The very idea of transitioning a business to net-zero carbon emissions can be daunting. Revamping processes to reduce emissions will likely take years; switching to alternative energy sources across a globally distributed business is a complex endeavor. While some initiatives will save money through energy efficiency, others that need to be implemented will be costly — and risky, particularly if they involve bets on new technologies or business models. Without meaningful pressure from regulation or an external carbon price — and most businesses are experiencing neither today — a conventional financial case can be hard to make.
The cost of the transition shouldn’t be compared with the status quo, but rather with the costs and risks of taking no action
It can be tempting for managers to try to delay their organization’s transition to net zero until they have greater certainty — that is, until they use scenario analysis to evaluate the potential costs of standing still. When management teams evaluate their business against a future in which governments, competitors, customers, and investors all have transition plans, they realize that the true cost of transitioning to net-zero emissions should not be compared with the status quo. That won’t exist in a few years, so the meaningful comparison is with the increased costs and risks the business will face if it takes no action. The new comparison forces corporate leadership to look beyond how climate will affect the business and focus on a broader agenda that includes the obligation to change and the opportunity to thrive in a low-carbon business environment.
Three Key Scenarios and Potential Shifts
Companies often start out using scenario analysis to get ahead of risks, but the process can also uncover counterintuitive opportunities in a net-zero future. For example, one mining company involved in oil, natural gas, and thermal coal discovered that limiting the rise in global temperatures to 1.5 degrees Celsius, per the goals of the Paris Agreement, would create the best financial outcome for its business over the next 30 years. In this scenario, the reduced demand for its high-carbon commodities would be outweighed by booming demand for the nickel and copper it mines, essential elements for the transition to clean energy used in batteries and cables. The projected declines in the most threatened sectors, even in the most ambitious transition scenarios, are more than outweighed by the large upsides for the commodities feeding the transition.
For banks, scenario modeling can highlight the greater financial value and climate impact of engaging with high-carbon clients and helping to finance their transitions. This is an alternative to cutting ties with them for the sake of having a “clean” balance sheet, but in essence merely transferring the problem to someone else.
For banks, there’s greater financial value and climate impact helping high-carbon clients finance transitions than cutting ties
But how can managers evaluate the true cost of delaying a transition to net zero when there are so many huge unknowns? Focusing on three key scenarios — the worst case, the best case, and a middle ground between the two — can generate practical insights into the wider range of outcomes possible. A worst-case scenario assumes that there are no changes to our current path and global warming significantly surpasses a 1.5 degrees Celsius increase, triggering a climate disaster. The best case looks at what happens if, in line with the Paris Agreement, governments and companies work together to reduce emissions enough by 2030 for life to remain relatively normal over the long term. And the middle-ground scenario models delayed policy action, with business as usual until 2030, at which point countries and companies will be forced to dramatically slash their emissions to head off aclimate catastrophe.
Within each scenario, managers must consider not only the potential impact of climate risks on their businesses but also the costs involved in transitioning to an operating model with lower carbon dioxide (CO2) emissions. That includes evaluating the potential effect of shifts on several fronts that are intermingled: policy changes, competitors’ strategies, and customer pull.
Few companies are redesigning their businesses to take carbon pricing explicitly into account, primarily because only the European Union and a few other economies have carbon taxes. Still, an increasing number of companies are considering implementing internal shadow carbon prices to make their emissions’ impacts on their underlying economics more transparent. Currently, these taxes are limited to energy-intensive, high-emissions industries, and the pricing of carbon is too low to be an effective deterrent. But the cost of offsetting corporate carbon emissions could surge tenfold over the next decade, to between $20 and $50 per metric ton of CO2 or even higher, as growing numbers of businesses adopt net-zero targets, according to some estimates.
Stress-testing how a business will stand up in an alternative future in which carbon prices soar or carbon emissions become socially or legally unacceptable can clarify the potential costs of inaction. One way to do this is by incorporating shadow carbon costs alongside financial results to evaluate investment decisions. Examining a target company’s exposure to potential carbon-pricing changes enables a potential investor to better evaluate the future profitability of projects and strategies. It also helps to promote a culture of constant carbon footprint reduction, even in the absence of an adequate regulatory framework.
Scenario modeling for how climate change and decarbonization policy changes will affect competitors’ strategies is critical. Government policies are increasingly creating life-and-death issues for many companies that fail to prepare for a net-zero world. The United States has set a target of half of vehicles sold in the country being electric by 2030, and the United Kingdom has banned the sale of new gas- and diesel-powered cars after 2030. Further regulatory actions in other high-carbon sectors — to restrict either production such as phasing out coal plants or demand such as phasing out gasboilers — is likely if targets for net zero are to be met.
Companies that are acting on climate today are driven less by regulatory pressure itself, which is not yet strong enough to change business models than by the anticipation of that pressure and the need to be competitively positioned before, it happens. Auto companies that have invested in developing electric vehicles (EVs) have a significant advantage over rivals as sales of EVs start to take off. Utilities with more-diversified portfolios that include wind and solar power are positioned to grow, while those that stick to generating power from fossil fuels will have to adapt or risk extinction.
Rising Interest in Decarbonization
Signs of rising interest in commercial solutions for decarbonization are already becoming apparent, with corporate customers embarking on their own net-zero transitions. Customer interest is trickling along the value chain: Automakers are looking to buy net-zero steel for their vehicles as attention shifts to the climate credentials of materials once tailpipe emissions are eliminated by the move to EVs. In turn, steelmakers are looking for iron ores that produce fewer emissions in the blast furnace — and for more steel scrap.
Customer interest is also spreading from corporate entities to small businesses through the procurement requirements that some organizations are now implementing in their supply chains. And companies will eventually learn how to translate consumer interest in climate change into commercial value.
The incentive to crack that code is high. Already, the degree to which people feel connected to a brand is highly correlated with the effort they think it is making on climate change, even if they aren’t fully aware of everything the company is doing. We found just one brand out of 100 for which most customers said they knew what the brand was doing. But companies should not bet on consumers’ lack of awareness persisting in all their future scenarios.
Managers have successfully identified new options by modeling alternative futures using scenario planning to look beyond their current situations and to consider uncertain and turbulent events. As the world uses more of its remaining carbon budget, carbon budget, managers can better evaluate the risks, opportunities, and likely outcomes of shifting toward net zero by evaluating different climate-related scenarios involving shifts of policy, competitors’ strategies, and customer preferences. Scenario analysis can help the world halve carbon emissions by 2030 to meet the goals of the Paris Agreement and eventually achieve a net-zero future.