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Sustainability

The chickens are coming home to roost: Companies admit their climate promises were unrealistic

Published 6 November 2023 in Sustainability • 6 min read

The vast majority of plans are not worth the paper they are written on, research shows. A comprehensive path toward net zero should address Scope 3 emissions, incorporate carbon offsetting, and consider internal carbon pricing.

In a bold strategic move, BPannounced in 2020its ambitious plan to slash oil and gas production by some 40% by 2030as part of a strategy to combat emissions and transition towards more sustainable energy sources. 

However, the company has recently undergone a notable shift in direction, revising and reducing its initial targets. BP is now anticipating a 25% reduction in oil and gas output by 2030.The shift follows a period of skyrocketing fossil-fuel prices, leading BP to report record-breaking annual earnings for 2022. Recently, Nestlé gave up on its carbon neutrality goals for some brands, and Rio Tinto announced that it will likely fail to reach its 2030 targets.

As the global push for sustainability gains momentum, stakeholders are increasingly emphasizing the importance of corporate transition plans, such as BP’s, as a crucial tool for assessing the impact of the green transition on companies. This need is growing increasingly urgent as we approach COP28 in Dubai at the end of this month, where business and policy leaders face mounting pressure to accelerate the shift away from fossil fuels and cut emissions by half within this decade.

However,  research conducted by multinational consultancy EY reveals that a mere 5% of FTSE 100 companies’ transition plans are deemed “credible”, raising doubts about the genuine commitment of these businesses to reducing their emissions. 

Despite approximately 80% of those large public companies disclosing some form of transition plan, the lack of sufficient detail highlights the substantial amount of work still required to outline a comprehensive path toward net zero. 

In response to the lack of transparency and inadequate transition plans, regulatory measures in the UK are on the horizon. The government is considering rules that will require large companies to publicly disclose decarbonization plans, explicitly outlining how they intend to reduce their emissions and the associated costs involved. Meanwhile, the EU and the US are introducing or proposing stricter accounting rules.

The question arises: How can companies develop credible and effective transition plans?

Too much reliance on unproven technologies 

One of the key obstacles is companies’ reliance on overly optimistic forecasts regarding the costs of climate change.For instance, some oil and gas majors have presented carbon capture and storage (CCS) as a solution to sustain fossil fuel production while simultaneously mitigating greenhouse gas pollution. 

However, despite significant investments and years of research, CCS has not lived up to its potential.The high costs associated with implementing this technology have hindered its large-scale deployment, limiting its impact on global emissions. Although the US is taking steps to incentivize CCS through the Inflation Reduction Act’s tax breaks, relying heavily on unproven technologies undermines the credibility of transition plans. Rio’s CEO Jakob Stausholm recently admitted: “There is a lot of technology that doesn’t exist and has to go through an R&D funnel, and that just takes a long time.” 

An imperfect incentive system 

Meanwhile, companies across various sectors often fail to make the necessary investments to decarbonize their operations due to concerns about short-term profitability. Although the long-term consequences of climate change, including potential “stranded assets”, may outweigh upfront costs, executives, driven by bonuses tied to earnings or share prices, are often reluctant to take the necessary actions.

emissionsRecent research conducted by multinational consultancy EY reveals that a mere 5% of FTSE 100 companies’ transition plans are deemed “credible”, raising doubts about the genuine commitment of these businesses to reducing their emissions

Consequently, many transition plans lack substance and fail to translate into meaningful actions.

Flawed financial models 

Another factor contributing to the reluctance to prioritize climate strategies is the uncertainty surrounding economic forecasts.A report from the Institute and Faculty of Actuaries highlights how numerous financial institutions underestimate the risks associated with temperature rises, thereby impeding their ability to accurately forecast the economic costs involved. 

Therefore, some businesses adopt a “wait and see” approach, preferring concrete evidence before committing to climate action. Furthermore, macroeconomic challenges, such as inflation, the economic slowdown, and heightened geopolitical tensions may have diverted companies’ attention away from the climate crisis. These external pressures further complicate the development and implementation of robust transition plans.

A fear of the ‘woke’ police 

Additionally, companies that do invest in their climate transition may face opposition from right-wing politicians and industry skeptics who rue “woke capitalism”, or businesses that prioritize sustainability over short-term profits.This backlash can create additional challenges for companies striving to implement effective and credible transition plans. 

Strategies to drive accountability 

To encourage companies to take their transition plans more seriously, several strategies can be employed. 

First, regulatory action is necessary to address concerns over regional competitiveness.The implementation of measures like the EU’s Carbon Border Adjustment Mechanism (CBAM) can compel foreign importers to shoulder the financial burden of their carbon emissions. This mechanism serves to create a fair environment for European companies that are already subject to emissions taxes such as the Emissions Trading System (ETS). 

Such tools can alleviate fears of industrial decline via “carbon leakage”, where production shifts to regions with lower or no carbon taxes, such as China, while simultaneously incentivizing companies to invest in decarbonization efforts. 

Integrating internal carbon pricing into a transition plan can be a valuable tool for changing behavior and investment decisions

Second, revisiting compensation policies for top executives is essential. AsI by IMD has reported, current pay plans often incentivize short-term profit maximization at the expense of environmental goals. Aligning executive compensation with climate impact encourages executives to integrate sustainability into business strategies.

Third, R&D tax credits can play a significant role in fighting climate change by encouraging research and development activities centered on clean technologies. Providing financial incentives for companies engaged in R&D for climate solutions creates a supportive environment for innovation, advancing the transition to a low-carbon future.

Key elements of an effective transition plan

A comprehensive transition plan should extend beyond direct emissions (Scope 1) and indirect emissions from purchased energy (Scope 2) to include Scope 3 emissions. These occur throughout the value chain, in upstream (sourcing raw materials) and downstream activities (use and disposal of products by consumers).

Including Scope 3 emissions in the plan requires collaboration with suppliers, customers, and other stakeholders to implement strategies for emission reductions, such as supply-chain optimization and sustainable product design.

To achieve environmental goals, a robust transition plan should also consider the need for carbon offsetting. In cases where progress towards climate targets is slow, offsetting allows companies to compensate for remaining emissions by supporting projects that reduce or remove carbon from the atmosphere. This approach helps achieve a net-zero state by balancing out emissions with equivalent reductions elsewhere.

Additionally, integrating internal carbon pricing into a transition plan can be a valuable tool for changing behavior and investment decisions. This voluntary practice involves assigning a monetary value to emissions within a company’s own operations, to align their climate actions with improving overall financial performance. 

Ultimately, companies worldwide continue to face the challenge of developing credible transition plans aligned with emission reduction goals amidst the escalating climate crisis. By optimizing strategies, companies can not only improve the credibility of these plans but contribute to a more sustainable future.

Authors

Karl Schmedders - IMD Professor of Finance

Karl Schmedders

Professor of Finance at IMD

Karl Schmedders is Professor of Finance at IMD. In his research, he applies numerical solution techniques to complex economic and financial models, shedding light on relevant market issues and industry problems. He is also Director of IMD’s new online certification course for structured investment products in partnership with Swiss company Leonteq, teaches in the Advanced Management Concepts (AMC) and Executive MBA programs, and is an advisor on International Consulting Projects in the MBA program.

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