To Transition to Net Zero, Model the Alternative

The very idea of transitioning a business to net-zero carbon emissions can be daunting. Revamping processes to reduce emissions will likely take years, and 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.

It can be tempting, then, 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 a likely worse alternative: 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 — which, in a few years, will no longer exist — but with the increased costs and risks the business will face if it takes no action. Leaders’ attention shifts from the risks of climate affecting the business to a bigger agenda, which includes the obligation to change and the opportunity to thrive in a low-carbon business environment.

Analyzing 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 high-carbon sectors, including oil, natural gas, and thermal coal, discovered that efforts to limit the rise in global temperatures to no more than 1.5 degrees Celsius, per the goals of the Paris Agreement, will actually create the best financial outcome for its business over the next 30 years. In this scenario, the reduced demand for those commodities would be far outweighed by the booming demand for other materials it mines that are essential for the transition to clean energy, such as the nickel and copper used in batteries and cables. The projected declines in the most threatened sectors, even in the most ambitious transition scenarios, are far more than outweighed by the large upside 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 rather than cutting ties with them for the sake of having a “clean” balance sheet and merely transferring the problem to someone else.

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 wide range of outcomes possible. A worst-case scenario assumes that there are no changes to our current path and that the world significantly surpasses a 1.5 degree C increase in global warming, 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 that life will 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 a climate catastrophe.

Within each scenario, managers must take into account 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 emissions. They have to evaluate the potential effect of shifts on several fronts that are intermingled: policy changes, competitors’ strategies, and customer pull.

Policy Changes

Few companies are redesigning their businesses to take carbon pricing explicitly into account, primarily because only the European Union and some other economies have carbon taxes. (An increasing number of companies are considering implementing internal shadow carbon prices to make emissions’ effects on 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 a 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 financials 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 having half of all vehicles sold in the United States be 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 gas boilers), is likely if governmental targets for net zero are to be met.

Competitors’ Strategies

Companies that are acting on climate today are driven less by regulatory pressure itself (because it 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 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.

Competitor strategies can be a threat, driving a fear of being left behind. They can also be opportunities to create the solidarity among companies that’s required in order to take on the costs and risk involved in the net-zero transition before being forced to do so. Future scenarios look more attractive when others in the sector have taken on the same burdens. Leaders at one company we interviewed described a “dark six months” when they made climate commitments ahead of their peers but noted the comfort that came when their big competitors followed suit.

Customer Pull

Today, despite widespread interest in and concern about climate change, there is little commercial pull from customers. Framed in today’s market, a business case based on customer demand looks pretty speculative and may be less attractive than the status quo. But comparing against alternative futures, not against what’s happening today, paints a different picture. The reasons to believe that customer pull is likely to grow are compelling.

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 the materials once tailpipe emissions are eliminated in 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 driving through their supply chains. And it will eventually reach consumers, as companies learn how to translate the interest people already have 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 don’t actually know what efforts the company is making. We found just one brand out of a hundred for which a majority of its 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.

A Net-Zero Future

Managers have successfully identified new options by modeling alternative futures using scenario planning to look beyond their current situations, including for uncertain and turbulent events. As the world uses more and more of our remaining carbon budget, evaluating different climate-related scenarios involving potential shifts of policy, competitors’ strategies, and customer preferences can help managers better evaluate the risks, opportunities, and likely outcomes of shifting their businesses toward net zero and avoid the trap of opting for a status quo that is fleeting. Scenario analysis can help the world halve carbon emissions by 2030 to meet the goals of the Paris Agreement and reach a net-zero future overall.