of climate financing for such countries will be centre-stage in the negotiations. In 2009 developed economies promised to mobilise US$100bn per year in financing aid for developing countries to address climate change, a goal on track to be met only by 2023. However, the actual need for climate financing is several times that amount, which has led to developing countries making only modest pledges. The gradual increase in overall multilateral spending currently envisaged is unlikely to change that dynamic. More promising is a programme agreed at COP26 between several developed countries and South Africa, which committed US$8.5bn explicitly to enable the country to phase out coal power. This more targeted, structured finance vehicle is the largest of its kind and could serve as a model for future climate financing deals if it is seen as successful.

Advances in financing and technology will continue to drive transformation

Green financing has increased exponentially in recent years. Climate bonds worth more than US$452bn were issued in 2021, an increase of more than 50% on the 2020 figure of US$297bn, according to the non-profit Climate Bonds Initiative. Equity, in the form of both market valuations of green companies and venture capital funding for clean-energy start-ups, has similarly increased.

The benefits of existing research and development (R&D) in renewable energy are already bearing fruit. Prices for battery storage continued to decline in 2021 despite supply-chain disruption, and the cost of solar and wind power generation is already below that of most fossil fuels. New technology, particularly carbon-capture and hydrogen fuel-cell technologies, is among the most heavily invested-in sectors among start-ups. Both are currently too expensive to be viable in reducing overall emissions in 2022, but advances in these areas this year may have implications in the medium and long term.

However, the landscape for green investment is changing in 2022. The EU and the UK have proposed stricter reporting rules for financial disclosures. The UK began a consultation on its sustainability disclosure requirements (SDR) standards in October, which is likely to conclude in the first half of this year, following the EU’s Sustainable Finance Disclosure Regulation (SFDR) passed in 2019. The EU’s taxonomy for sustainable activities, a classification system that informs the SFDR by providing a list of activities considered sustainable, also came into force on January 1st 2022. Additionally, the creation of an International Sustainability Standards Board (ISSB) at COP26 will allow definitions for green investment to be harmonised globally.

These initiatives, particularly the taxonomy, aim to address so-called greenwashing, or marketing a project or instrument as green when its actual contribution to overall decarbonisation is minimal. The total amount of “sustainable” investment products has ballooned since the 2015 Paris Agreement; however, a lack of a rigorous assessment system has led to significant greenwashing, creating fears of a bubble. In the short term, sustainable investment in Europe has slowed compared with other advanced economies (although from a high base), in part owing to stricter standards on what is considered sustainable. The adoption of more uniform standards in Europe will have a global impact, and greater scrutiny of these definitions may potentially slow growth in the sector but will lead to more effective allocation of financial resources in the medium term.

Natural disaster risk will remain elevated and become less predictable

The frequency of extreme weather events has already risen as a result of climate change, with the number of relevant loss events tracked by insurers trending more rapidly upwards in recent years. In its 2021 report the Intergovernmental Panel on Climate Change (IPCC) said that extreme temperature events (those that have historically occurred once every ten years) had increased across several categories.

In addition to resilience risks for businesses and governments, this is also affecting international negotiations over finance for developing countries. Developing countries at COP26 advocated for more financial support to be steered towards addressing “loss and damage” caused by climate change rather than accelerating their energy transitions. This has generally been less popular among developed countries, as it is more difficult to mobilise private capital to mitigate disaster risk than to scale new energy. Additional funding for loss and damage is likely to be a key demand of developing countries in advance of COP27, and this will become a more significant issue as such countries remain more vulnerable to climate change.

The analysis, forecasts and data featured in this article can be found in EIU Viewpoint, our new country analysis solution. EIU Viewpoint provides unmatched global insights covering the political and economic outlook for nearly 200 countries.