Business Value Creation through Decarbonization

This week, Climate Decoded interviews Torsten Lichtenau – Senior Partner and Global Head of the Carbon Transition Practice at Bain & Company – as he delves into the pivotal topic of corporate decarbonization strategy. Drawing on Torsten's extensive experience, we uncover value creation opportunities in sustainability, learn how to overcome key decarbonization challenges, and explore how to harness technology for strategic success.

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Q: How important is a robust decarbonization strategy for businesses today, especially in light of global climate goals to limit warming to 1.5 degrees?

A: Decarbonization strategy is important because, for a majority of industries, especially if your carbon footprint and intensity are substantial, articulating and executing a robust decarbonization strategy links to value creation. Why do we say decarbonization links to value creation? For a few reasons:

• Many companies are exposed to regulations such as carbon taxes or IRA subsidies. Because of that, it’s clear that we need to decarbonize and that we need to do it in the most cost-effective and strategic way.
• Additionally, many clients and customers are showing that low-carbon offerings can drive customer differentiation.
• Investors care about this because they feel that a business that handles carbon in the right way is more resilient.

No matter what pathway companies choose, they need to be able to showcase the resilience and attractiveness of the business under different scenarios. So if it's 1.5° degrees, 2.0°, whatever that scenario is, companies need to show that in different scenarios, your business can cope and your business can thrive.

Also, decarbonization strategies should not be static. Plans should have a bit of flexibility depending on the pace of the transition.

Q: Does the decarbonization strategy usually belong to the Sustainability team? What role do cross-functional teams play in ensuring that a company's decarbonization strategy is not only effective but aligns with regulatory frameworks and reporting standards?

A: The sustainability team can play a key role in articulating the company’s decarbonization strategy in line with external expectations, reporting requirements, and stakeholders' requests. In many companies, sustainability teams still take the pen when drafting the climate transition action plan. However, to be effective, the decarbonization strategy has to be embedded into the company’s corporate strategy and move from being the accountability primarily of the sustainability function. This is the only way to ensure consistency in the strategy articulation, sound decarbonization investment, and effective execution of the plan.

Embedding decarbonization into your corporate strategy helps justify any investment in your reduction efforts. Decarbonization investments that don't fit into larger capital allocation plans are unlikely to be properly funded, or funded at all. For example, think about an oil and gas company that wants to decarbonize its operations or invest in hydrogen and carbon capture and storage. They will want to make sure that these decarbonization strategies fit into the corporate strategy so that they can claim their share of the CapEx in the yearly plan.

Q: How does embracing the energy and carbon transition present a value-creation opportunity for businesses? What are some tangible benefits they can expect to achieve?

A: The energy and carbon transition is probably one of the most profound changes that businesses have faced in decades. In essence, we’re completely changing the energy system at a pace we’ve never done before. At the same time, this is about addressing the dual challenges of energy security and affordability while driving towards a low-carbon business.

Value from embracing the carbon and energy transition can usually come from three sources:

1. Driving down cost and carbon in tandem
2. Driving differentiation from low-carbon solutions
3. Driving company valuation multiple through investors' view on resilience

Additional benefits include higher employee engagement and reduced reputation risks.

To give a concrete example, think about a packaging company moving to a sustainable packaging solution. That makes them much more attractive to their customers because their customers have also likely made very big commitments in their supply chain. This drives growth.

Other good examples would be automotive companies shifting toward EV in a profit-making way or chemicals companies embracing recycled and bio feedstock. If you’re able to embrace change and be effective and cost-efficient in the way that you do it, you will gain a huge advantage.

Q: What challenges have you observed in the transition to decarbonization, especially in achieving ambitious targets?

A: There are usually 2-3 key challenges:

The first challenge is moving from target setting to delivery.

When we look at the statistics, we see that roughly a quarter of companies are missing scope 1 and 2 emission targets, and a third are missing scope 3 targets. Being able to translate a big goal into concrete actions for the business, with the right incentives behind it, is absolutely critical and a step that quite a few are struggling with. That ties very much with ownership: having a clear ownership incentive and internal carbon pricing within the organization.

The second challenge is that companies see decarbonization as an additional cost to doing business.

They understand that they have a sustainability goal and that there are levers to decarbonize, but that costs money. However, at some point, companies may run out of investment if they can’t link decarbonization to monetization. Unfortunately, too often, we see decarbonization plans being seen just as a pure cost with little upside.

The third challenge is what I would call over or under-rotation.

Under-rotation happens when you fall behind customers’ expectations or peers’ progress. As an example, consumer products companies are expecting more and more from packaging companies in terms of decarbonization. If they don't move, they will be at a disadvantage. Over-rotation, however, happens if you make the transition so fast that you have products that customers don't want to pay for yet, leaving you unable to make the business case work. Finding the right balance between these two is key. We clearly want to move as fast as we can, but there's also the reality of the market. Finding the right level of acceleration is tricky to get right.

Q: How are technology and innovation helping companies achieve their decarbonization objectives? What strategies and tools can companies use to influence and collaborate with suppliers?

A: There are only three levers to get to net zero. Those would be regulation, behavior change of consumers, and technology. Technology is key and has already made a huge change.

Renewable energy, for example, is getting cheaper and cheaper in many parts of the world, cheaper than coal-fired power plants in many countries. Another example is EVs, which are on the cusp of being more economical than internal combustion engines. However, many other areas, like green steel, cement, and sustainable aviation fuel, are more expensive than their non-sustainable alternatives. Therefore we need technological progress to drive down cost and adoption.

One strategy we've seen working well is making sure you are investing in the research, development, and innovation, not only the performance of the product but also the carbon impact of the product.

Also, we’ve seen an increase in value chain collaborations happening. As an example, look at green steel in Sweden. There’s a company called Hybrit where you have a utility, Vattenfall,  an iron ore producer, LKAB, and a steel manufacturer, SSAB, coming together across the value chain to produce green steel. We’ll increasingly need value chain collaboration like this to get to net zero.

Another opportunity for technology is the ability to reduce cost by leveraging the experience curve. Often, when you introduce a low-carbon, differentiated product, it might be slightly more expensive at the beginning. You need to be able to find early customers willing to pay this premium to take the cost down and bring it to more people.

Q: Considering the global regulatory environment and general urgency to reach net zero by 2050, what advice do you have for companies looking to accelerate, or even begin, their decarbonization efforts?

A: To start, my first piece of advice is to set an ambition, but be realistic about your target based on stakeholder expectations and your ability to differentiate. Differentiation doesn’t only come from having a big target. It's also about making sure that you can document and deliver your results. So listen closely to different stakeholders and set a target that stretches the organization yet is also credible.

The second advice is to understand your decarbonization levers and the cost of those levers. Identifying and tracking your levers over time is what translates your targets into results. This is the step that most companies are currently busy with.

The third piece of advice is to clarify how you get value from decarbonization. Is it about reducing costs and carbon in tandem, monetization with customers, and/or asserting the resilience of the climate transition action plan with investors? Being clear about the sources of value and how to capture them is what is required here.

The fourth piece of advice is to identify what operating model is needed to deliver decarbonization. A company must ask itself, “How do we change incentives? Do we put a price on carbon in the organization to make a different financial decision?” This is a critical step to make sure decarbonization is embedded in the fabric of the organization.

Lastly, organizations need to make use of digital tools. When you think about carbon accounting and carbon management, you need to be able to track it like other costs. If it’s just living in Excel, nobody will do anything about it. A digital tool is necessary to understand your footprint over time as well as to build and optimize your plan for decarbonization. Carbon accounting software is a key ingredient in getting there.

Climate & ESG News Roundup

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UK Transition Plan Taskforce Unveils Groundbreaking Climate Disclosure Framework

The UK Transition Plan Taskforce (TPT) has unveiled its ”gold standard” Disclosure Framework  empowering companies and financial institutions to strategically approach their transition to the low carbon economy.  Released on October 9, 2023, the TPT Disclosure Framework establishes a solid foundation for companies to outline credible and robust climate transition plans, and to provide consistent and comparable information about those plans as part of their climate-related disclosures. While it is focused on a company’s disclosures about its transition plan, it also gives companies a strategic road map for developing their plans.

The TPT Disclosure Framework underscores the critical role of transition plans in steering both investment decisions and internal corporate climate strategies. Designed for global applicability, it builds on the International Sustainability Standards Board (ISSB)’s first two sustainability disclosure standards (IFRS S1 and S2).  It also seamlessly aligns with the Glasgow Financial Alliance for Net Zero, not only making it practical for GFANZ member companies to apply it, but also amplifying its impact on a worldwide scale. The guidance can also be used by companies reporting against the TCFD Recommendations, and by companies complying with other climate disclosure requirements around the world, including the CSRD.  A core tenet of all the current and emerging climate disclosure rules is that if a company has a transition plan, it must disclose it.  The TPT Disclosure Framework gives companies a road map for disclosing more details so investors can better understand the plan.  

The Framework revolves around three key principles: Ambition, Action, and Accountability.  There are five core disclosure elements, starting with a Foundation of explaining the company’s Strategic Ambition.  Other elements include Implementation Strategy, Engagement Strategy, Metrics & Targets, and Governance, with 19 sub-disclosures to provide investors with a comprehensive understanding of the details behind the plan.  One of those sub-disclosures is GHG metrics and targets, and the requirements align directly with the ISSB expectations:  including Scopes 1,2, and 3 emissions and details about how a company plans to meet its targets. Recognizing the dynamic nature of transition planning, the TPT recommends providing annual progress reports, and re-assessing  the overall transition plan every three years.   The TPT’s next step is focusing on sector-specific guidance for seven pivotal sectors, and it is actively seeking public input. 
Companies can start using the TPT Disclosure Framework now.  Doing so will also help them be prepared for the future.  The Financial Conduct Authority plans to include mandatory transition plan disclosures in its upcoming consultation on incorporating UK-endorsed ISSB standards into its reporting requirements.  This is expected to happen next year, with new rules effective as of January 2025. The UK Government is also set to introduce requirements for large public and private companies to disclose transition plans. It's advised that companies proactively embrace the Framework now, positioning themselves to strategically prepare for the transition, and to be ready for impending mandatory compliance. 

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Key Findings from TCFD's Final Status Report

The TCFD has released its much-anticipated final status report, spotlighting crucial advancements in global climate-related financial disclosures. The report underscores a significant increase in companies aligning with TCFD recommendations. In 2022, a striking 58% of companies disclosed in line with at least five of the 11 recommended disclosures, a substantial leap from 18% in 2020. However, only 4% disclosed in line with all 11 recommendations, indicating room for improvement in comprehensive reporting. The ISSB now will continue the work of the TCFD to monitor progress towards climate-related disclosures against the recommendations.  

Notably, the report highlights a surge in disclosures related to climate-related risks or opportunities, board oversight, and climate-related targets. Between fiscal years 2020 and 2022, these disclosures saw substantial increases of 26%, 25%, and 24% respectively. Nevertheless, there remains an imperative to enhance transparency on the actual and potential impacts of climate change on companies. The report further emphasizes that while sustainability and annual reports have seen an upswing in climate-related financial information, it remains underrepresented in financial filings. Additionally, over 80% of major asset managers and 50% of major asset owners reported in line with at least one of the 11 recommended disclosures, signifying a growing recognition of the importance of climate disclosure in the investment community.

Helpfully, the TCFD includes case studies on companies already measuring and reporting on scope 3 and their learnings. Key takeaways from the case studies and larger report include:

• It is necessary for companies to commence Scope 3 measurement, even if initial estimates are rudimentary, as they can be refined over time. 
• Companies must engage various internal teams, integrate disciplines, and maintain centralized efforts for accurate reporting. 
• Flexibility in reporting systems to adapt to evolving requirements and the capacity to accommodate data from diverse sources is crucial. So is robust supplier engagement, which is essential for transparency in GHG emissions, thus aiding in effective management of supply chain Scope 3 GHG emissions and decarbonization actions. 
• Restating Scope 3 GHG emissions due to organizational changes or improved methodologies is a natural progression towards enhanced reporting accuracy and is positively received by stakeholders. 

These insights serve as invaluable guideposts for businesses embarking on Scope 3 reporting, ensuring they navigate this complex terrain effectively.

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Brazil announces ISSB adoption;  Australia issues draft ISSB-aligned Australian Sustainability Reporting Standards

On October 20, Brazil announced adoption of the ISSB’s sustainability disclosure standards.  The CVM issued a resolution enabling voluntary use within the regulatory framework effective for 2024 reporting.  The goal is to kick-start use of the standards and engage with the market, on a path to mandatory ISSB-based reporting beginning in 2026.  Chile, Colombia, Mexico, and Panama are also considering ways to integrate the ISSB standards in their markets, and this was a theme discussed at the IFRS Foundation Trustees meeting in Panama last week.  Stay tuned!

Australia's Accounting Standards Board (AASB) has released an exposure draft outlining proposed Australian Sustainability Reporting Standards for companies, aligning with the recently released sustainability disclosure standards from the ISSB. This move follows the Australian government's consultations on implementing mandatory climate-related financial disclosure requirements, with large businesses expected to comply beginning in 2024, followed by smaller entities in subsequent years. The AASB's draft, open for feedback until March 1, 2024, builds upon ISSB’s first sustainability standards, IFRS S1 and S2.  It includes some modifications to focus on climate-related risks and opportunities and adds a specific provision requiring entities that determine they are not exposed to material climate-related risks or opportunities to “explain how it came to that conclusion.”  The exposure draft includes comprehensive emissions disclosures (Scopes 1, 2, and 3), incorporating Australia-specific provisions for methodologies under the existing Australian National Greenhouse and Energy Reporting (NGER) Scheme, with the GHG Protocol also accepted as an “internationally recognized greenhouse gas emission measurement framework.”  The AASB’s proposed standards also include market-based Scope 2, in addition to the location-based requirements of the ISSB.  

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EU Proposes Postponing Additional Reporting Standards Under the CSRD 

The European Commission (EC) has announced plans to delay the development of sector-specific sustainability disclosures as it continues implementation of the CSRD. These plans, outlined in the Commission’s 2024 Work Programme, will allow companies to focus on preparing disclosures based on the European Sustainability Reporting Standards (ESRSs) issued on July 31, officially approved by Parliament last week.  The EC proposal would postpone the deadline for the adoption of additional sector-specific reporting standards for two years, from June 2024, to June 2026.  

Companies preparing for CSRD compliance beginning in 2024 and 2025 can now focus on the ESRSs as issued on July 31. There are no changes to what large corporations need to do to prepare for those requirements - US companies with large, in-scope subsidiaries that were already preparing should keep doing so, and those that were waiting should start. 

Additionally, the Commission recommends a two-year delay in adopting reporting standards specific to non-EU parent companies who will be required to comply with the CSRD in 2028 (applying to companies that earn more than €150m in revenue from their operations in the EU, and have one subsidiary/branch located in the EU that meets the size threshold).   The CSRD originally set a deadline for 2024 for the EU to adopt reporting standards for these companies.  The Commission has recommended taking two more years to consider what reporting standards should apply to them.  By 2026, these companies will know what is expected, and still have time to prepare.  Also by 2026, the global landscape for reporting will be more developed, allowing more time for considering international alignment.  

The 2024 Work Programme also highlights various sustainability and climate-related initiatives, emphasizing the EU Green Deal as a major priority. The Commission also adopted a Delegated Directive updating the size criteria across the EU regulatory framework to adjust for inflation: revenue and balance sheet thresholds will be raised by 25% (for “large” companies, the new thresholds are €25m balance sheet total and €50m annual net turnover.) Companies that were on the cusp of any of these thresholds may be impacted. However, most large, multinational companies will need to stay the course.