The Governor of the Bank of Israel spoke at the National Conference for Energy organized by the Israeli Institute for Energy and the Environment
· “The issue of climate change is of the highest importance and is characterized by a high level of uncertainty and a variety of risks. We at the Bank of Israel are continually monitoring this situation, in full partnership and cooperation with stakeholders in Israel and abroad.”
· “The design of climate policy must include internalizing the balance between physical risks as well as the transition risks and costs to which it will lead, together with the investment of effort in meeting the targets to which Israel has committed itself. In parallel and in order that the policy measures that are adopted will have a real impact on reducing risk rather simply generating short-term change (which characterizes the path Israel is currently on), emphasis must be placed on the acceleration of renewable technology development and adoption.”
· “Achieving a zero-emission energy system is a necessary and important condition for reducing man’s effect on the climate and mitigating global warming. At the same time, if this is done hastily and without comprehensive long-term planning, the result is liable to reduce the economy’s energy security.”
· “Israel is notable in the global effort to phase out coal, as its last coal-fired power plant is scheduled for closure in 2026. Nonetheless, and given the existing policy tools, Israel does not have any feasible plan that can facilitate the transition from natural gas to zero-emission sources in the near term. In order to meet its commitments, additional policy measures will be needed in coming years, as well as the adoption of additional technologies, some of which do not currently exist or are not currently feasible.”
· “It is important to state that even if Israel does not fully meet emission reduction targets set by the government, it is nonetheless essential to implement the necessary policy. This of course must be done wisely and while preserving energy security and continuing to reduce emissions. One of the feasible tools for achieving carbon neutrality in Israel is renewable energy technology. The high tech sector, which has achieved a name for itself in recent years, can also contribute its share to this effort.”
· “The greater the likelihood that physical risks will be realized, the more likely it becomes that there will be economic consequences. These include an increase in the economy’s risk premium, which will worsen the economy’s cost and terms of borrowing, will increase the insurance sector’s expenses and, in an extreme scenario, will adversely impact the ability to service debt and will reduce the value of credit providers’ portfolio of collateral. It is important to note that we do not currently see any real chance of such a scenario being realized in Israel in the near future; nonetheless, the possibility deserves attention.”
· “An example of a financial risk that stems from transition risk is lower valuation of companies that are responsible for high emissions. These companies face the risk that their credit ratings will be lowered and that the financial institutions exposed to them will experience market losses. Thus, an initial analysis carried out by the Bank of Israel shows that the risk resulting from credit to large polluting borrowers is about 5.5 percent of the banks’ total credit risk due to large borrowers and about 2.3 percent for the banking system as a whole. Although this is not a significant proportion of the risk, it is not negligible either.”
· “The Climate Law, which in its current form adopts the 2050 climate target and the government decisions regarding the 2030 target, is an important piece of legislation and constitutes another step along Israel’s path to carbon reduction. Another policy tool that can contribute to the climate issue, and in a way that aligns with the recommendations made by international organizations, is to reinforce the competitiveness of renewable-energy-based industries relative to fossil-fuel-based industries by the imposition of a carbon tax.”
· “The process of adaptation involves a high level of uncertainty. Therefore, it is important to carry out a national assessment that will evaluate the potential risks facing Israel—something that has not yet been done—and will delineate the directions toward possible solutions. It is important that such an evaluation will begin with a scientific analysis, on the basis of which individual sectors of the economy will be examined. This should be accompanied by an analysis of financial and planning aspects of the issue in order to create regional channels of discourse and coordination with other countries in the region.”
The climate and global warming crisis has been an issue for policymakers around the world for several decades, and in recent years, the issue has gained increasing public attention. The climate issue has numerous and multidisciplinary implications and resolving it will require cooperation among countries and organizations. Today, I would like to present an economic analysis of the climate issue, from the perspective of a central bank that is responsible for price stability, for the stability of the financial system, and for providing economic advice to the government.
My remarks will be divided into several sections. First, I will present some background on greenhouse gas emissions, which is at the heart of the discussion of global warming, and the policy steps taken by the international community in response to the problem. I will then survey the challenges to the economic and financial systems that stem from the climate crisis. Following that, I will relate to the unique challenges facing Israel in the effort to reduce emissions. I will then briefly present an analysis carried out by the Bank of Israel that evaluates Israel’s ability to meet its emission reduction commitments. Finally, I will discuss the connection between banking and global warming and describe the measures that the Bank of Israel has taken in this context.
I would like to begin with a quick survey of the milestones in the development of climate change as an international issue:
In 1972, the first international conference took place in Stockholm, which led to the founding of nongovernment organizations that work for the conservation of natural resources and the solution of environmental problems. In 1989, after the hole in the ozone layer was discovered, the Montreal Protocol was signed, with the goal of reducing the emission of gases that harm the ozone layer. That agreement has been successful and is providing hope for other international efforts in this domain. In 1992, the first Earth Summit took place in Rio de Janeiro, where a plan of action was approved for sustainable development. One of its goals was to create an international framework for reducing greenhouse gas emissions. In 1977, the Kyoto Protocol, for the reduction of greenhouse gas emissions, was signed. The agreement went into effect in 2005 but none of the signatories met the target that was set. In 2015, the Paris Agreement was signed by 196 countries who committed themselves to limiting the increase in the global temperature to 2 degrees Celsius. The vast majority of the signatory countries did not meet the targets of this agreement either, as we will see below.
Last year, at the Glasgow Climate Conference, international agreement was reached on reducing greenhouse gas emissions and most of the countries, including Israel, presented national targets for a significant reduction in pollution. Many countries accepted the target of carbon neutrality by 2050 in order to reach the Paris Agreement targets. The term carbon neutrality implies a balance between carbon emissions from human sources and their absorption in carbon sinks. Below, I will relate to the targets set in Glasgow and the likelihood of their being met.
I would like now to present some data on the current situation, which are important to provide background for the discussion.
Each year, about 50 gigatons of carbon are emitted into the atmosphere in a large number of processes, including electricity production, creation of waste, agriculture, manufacturing, etc. At the same time, only 24 gigatons are absorbed by the oceans and the onshore biosphere. Therefore, carbon emissions worldwide need to be reduced by 26 gigatons, i.e., by more than one-half, in order to meet the target of carbon neutrality by 2050. This is a dramatic reduction with far-reaching consequences.
A few major countries are responsible for a large part of global greenhouse gas emissions. Israel’s share of total carbon emissions is negligible, while its rate of emissions normalized for the size of the population is quite similar to the global average.
A critical step in the design and monitoring of emission policy tools is to identify the sources of greenhouse gas emissions. The graph presents the distribution of emission sources and shows that about 80 percent are the result of electricity production. Therefore, the reduction of emissions needs to focus on this source.
There are two main efforts, which complement one another. The first is a mitigation effort, which is intended to reduce carbon emissions, while the second is an adaptation effort, which involves adapting to the changing reality. I would like to further describe the mitigation effort both in Israel and worldwide and then discuss the implications of adaptation on the financial world.
The political initiatives that were the focus of the Glasgow Conference were intended to further mitigation by means of weaning the world off coal, the most significant source of emissions. When looking at the distribution of emission sources in the OECD countries and in the five largest polluters outside the OECD, i.e., China, India, Russia, Indonesia and Brazil, the centrality of coal in the emissions of the vast majority of countries is evident. Furthermore, we can also see the importance of oil and the not insignificant part played by natural gas.
In many countries, including Israel, it is understood that the effort to reduce greenhouse gas emissions will require an energy transition based on zero-emission energy sources. This process is expected to occur in three stages:
The first stage is a transition from coal to natural gas in the production of electricity. As I mentioned earlier, coal accounts for a main share of electricity production. Therefore, the completion of this first stage is expected to last for several years and will continue to be an issue at the Sharm el Sheikh conference next year.
I would mention that Israel stands out in this context as its last coal-fired power plant is expected to close in 2026. This accomplishment, which was also emphasized in the annual report of the IMF, places Israel at the forefront of the effort to phase out the use of coal.
The second stage of the energy transition—which in certain countries is being carried out simultaneously with the first—involves reducing the use of oil. Although oil’s rate of emissions is lower than that of coal it is nonetheless significant. The core of this stage is to reduce the use of oil in vehicles by, for example, transitioning to electric vehicles. The implementation of this stage faces regulatory difficulties and problems in consumer preferences worldwide.
As part of encouraging the implementation of this stage, Israel signed the British Initiative at the Glasgow Conference, thus committing itself to having only zero-emission vehicles on the road by 2035. The government has even imposed restrictions on the emissions of new vehicles already starting from 2030.
The third stage is a transition from natural gas to zero-emission energy sources, or in other words, renewable energy. Although the production of electricity by means of natural gas leads to significantly lower levels of greenhouse gas emissions than existing alternatives, it nonetheless still produces not insignificant emissions.
In Israel, 7 percent of electricity production is from renewable sources, almost all of which is solar. At the same time, the creation of a renewable energy industry in Israel constitutes a major achievement for the government, following a long period in which renewable energy activity did not manage to take root.
A look at the distribution of renewable energy sources shows Israel’s position to be an outlier, with 96 percent of renewable energy coming from solar. This is compared to only 11 percent in the rest of the world. Israel’s reliance on solar energy is not out of choice, in view of the scarcity in wind and water that it faces.
It should be remembered that the use of solar energy involves a certain amount of risk since it cannot currently be transferred from one time period to another. That is, solar energy has to be consumed close to the time of its production and cannot be stored for use at night or during the winter. It is critical to diversify the sources of energy, since beyond a certain point and without appropriate planning for the long term, reliance on sources of energy that depend on the weather as an alternative to legacy energy sources involves significant risk to energy security. Thus, for example, there were low levels of wind in Europe during last summer and autumn, which led to low production by wind turbines. This together with a number of other events combined to create what was called "a perfect storm" that constituted a threat to energy security for many Europeans.
This tension—between the need to achieve a carbon-neutral economy and energy security—is an important policy issue for decision makers and I will relate to this below.
After briefly presenting the problem, I would like to describe further the economic risks that stem from the environmental risk.
From an economic perspective, the issue of the climate and global warming involves two main risks:
The first involves physical risks, which include an increase in the frequency and intensity of extreme climate events, such as heat waves, floods and fires, as well as more gradual long-term changes, such as an increase in sea level and droughts. These phenomena constitute a danger to infrastructure, property and life.
As the likelihood of such scenarios increases, it is also expected that there will be economic consequences. These include an increase in the economy’s risk premium, which will worsen the economy’s cost and terms of finance, will increase the expenses of the insurance industry and in the extreme case will impinge on the ability to service debt and will reduce the value of the credit providers’ portfolio of collateral. It is important to mention that we do not currently see any real likelihood of such a scenario being realized in Israel in the near future, nonetheless, the possibility deserves attention.
The second type is transition risk, which stems from the process of transformation occurring in the environmental protection domain. This type of risk relates primarily to companies and organizations that will be “stuck” with surplus infrastructure based on polluting energy sources or that will have to pay high levels of taxes. One of the largest transition risks stems from the transition to renewable energy, which is liable to endanger energy security. Energy security makes it possible for households, businesses and governments to plan their needs and investments efficiently. This is a necessary condition for the smooth functioning of the economy and I view this as an issue with macroeconomic importance. Moreover, energy is a unique good in that a disruption of its supply leads to large-scale harm to economic activity that is disproportionate to its small share of GDP (only about 7 percent).
At this point, I would further clarify an important point that sometimes gets lost in the public discourse: the fact that transforming the energy system to zero emissions, which involves replacing the primary energy sources, is, as mentioned, a necessary and important condition for reducing man’s effect on the environment and mitigating global warming. At the same time, if this is done hastily and without comprehensive and long-term planning, the result is liable to reduce energy security.
Decision makers face a complex challenge – to deal with climate change in a way that takes into account all of the risks when weighing the likelihoods of their realization and to act within the framework of responsible risk management. An overly rapid reduction in production capacity based on polluting sources before the capacity for producing, transmitting and storing renewable energy is enlarged is likely to cause substantial harm to Israel’s energy security. As economists, we must take into account the cost of non-provision of energy during the transition period, which is liable to be very large.
After surveying the climate risks on a general level and having presented their economic aspects, I would like to further dive into the risks that are relevant to the financial system. More specifically, I would like to discuss the possible risks that have some probability of being realized. I do not intend to claim that this is a reasonable or immediate-term scenario.
An example of a financial risk that stems from transition risk is a lower valuation of companies that are responsible for high emissions. These companies face the risk that their credit ratings will be lowered and that the financial institutions that are exposed to them will experience market losses. Thus, an initial analysis carried out by the Bank of Israel shows that the risk resulting from credit to large polluting borrowers is about 5.5 percent of the banks’ total credit due to large borrowers and about 2.3 percent for the banking system as a whole. Although this is not a high proportion, it is not negligible either. Physical risks are also likely to have a major effect on insurance companies on the liabilities side of their balance sheets to the extent that the frequency and intensity of extreme climate events increases.
Another financial risk may arise due to the significant changes in the preferences of the public and in patterns of demand, which are liable to affect the economy and the financial system. For example, greater resources will be required for legal issues as a result of a larger number of suits brought and additional environmental legislation. Another example is the boycott of companies with high emissions, which could lead to higher costs and reputation risks for companies and financial institutions exposed to them.
Having presented a birds-eye view of the economic risks created by global warming, I would now like to discuss the unique challenges facing the Israeli economy in this context.
A graph that presents the current situation relative to changes in the level of emissions in various countries since the Paris Conference shows to what extent the nations of the world have reduced their emissions since the time they made their commitments. The graph is a bit complicated and so I will quickly explain it: The blue bars represent the rate of change in total emissions in 2019 compared to 2015, where the dotted vertical line represents the drop in total emissions. The green line is the calculation of the emission targets set in 2015 at the time of the signing of the Paris Agreement. Finally, the blue dots normalize a country’s emissions according to rate of population growth, thus making it possible to see the change in emissions per capita during this period.
It appears that not only did countries not reduce their emissions, they actually raised them by 5 percent beyond the target change derived from the Paris Agreement. Furthermore, it appears that Israel is approximately in the center of the distribution and that there was no change in Israel’s emissions during this period. Therefore, and as is the case for the majority of countries in the world, we are far from our target.
Nonetheless, the rate of reduction in emissions per capita in Israel is one of the largest among the developed countries, which leads me to my next topic, namely the unique climate challenges facing Israel.
First, Israel has a high rate of population growth relative to other countries:
We can see a link between the change in greenhouse gas emissions and the growth in population for various countries. There is a positive correlation between population growth and growth in emissions. The higher the rate of population growth, the poorer is a country’s performance in reducing emissions.
Israel is below the trend line, which indicates that if account is taken of Israel’s rapid population growth—which would have raised total emissions if there were no policy to reduce them—there is a trend toward reducing emissions.
The Israeli economy is facing several other challenges that hinder its implementation of an effective emission reduction policy on the way to energy transition. This includes its status as an energy island, which limits its ability to trade energy and therefore diversify its energy sources. The diversification of energy sources would provide the possibility of relying on weather-dependent energy sources that have storage limitations. Another challenge is the limited stock of natural zero-emission energy sources, such as water and wind, which limits its ability to produce renewable energy other than solar.
I will now present the results of an analysis of Israel’s ability to meet the new targets presented at the Glasgow Conference, to which Israel has committed itself. The analysis involves a simulation carried out by the Research Department that examines a variety of policy measures and scenarios. I will present only the bottom line and anyone interested in further details is welcome to read the full results in the most recent Bank of Israel Annual Report.
Israel’s international commitment includes two general targets: a reduction of 27 percent in total annual greenhouse gas emissions by 2030 relative to 2015 and a reduction of 85 percent by 2050.
The policy measures that were examined in the simulation indeed lead to not insignificant structural changes that affect the rate of increase in emissions in the short run. However, in the long term, the trends in population growth and in GDP, and the accompanying demand for energy, have a dominant effect. Thus, the level of emissions will continue to grow and Israel will find it difficult to meet its targets. In order to meet the targets, additional policy measures will be needed in coming years, as well as the introduction of additional technologies, some of which do not currently exist or are not currently economically feasible.
In the simulation, three policy scenarios were examined with respect to the amount of electricity produced from renewable sources:
The first is “business as usual” in which Israel continues to produce electricity from renewable sources at a level of 10 percent of total production, which is approximately the level today.
In the second, the production of electricity from renewable sources is increased to 30 percent of total production by 2050.
In the third scenario, 100 percent of electricity is produced from renewable resources by 2050.
It is important to note the policy tools examined in the simulation do cause not-insignificant structural changes that impact on the growth rate of emissions in the short term. However, in the long term, the impact of the trends of population and GDP growth increase, and with them the demand for energy.
The simulation results indicate that under all the scenarios, Israel will not be able to meet the targets to which it has committed, and under the first two scenarios, the deviation begins as early as 2023. The bottom line: As of now, and given the existing policy measures, Israel has no feasible trajectory that will allow it to transition from the use of natural gas to zero-emission sources in the near future.
In order to comply with the undertakings, additional policy steps will be required in the coming years, as well as the use of technologies, some of which, as of now, do not exist or are not worthwhile economically.
It is important to mention that the gap between the emission reduction targets and the ability to achieve them with existing technologies is not unique to Israel and it appears that only a few countries will be able to meet the targets, as is the case with the widespread non-compliance with the targets of the Paris Conference, as discussed earlier.
Nonetheless, it should be mentioned that even if we do not meet the targets, it is important to implement the policy that is needed to continue reducing emissions. This of course must be done wisely in order to maintain energy security, as I already mentioned. One of the feasible tools for achieving carbon neutrality in Israel is renewable energy technologies. It may be that the high tech sector, which has flourished in recent years in Israel and has developed a name for itself, will be able to contribute to this effort.
Just to get an idea: During the past decade, there has been a phenomenal increase of 30-fold in investment in companies that specialize in the climate. As of 2021, the investment by venture capital funds worldwide in the domain of climate was about $50 billion. The lion’s share of the investment was in climate tech companies (which in the past were known as cleantech), which are investing effort in the development of technological solutions to reduce greenhouse gas emissions. The CEO of Blackrock, one of the largest investment institutions in the world, recently said that “the next 1000 unicorns will be climate tech companies.” In Israel, the investment in this space has broken a local record and in 2021 total investment in climate tech companies stood at $2.2 billion. The involvement of the high tech sector in the public effort in this direction is likely to produce results that will bring Israel closer to meeting its targets.
As part of this activity in Israel, the government recently passed the Climate Law, which in its current form adopts the 2050 climate target and the government decisions regarding the 2030 target. It is an important piece of legislation and constitutes another step along Israel’s path to carbon reduction.
Another policy tool that can contribute to the climate issue, and in a way that aligns with the recommendations made by international organizations, is to reinforce the competitiveness of renewable-energy-based industries relative to fossil-fuel-based industries by the imposition of a carbon tax.
A carbon tax constitutes a kind of “pricing” system for greenhouse gas emissions and it will support the market in internalizing the externalities of emissions within prices. In this way, it will help to reduce emissions while minimizing the distortion of resource allocation in the economy and helping to focus technological development on the reduction of emissions. In view of the high level of uncertainty with respect to the types and characteristics of future technologies for reducing emissions, the pricing of emissions by means of a carbon tax is a tool that can bring about the most efficient outcome in the reduction of emissions while at the same time reducing the cost of the process to the economy. Since this measure also involves a higher price for electricity, it is important that it be accompanied by supplementary measures for mitigating the effect on sensitive populations without harming the incentives to reduce emissions.
I will conclude with a short discussion of adaptation to the potential effects of climate change. The process of adaptation involves a high level of uncertainty. Therefore, it is important to carry out a national assessment that will evaluate the potential risks facing Israel–something that has not yet been done–and will delineate the directions toward possible solutions. It is important that such an evaluation begin with a scientific analysis, on the basis of which individual sectors of the economy will be examined. This should be accompanied by an analysis of financial and planning aspects of the issue in order to create regional channels of discourse and coordination with other countries in the region.
The climate issue has the potential to create long-term risks in the financial world, and as a result, there has been an active discussion in recent years of the role of financial supervisors in the climate space. Thus, for example, the Capital Market Authority published a draft amendment to the consolidated bulletin that instructs investors and financial institution to take ESG considerations into account. Last April, the Israel Securities Authority published a review and recommendations regarding disclosure of corporate responsibility and ESG risks.
Alongside the increasing activity in the climate domain worldwide, the Bank of Israel is also becoming active in this direction. In 2020, the Bank of Israel joined the Network for Greening the Financial System (NGFS), an organization that brings together more than one hundred central banks and financial regulators and which is active in creating a green financial system. This involves supporting modification of the financial system in order to deal with the consequences of the climate crisis in the global transition to carbon neutrality. Additionally, the then-Supervisor of Banks sent a letter already in 2009 calling on the banks to identify, assess and manage environmental risk and the banks were required to do so according to the principles generally accepted worldwide. In December 2021, the Bank of Israel revised the disclosure obligations that apply to the banks with respect to ESG in general and the environment in particular and tailored them to the best practices worldwide. In parallel, the Bank of Israel is planning to formulate a uniform stress scenario for climate risk, which will be used by the Bank of Israel and by the commercial banks.
To conclude my talk today, I would like to emphasize again that this issue is of the highest importance; it is characterized by a high level of uncertainty and a variety of risks. At the Bank of Israel, we are continually monitoring the knowledge being accumulated worldwide, the trends and the emerging practices and we are active on the issue of climate risk. We are doing so in partnership and cooperation with stakeholders in Israel and abroad, which includes discussion and brainstorming with government ministries, other financial regulators, academics, and other relevant players.
The design of climate policy must include internalizing the balance between physical risks at the same time as transition risks and the resulting costs, together with the investment of effort in meeting the targets to which Israel has committed itself. In parallel, and in order that the policy measures that are adopted have a real impact on reducing risk rather simply generating short-term change (which characterizes the path Israel is currently on), emphasis must be placed on the acceleration of renewable technology development and adoption.