Energy Security and the Road to Net Zero: the Role of the Derivatives Market

Climate change may be humanity’s greatest threat. Rapidly increasing greenhouse gas emissions have led to rising sea levels, recurring heatwaves and melting glaciers, all of which have contributed to an increasingly dismal economic and environmental outlook. Between 2030 and 2050, the World Health Organization forecasts there will be an additional 250,000 deaths per year as a direct consequence of climate change. Between 2016 and 2018, climate-related disasters were reported to have cost the global economy $650 billion.

In an effort to mitigate and ultimately offset these effects, governments and organizations across the globe have committed to implementing solutions to halve greenhouse gas emissions within the next decade, and eliminate net emissions by 2050. Specifically, the EU and US have committed to reaching carbon neutrality – or net-zero emissions – by 2050, China has committed to become carbon neutral before 2060, and other countries participating in the 2015 Paris Agreement have made similar commitments. More recently, decisions made at the 2022 United Nations Climate Conference reiterated the commitment to achieving carbon neutrality within previously proposed time frames. As a result of these initiatives, a number of new solutions to reduce or eliminate carbon emissions have developed, in addition to new markets to finance these solutions.

One particular area of focus has been the intersection between the net-zero transition and global energy security. The energy sector produces around three quarters of global greenhouse gas emissions, making it a primary contributor to the climate crisis. In order to ensure long-term energy security while achieving global net-zero targets, public and private investments in renewable energy and green technology must triple by 2050. However, recent volatility in energy markets, exacerbated by geopolitical conflict, has negatively affected green investment. Innovation in financial and risk management solutions will be vital to safeguarding energy security and facilitating the transition to a net-zero economy.

This paper from the ISDA Future Leaders in Derivatives program aims to build on existing literature on the topic of decarbonization and provide insight into how the derivatives market can protect energy security while facilitating the transition to net zero.

Insights and recommendations include:

  • Current state of the market: Insight into the current state of the market and the challenges resulting from extreme price volatility in energy markets, most notably for corporates in the energy sector participating in cleared derivatives markets.
  • Medium-term recommendations: Scale existing voluntary carbon credit markets, further standardize emissions products and create the necessary legal framework to establish a unified global market.
  • Long-term recommendations: Update derivatives products to reflect rapidly evolving needs as renewable energy grows in adoption and importance to global energy security.

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