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Net-Zero Transition: Creating Value

How to maximize a net-zero economy.

Net-Zero Transition: Creating Value

Sustainability is an opportunity for growth. Companies that stay ahead of the curve will find themselves in a position to take advantage as our economy decarbonizes. This article discusses the positives and negatives of a net-zero economy and how to maximize it.

The Movement of Capital

Climate change is endangering our planet. with 5 million deaths annually. 100% of scientists agree on human-induced global warming. Investors are demanding action for firms to reduce their emissions by taking steps toward zero net carbon output. 87% of global emissions are aiming to be reduced under net-zero commitments. Financial firms are committed to keeping warming below 1.5°C warming by managing $130 trillion in the capital.

According to McKinsey analysts, currently, 65% of annual capital spending is on high-emissions assets. Achieving net-zero by 2050 will change the pattern. As companies modify their operating budgets, 70% of capital will be spent on low-emissions assets. This shift will increase the demand for green energy, equipment, and infrastructure. Industries will expand with this new wealth of available cash coupled with high potential value pools that will generate $9 trillion to $12 trillion annually by 2030. To put in perspective, when former U.S president Barack Obama was in office, he received an annual salary of USD $400k. From 2022 to 2030, he would have received $2,8 million.

This is an opportunity for sustainable growth. Apple, Unilever, Bank of America, and many more are ahead because they're shifting their strategy and employing low-cost green finance to develop carbon-free production capacity.

New Industrial Opportunities

If the world reaches net-zero by 2050, the economy will shift away from commodities and services that emit high levels of greenhouse gases (GHGs) and toward those that don't. Changes to the value chain would affect how industries work. A value chain outlines all the phases in manufacturing a product or service, including all phases from production to distribution. Competition for great rates, great products, and client loyalty is tough, therefore organizations must continuously focus on value. For example, as electric vehicles (EVs) replace internal-combustion engine automobiles, there will be a reduction in demand of 60% by 2050 compared to 2019.

Instead of coal or gas-fired power plants, more electricity would come from renewable sources like the sun and wind. From 2000 to 2020, the demand for renewable energy in the United States grew by 90%. From 2009 to 2019, the global share of renewable energy is expected to grow by 28%. In 2026, 95% of all new power capacity around the world will come from renewable sources.

Clean energy and materials, vehicles and their components, and food packaging are all in high demand while high-emission markets diminish. Impacts of the world reach net-zero by 2050:

  • Increase the use of hydrogen by 2050. In the automotive industry, it will contribute to powering 400 million cars globally.
  • Decrease use of conventional biofuels by 2050. An estimated 40% of the total supply drops to zero, replaced by 100% bioenergy.
  • Fossil fuel production declining by 6% from 2021 over the next 15 years.
  • Decrease of oil production by 55% compared to 2022.
  • Decrease of gas production by 70% compared to 2022.

Green premiums are making some markets more profitable than traditional ones. As demand for traditional products declines, the most profitable areas can have a marginal increase of 15% to 150% higher than the norm. Such areas include recycled plastics, meat alternatives, sustainable building materials, and chemicals. Companies track growth by calculating their compound annual growth rate (CAGR. CAGR is an accurate approach to calculating returns on assets, investment portfolios, and other things whose value can change over time.

  • Recycled Plastics: Growth 4.8% from USD $46.09 billion between 2021 to 2030.
  • Meat Alternatives: Growth of 19% reaching USD $24.8 billion from 2022 to 2030.
  • Sustainable Building Materials: Growth of 12.6% reaching USD $383.85 billion from 2021 to 2025.
  • Chemicals: Growth of 9.10%, surpassing USD $16.27 million from 2022 to 2028.

UK-based charity Ellen MacArthur Foundation looks to build a circular economy to eliminate waste and pollution. They have gathered the support of government groups and over 500 organizations, they have pledged to reduce 20% of worldwide plastic packaging companies by 2025. Currently, recycled polyethylene terephthalate (PET) costs $300 per metric tonne more than virgin PET compared to the $40 per metric tonne price differential from 2011 to 2019. As supply meets demand, green premiums may fall. In the short to medium term, supply-and-demand imbalances will cause premiums to rise, which will benefit providers.

The markets mentioned above are for low emissions, expecting a $3.5 trillion in annual demand by 2050. These include solar and wind farms, and industrial gear like ships or trains. In 2021, the capacity for global renewable electricity is expected to increase 39% and is expected to increase 60% by 2026 compared to 2020 levels.

As the world moves towards cleaner and more sustainable energy, many fossil fuel corporations are being left behind. The global electric power sector could lose $2.1 trillion by 2050 as they phase out old technologies. Many stranded assets are on the balance sheets of publicly listed corporations, their early retirement could diminish the business's value.

The Glasgow Financial Alliance for Net Zero is made up of more than 450 institutions that control more than $130 trillion in private capital. These institutions have promised to align their portfolios with net-zero goals. The EU offered €1 trillion (USD $1,071 billion) in public and private finance for the European Green Deal.

Creating Value

Businesses must take more risks because of these factors. To protect cash flows, many corporations have been inactive about sustainability programs, doing only what is necessary by law or meeting the fundamental expectations of shareholders and other non-financial stakeholders.

The world is transitioning to a Net Zero emissions economy and companies need strategies that can outperform. For example, some oil corporations are abandoning hydrocarbons while others persist in these markets by finding low-polluting resources with high breakeven costs. Companies will need to build a "strategy under uncertainty" like never before due to the world's uncertain transition pathway.

There are four strategies to create value during the transition toward net-zero:

  • Portfolio Transformation
  • Green Business
  • Be Distinct to Obtain Premiums
  • Business Processes & Supply Chains

Portfolio Transformation

Companies invest across industries to maximize earnings. Two factors affect income. First, a company's industry choice accounts for half of its profit. Second, successful companies shift investment locations.

The average company might be better off in the industry where they can excel, rather than being at the top within an average-sized enterprise. Power curves show where a company stands on a scale of how powerful it is. Half of a company’s position on the curve is determined by industry choice as 90% of economic profit goes towards the top quintile. In a study comparing 12 tobacco and 20 paper firms, 9 tobacco firms made the top 5%, while no paper companies did.

More than 1,600 companies were studied to identify investment shifts. Researchers found one-third of capital was almost identical to last year, with a correlation of 0.99. The industry as a whole was 0.92. The data suggest that plans led to minor adjustments, regardless of industry. The top third of the sample shifted 56% of capital across business units and had 30% higher total returns to shareholders (TRS) annually than the bottom third. Every economic sector had the same conclusion.

Businesses must change where they invest if success depends on high-risk-high-reward investments. Business leaders should assess their sector’s growth prospects and rebalance their holdings. For example, Neste Oil is a sustainability leader that has transitioned from high-emissions firms to low-carbon enterprises. They made this transition by investing in feedstock platforms, green-refinery capacity, new technology, and market strategies.

Neste transitional timeline:

  • In 2015, 50% of Neste's operating earnings came from gasoline and chemicals.
  • Between 2015 to 2021, Neste's market capitalization tripled using 90% renewable sources.
  • In 2018, 70% of their operating income came from renewable.

Leading companies target transition-driven growth in industries or subsegments to grow. They work with those who have an existing niche in these areas to expand creatively while maintaining their main sector competence. For example, 10 leading European telecoms invested in diverse portfolios to target different market groups with varied growth rates. From 1999 to 2005, the 10 companies grew by 9.5% yearly, on average.

Portfolio-changing actions can involve large investments. They offer a large risk especially when regulations are uncertain. It is important to consider how regulatory uncertainty might affect the company's bottom line. By collaborating with other stakeholders, you can reduce market risks and increase the stability of demand in response.

Green Business

Existing firms struggle to go green. Established organizations have practical and motivational obstacles, including developing a subsidiary company within a larger parent company or lack of finances. As a result, corporations miss out on chances in emerging green markets. Established companies shouldn't give up, instead focus on using assets, skills, and partnerships.

Asset managers are in a position to give money and share intellectual property with green businesses. This reduces startup costs, but also creates economic growth by investing in sustainable practices that will succeed long-term.

Incumbents have the skills and expertise to develop small businesses within larger ones. For example, Hydro-Québec's engineering skills and power network knowledge allow them to develop and manage the province's largest and most reliable EV-charging network.

Building partnerships with key stakeholders, existing customers, and significant investors, as well as, on occasion, the parent company, is essential for acquiring clients.

Be Distinct to Obtain Premiums

Businesses should be looking to increase their sustainability credentials by marketing products with significant green qualities. A study done in 2021 on more than 10,000 people around the world found that 85% had switched to more environmentally friendly products within 5 years.

Businesses need to help customers understand sustainable attributes and value to charge green premiums. Consumers can't identify "greenwashing" from environmentally friendly products.

Across four countries, researchers surveyed the age range of the general population, 18–74 regarding their consumer sustainability habits:

  • 60% of consumers don't know anything about green claims.
  • 54% of customers believe environmental labeling is a sales tactic.
  • 53% of survey respondents couldn't discern green claims apart.
  • 18% of respondents trust official authorities to check green claims.
  • 14% trust private organizations.

Companies provide third-party-verified information evaluations to explain how companies make their goods. Energy Star Performance Indicators(EPIs), life cycle assessments (LCA), and other certifications prove a product’s sustainability.

The eco-friendly company can market themselves more effectively by changing their branding to appeal to people who care about the environment. For example, in January 2009 before Florida Power & Light transitioned into NextEra Energy, their stock price had a high value of 8.72. On December 31, 2021, their stock closing price increased by 974%.

Business Processes & Supply Chains

Companies entering faster-growing market areas are financially benefitting from going green. A study found that 92% of consumers trust brands that are environmentally conscious with 88% more loyalty.

Other carbon-cutting firms can make money in other ways. Sustainability improves environmental and financial efficiency, saving money, gaining market share, earning more, or funding sustainability programs. Evonik industries took advantage of their opportunities and eliminated carbon from their operations. In 2021, their overall financial performance and cash flow increased by 20% compared to 2020, with sales growing 23% to €15 billion ($16 billion USD).

Sustainability needs improving. Heavy mining releases 20 times more GHGs than low-emitting mines. Up to 15 times for metals. As the price of carbon increases and the price of renewable energy decreases, companies with low-carbon assets will have lower operating costs.

Companies want cost-effective decarbonization and sustainability investments. They use company-specific GHG abatement curves, which show the positive or neutral present value (NPV of a project's net climate change benefits overtime periods.

Companies can produce eco-friendly products by cooperating with suppliers. Energy and materials make up most of a product's GHG footprint, but there is a challenge to switching to low-emission inputs.

Scarcity is one factor. Recycled plastics and other low-emissions materials are in high demand. A study in 2030 found Europe's demand for flat green steel might be 50% higher than the supply. Meaning companies need long-term contracts to secure green supplies to secure enough supplies to maintain their net-zero pledges.

Conclusion

The transition to a low-carbon economy will allow companies the opportunity for financial gain as they shift their strategies. The increased flow of capital from transitioning from high- to low-carbon outputs can be used to finance sustainable economic activities such as clean, renewable, and sustainable energy. During this transition, investors need to take risks so that companies can stay competitive. Sustainability is good for the bottom line. By using assets from different fields, partnerships, and shifting investments, companies can expect increased returns and a sustainable future.

The race to net-zero carbon emissions is on and many companies need a technological breakthrough or adjustments in their products if they hope for success. The shift contains many challenges, but the positives outweigh the negatives to not pursue.

Emma Chiu

Product Analyst

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