by Matthew Smith, Strategy Lead, Sustainability Integration at Advisense
Over the past few years, the number of private companies setting net-zero emissions goals by 2050 and launching ambitious climate transition plans has expanded exponentially. Organisations like the Science Based Targets initiative have been set up to facilitate goal-setting and monitor progress, and sector pathways have been established to demonstrate for companies the pace of change required to deliver net-zero emissions by 2050. While these plans have generally been positively received as evidence that companies are working positively on climate transition, there are growing indications that they may undermine the action that is needed for rapid decarbonisation of the private sector.
The main challenges with company net-zero plans are twofold. Firstly, the initiatives listed by companies are rarely credible when measured against the emissions reductions they are expected to deliver, and secondly the achievement of almost all plans for net-zero is contingent on external factors that are outside of the company’s control.
The Economic Cost of Lowering Emissions
Beginning with the lack of credible initiatives to deliver ambitious emissions reductions. The main issue is not necessarily that companies are lazy or uneducated on climate issues. Most private companies now have functioning and competent sustainability teams, who work hard internally on pushing through ambitious climate agendas. The dilemma is that private companies operate in a highly competitive environment where each dollar/euro spent must be justified and ideally provide either cost cuts or a measurable competitive advantage.
Consider the cost of delivering products or having investment or lending portfolios that have considerably lower carbon emissions than competitors. For these products or portfolios, the question is not only whether competitively low emissions are technically feasible, but also if they are commercially viable. Lower emissions may well mean higher production costs and lower or more inconsistent returns. If consumers value the lower emissions, they may be willing to pay a premium, but this is far from a given.
Vague Commitments
Very few companies are willing or able to invest considerably in sustainable product or portfolio development without there being a business case for increased revenue. In some cases, the business case may be compelling, while in others, consumers may be less motivated by sustainability and therefore less willing to pay for lower emissions.
In this context, transition plan initiatives are often deliberately vague on the concrete actions for delivering lower emissions in their products or portfolios, yet painfully explicit on lesser initiatives such as company travel, virtual meetings and training & awareness raising. While such initiatives are all commendable in their own right, they will not contribute to the radical transformation of business models necessary to deliver on net-zero goals.
External Factors, the Decarbonisation Gap and Rosy Assumptions
Let us now examine the scope of the external factors challenge. Even if we accept that all decarbonisation initiatives are implemented, measured and achieved to their full potential, most companies have what is often referred to as a “decarbonisation gap”. This is the gap between the emissions reduction level the company will achieve through its own initiatives – and net-zero emissions from the company by 2050. This gap is effectively a signal from the company that the initiatives they have put in place are insufficient to meet their own net-zero goals.
Despite the existence of this gap, often in the range of 30-50%, it is not considered a show-stopper for net-zero transition plans. The 30-50% hole in the equation is instead filled by disclaimers. Every transition plan you read will at some point state that the company cannot achieve the goals on its own and that achieving its net-zero ambition will require stricter regulation, better incentives, technical and scientific breakthroughs and/or more global cooperation. In other words, companies are telling us that, given what they currently know, their plans are unachievable.
Net-zero achievement is instead based on a set of loose assumptions that sometime in the future, the collective conditions under which they operate will be far more conducive to decarbonisation than they are today. These future conditions must be so positive, and the initiatives put in place so effective that they are also able to neutralise the emissions from companies’ cumulative annual growth.
Higher Global Warming Can Change Transition Plans
While most of us would like to believe that delivering a net-zero economy by 2050 and therefore limiting global warming to 1,5 degrees is still achievable, the hard facts of climate science and global cooperation warn against such optimism. The IPCC’s own modelled pathways show that Nationally Determined Contributions (NDCs, countries’ self-defined national climate pledges) currently lead to a median global warming of 2.8°C by 2100.
Note that 2.8°C (1,3 degrees above our 1,5-degree target) is contingent on all pledges being fulfilled. Internationally, NDC targets are insufficient and national decarbonisation initiatives are even further behind. In other words, there is little to suggest that a radical change in the conditions required for companies to achieve net-zero goals is underway.
What does this mean for companies setting net-zero targets? In short, the most serious consequence is that everyone in the company who has read the plan and reflected even superficially over the conditions for its’ success, will likely conclude that the plan’s achievement is beyond the control of the company itself. So far beyond its control, and so dependent on outside developments, that it is not worth the paper it is printed on. Goals that are long-term and conditional on outside factors risk undermining the accountability they were put in place to deliver.
Company Management can far too easily explain away a lack of progress on circumstances beyond their control, and important (but expensive) climate initiatives may be replaced or downscaled to make way for other pressing issues. After all, what is the point of pouring money and resources into capital expenditures that is guaranteed to fall short of the company’s own ambition?
Worse, a lack of progress can also lead to creative climate planning where baseline years are adjusted, or emissions scopes included/excluded, to mask the company’s lack of progress towards their stated net-zero ambitions. Furthermore, companies net-zero goals can obscure from policy makers the true scale of the transition dilemmas in different sectors, providing a fall sense of security that we are on the right track given the private sector delivers on its’ goals.
Designing Credible Transition Plans
The challenge then is to deliver credible transition plans while still adhering to a net-zero agenda. This requires a significant change in mindset and approach when designing plans and setting “net-zero by 2050”-targets. The net-zero ambition comes directly from the imperative of limiting global warming to 1,5 degrees. If emissions globally are not reduced to net-zero by 2050, global warming will exceed the 1,5 degree limit. The limit is scientifically based and internationally mandated, settled on by an international community of states led by the United Nations. Holding global warming to 1,5 degrees means avoiding the worst effects of climate change and providing stability for our environment.
While the private sector has a central role to play in delivering a net-zero economy, individual companies are heavily dependent on sanctions and incentives put in place by governments in the geographical areas they operate. The international community has set a net-zero goal on the basis that they also have the means and ability to deliver on it. Governments have a range of economic tools they can, at least theoretically, put into place in time, tools that are simply not available to the private sector. This does not provide the private sector with an excuse to be lax on decarbonisation, but rather a responsibility to engage with policy makers to put in place conditions that provide a competitive advantage for companies that are willing to invest in reducing their emissions.
Transition plans should deliver reductions goals that are realistic and based on the most ambitious initiatives possible, not on the most optimistic assumptions. They should be clear on the fact that attaining net-zero emissions by 2050 is currently unachievable, include a quantification of the decarbonisation gap, and an outline of the sanctions/incentives that the company sees as necessary for making net-zero a possibility. The decarbonisation gap, and the means to close it, could then be reported and aggregated sector by sector to provide valuable information on the magnitude of the challenge for each part of the economy.
Complying with Regulatory Requirements
There is of course the question of whether such an approach would satisfy the requirements of the new Corporate Sustainability Reporting Directive (CSRD), which has specific requirements for companies’ transition plans. The answer is absolutely, yes. The CSRD requires among other things the disclosure of the company’s emissions target, benchmarking against a sectoral decarbonisation pathway and an explanation of decarbonisation levers and locked in assets.
All of these requirements may be fulfilled by the approach suggested above. The information provided is also likely to be more informative for stakeholders reading the reports as they would be presented with a more credible plan and with it more clarity on the actual transition risks the company faces over the medium to long term.
Investors Need to Hold Companies Accountable
At a time when the sense of urgency we need to have to reduce global emissions is difficult to overstate, it is tempting for companies to signal that they are part of the solution and that they accept the challenge and imperative of science-based emissions limits. However, setting goals that are both individually unrealistic and inherently uncontrollable is a recipe for inaction and unaccountability that risks slowing climate action. Companies need to define their decarbonisation gap as precisely as possible and demand action from policymakers to incentivise its closure as quickly as possible. It is also the role of sustainable investors to hold companies accountable for their sustainability commitments.
Matthew Smith is Director and Strategy Lead for Sustainability Integration and has over 15 years of experience working in Sustainable Finance. Before joining Advisense, Matthew worked at KPMG Norway and at Norway’s largest private asset manager Storebrand Asset Management as an ESG analyst, with primary focus on ESG risk analyses of portfolio companies. In addition, Matthew was Head of Sustainability for the Storebrand Group for one year and Head of Sustainable Investments leading a team of seven analysts for 5 1⁄2 years.
