Why the transition to net zero is business's business
9 April 2021 - CISL Course Convenor Dimitri Zenghelis unpacks the three major climate change-related risks affecting organisations and illustrates the significant opportunities that will be gained from transitioning to a net zero carbon business model.
Climate change is increasingly taking centre stage in strategic business planning. The transition towards more resilient, sustainable, and inclusive ‘net zero’ emissions business models – once seen as a peripheral issue for businesses appealing to niche Environmental, Social, and Governance (ESG) markets – is now central to strategic business planning, corporate hedging, and risk management.
New risks threaten profitability
The impacts of a changing climate and the transformation of economies to reach net zero are changing the landscape of risk and opportunity for business. Climate change is already presenting clear risks for businesses:
1. Physical risk
All business sectors are confronted with a steady increase in physical risks as the planet warms, a process which has already begun. Companies will have to adapt to the increased risk of natural disasters such as floods, droughts, and ecological collapse. Symptoms of physical risk also include changes in resource availability and cost, fluctuating market demands as spending power is curtailed in affected regions, and more severe working conditions. Climate change will eventually adjust markets and is already beginning to have a direct impact on many business sectors and global supply chains.
2. Litigation liability
The litigation liability risk reflects a growing trend in which citizens seek compensation against private and public organisations whose actions have knowingly threatened people’s livelihoods. Being held accountable for greenhouse gas emissions can undermine business viability and compromise shareholder value on account of inadequate commitment to sustainability. Companies and their directors are likely to face greater legal liabilities if they fail to assess and disclose financial risks associated with climate change and their impacts on company performance. Governments are also being sued for facilitating high emissions. There are currently 25 climate-related lawsuits against governments or their representatives.
3. Transition risk
Transition risk is associated with keeping up with rapidly changing technologies, markets, policies and social norms. Public policy and national regulators are increasingly implementing and enforcing action (including regulation and more stringent carbon pricing) that incentivise or force businesses to reduce their carbon footprint and positively contribute to greener growth. In response to these policies, new technologies and more sustainable, efficient processes are beginning to outcompete old ones in terms of costs and productivity.
This not only risks rendering physical assets redundant or stranded (polluting plant will be retrofitted or retired before the end of its useful life), but also affects human capital (people will need retraining and reskilling for the new economy) and intangible capital (the ideas and processes companies invest in will need to be net zero consistent), which increasingly forms the bulk of company’s wealth. This has the potential to transform market competition and create opportunities for sustainable business, especially as significant R&D and deployment shifts to low carbon sectors. Over time, business involved in high carbon activities will be rendered increasingly unviable.
The lost value of stranded assets
Heightened investor concern about asset stranding is leading companies to demonstrate what they are doing to mitigate their exposure to these risks. Companies will need to illustrate the role that they intend to play – not only in combating climate change – but in forging a business model that is resilient to, and profitable in, the low carbon, resource-efficient economy of the 21st century. The significance of working with government is also manifold; to provide the right policy signals that will incentivise low carbon production, as well as to share investment in infrastructure and skills of the future. Many high carbon sectors, such as energy, transport and buildings, are heavily regulated and policy driven. This underlies the need for clear, consistent and credible policies, whereby the government takes on its share of the policy risk it controls, for example through risk guarantees.
Markets are recognising the strong economic and commercial case for early greenhouse gas mitigation. There is a growing risk that failing to keep up with changing technologies and policies will render a variety of business assets ill-suited to the modern economy. This risk is reflected in share prices for renewable goods and services outperforming those produced by carbon-intensive sectors. Stock prices in fossil fuels have been underperforming for a decade, reflecting diminishing prospects in a low carbon future, while certain coal companies, such as Cloud Peak Energy and Blackjewel and Blackhawk Mining, have sought bankruptcy.
The successful development of vaccines and the deployment of fiscal stimulus packages in leading economies has raised anticipation of a post-COVID recovery in global demand. This has been reflected in a reversal of the falling price of fossil fuels and material resource in general in recent decades. Nevertheless, with America’s return to the international Paris Agreement and a promise to put the US on a track to net-zero emissions by 2050, big oil and gas players are writing off tens of billions of dollars’ worth of investment which are presumed to be unviable, while cutting production and increasingly focussing on renewable businesses.
Innovation is the key to sustainable business prosperity
The route to growth and decarbonisation starts with innovation. This provides businesses and society with the opportunity to boost productivity by getting more out of the limited resources we have. In future, the economy will be shaped by productivity-boosting knowledge capital. The more innovative and forward thinking an organisation, the more likely it is to prosper in the modern economy.
The sheer scale of the net zero transition generates substantial learning-by-doing, network effects and economies of scale in production and discovery. These are so large that we invariably underpredict the scope for productivity-augmenting clean innovation – a factor underlying the growing transition risk to business. This is true not only within clean sectors, for example where we have seen an 80 per cent reduction in key renewable costs such as rooftop solar panels and battery storage over the last decade, but also through strong evidence of spillovers into other parts of the economy, which are much greater than those associated with more mature fossil fuel investments.
The transition to net zero is an opportunity for business
Businesses are well placed, not only to adjust to, but also to benefit from, a net zero transition. This is particularly the case for those businesses that have ‘clean’ solutions to meet society’s needs, or for those that can help communities to build their resilience to the physical impacts of climate change. For some businesses, seizing these opportunities will require scaling existing activities, building strategic partnerships or finding routes to access new markets. For others, it will require investment in breakthrough climate technologies, new mindsets, and the rewiring of their operations and supply chain
To realise the benefits, however, it’s essential that all businesses should encourage policymakers to bring forward clear, consistent and ambitious policies to enable economically viable routes to rapid decarbonisation. This transition presents enormous challenges across all aspects of the economy. It also presents a unique opportunity to create new industries and markets, as well as to lay the foundations for a healthier and fairer society.
The strategic imperative
Transitioning to net zero will be a fundamental pillar of business leadership in future. There is a growing business need for individuals who understand the impact of climate change on a company’s operations, supply chains, and interdependencies with the wider economy and society at large. They must grasp the possible pace and scale of a transition to a net zero economy, as well as be aware of the risks and opportunities that go with it. These individuals will be key in designing and leading the necessary strategic change at a level and speed previously unseen in the private sector. The transition to a thriving, net zero business will require a new breed of leader, one with the confidence to move beyond the old model of growth that has proven to be insufficiently productive, environmentally unsustainable, and socially and regionally divisive. Working side by side, business leaders and governments will design and build our sustainable, net zero future.