The global response to climate change will create both opportunities and risks. There will be losers as well as winners. How will corporates respond to put themselves on a low risk path to a sustainable, low carbon future?
We may still be some way off getting there, but the international agreement made in Paris in December at least shows that the world wants to get to a place where global warming does not exceed 2 degrees. If the conditions are right there is even the possibility that we will go further and aim to get to no more than 1.5 degrees.
For businesses this is a clear signal that they need to think seriously about how they will navigate the journey to a sustainable, low carbon economy. Change brings both opportunities and risks, so there are going to be losers as well as winners. Some will race ahead, while others will fall by the wayside. Their plans will also have significant knock-on consequences for our energy system.
Now that the end destination is becoming clearer, forward looking companies are trying to find roadmaps that can help them get where they need to go. Unfortunately this is not going to be an easy road to travel. And some routes are more perilous than others.
The High Risk Road
Currently the majority of large businesses are on a path that could expose them to significant cost volatility and competitive risks. This is particularly the case for those based in more economically developed countries, where stronger climate change regulation is likely to be implemented sooner.
These businesses are taking some level of incremental action. They are putting in place cost-effective energy efficiency and carbon reduction projects within their own operations. They may also consider renewable electricity sources, as subsidies or carbon prices make them attractive. However, little is being done to reduce impact outside of those boundaries, by taking into account the actions upstream suppliers and downstream customers will need to take.
By focusing efforts on shorter term reduction targets and only implementing smaller, non-integrated projects, companies can become exposed in core markets to lower cost competitors, or to the emergence of sustainable substitute products or services entering the market.
The Low Risk Road
A smaller number of leading companies, such as BT, Unilever and IKEA, are developing a more comprehensive sustainability strategy. This goes beyond the incremental approach, putting in place an integrated plan to: achieve operational cost savings; address the direct and indirect business impacts of tackling the carbon emissions of suppliers, customers and governments; and building resilience to the physical impacts of climate change.
These businesses are going beyond just making improvements to their own operations, and are looking to measure and reduce the carbon across their whole value chain (or Scope 3, as it is known in the sustainability world). This measurement can be an eye-opening process for some companies, as they realise that their indirect impact massively outstrips their direct one, often by as much as 20 times. Although it can also provide enlightening strategic insights on ways to cut costs or inefficiency.
At the outset this can seem the more difficult road to travel, with significant work at required at the early stages. But this path provides valuable business intelligence, alongside a strategic view of the possible responses to climate change, which allows companies to assess their long term market future.
In practice this will help them to manage potential risks and areas of volatility, for example by predicting demand shifts for existing products or services and innovating to maintain competitiveness. Alternatively it can encourage companies to pioneer new business models or approaches that can improve sustainability, such as GE integrating its various business units for lighting, solar, energy storage and software into a single unit now known as Current.
Recognising that energy is one of the areas of the economy that will experience the most significant transformation, it is not surprising that one of the most common responses from many corporates is establishing an approach for getting an increasing amount of their energy supply from renewables. A number of companies including BMW, P&G, Google and Walmart have all made a commitment to 100% renewables through the RE100 campaign.
The value to a business of buying cleaner energy has also been bolstered by recent changes to greenhouse gas reporting rules. These now allow businesses to specifically recognise that they are purchasing low carbon fuels and electricity, rather than solely reporting figures based on national grid averages as was previously required.
Another tool that is becoming increasingly popular is the use of internal carbon pricing to encourage future-proofed investment decisions. Essentially this puts a shadow price on carbon, which is particularly useful when considering high levels of capital investment in plant and equipment which may become subject to a carbon tax, regulation or emissions trading schemes. But it is equally useful in determining the future expected value of smaller energy efficiency projects.
In 2015 the CDP reported that 437 companies claim to use an internal carbon price, up from just 150 in 2014. It seems to be catching on, with a further 583 companies reporting that they intend to use an internal carbon price in the next two years. There’s still no consensus on what the price of carbon should be. In practice there are a huge range of prices that vary by sector, with General Motors reportedly setting it at $5, J Sainsbury at $25, Exxon Mobil at $80 and Akzonobel at $122. But analysis by DECC and the Carbon Trust estimates that in a 2 degree scenario that the global price of carbon is expected to converge at $140 per tonne of CO2 by 2030 and $400 by 2050.
Going beyond this, some companies are setting medium and long term science-based targets for their carbon emissions. There are well over 100 corporates now signed up to the Science Based Targets initiative. This is still in its early days, with a largely untested methodology that is not yet applicable to every sector. But it does give companies a good idea of where they need to get to by 2050, taking into account their expected market share and the actual emissions reduction trajectory required by their sector to meet a 2 degree target. Companies that have already implemented these targets include Dell, Sony, Pfizer, Thalys and Enel.
The End of the Road
We are now only a generation away from 2050. Some might see this as being a long way in the future, especially when they are far more worried about next quarter’s results. Indeed, it is likely that many of the people currently making strategic decisions at corporates will no longer be alive to see the consequences of their decisions. Even the most capital-intensive juggernauts of the corporate world rarely look far beyond a 10 year planning horizon.
A lot can change for businesses in a just few decades. The world’s largest manufacturer of telecommunications equipment, Huawei, is under 30 years old. Microsoft and Apple are hitting 40. Or take for example the UK’s oldest financial index, the FT30, where just two companies have been continuously listed since its inception in 1935: Tate & Lyle and GKN.
Despite this, 34 years is an incredibly tight window in which to radically transform the entire global economy in order to have a reasonable chance at limiting global warming to no more than 2 degrees. To deal with the challenge of climate change within that short period of time will require the mobilisation of Herculean efforts from the private sector. We will need businesses to make use of the best of their abilities: the capacity for rapid technological innovation; the deployment of financial capital to accelerate the growth of markets for new products and services; and the ability to effectively manage large-scale infrastructure projects.
However, without the right market signals businesses are unlikely to be able to act at the scale that is needed. Fortunately, following decades of growing concern about climate change, the agreement in Paris was the first unequivocal signal that the political will is there to take serious action. If governments are going to achieve this then it will take a lot of carrots (mostly incentives and subsidies) and some very big sticks (mostly taxes and regulations).
There will be big opportunities and some serious risks for businesses along the road to 2050. But those companies that take action today to produce and follow a high quality road map will put themselves into a stronger position to navigate the treacherous path ahead.