As more companies adopt net-zero targets, attention is shifting from the targets themselves to ensuring that the necessary management practices and actions are in place to reach those targets. Committed companies need to set specific performance benchmarks to help them achieve their net-zero goals and successfully shift to a low-carbon future.
An increasing number of companies are now choosing to adopt science-based targets, which mandate real emissions reductions verified by the Science Based Targets initiative (SBTi), instead of solely relying on purchasing carbon offsets. As of 2021, more than 2200 companies have already set some form of science based target, covering 35% of global market capitalization. However, meeting these targets involves a substantial overhaul of many aspects of a company’s operations, including its strategy, supply chain management, and product design.
The primary management challenge is to measure, analyze, and ultimately reduce a company’s emissions, including its “scope 3” emissions. Scope 1 emissions are created during the production of a product or service, while scope 2 emissions are any electricity a company purchases. A company can thus reduce such emissions by sourcing renewable energy and reducing waste for instance through the production process.
However, for some companies (like energy companies), the main emissions come from a product’s use, not its production. Accordingly, the SBTi requires companies to set reduction targets for scope 3 emissions if they make up more than 40% of total emissions. Simply buying green electricity therefore won’t be enough for certain types of companies, like banks or energy companies, to meet their net zero targets. They’ll need to change their products, like how they structure their investment portfolios or lending practices. In some cases, some companies may require a complete overhaul of their business model and operations.
Fredrik Fogde, Associate Director of Climate Content at Sustainalytics, recently explained to me that what constitutes effective management practices will vary depending on the industry in question, but for companies whose scope 3 emissions make up a significant portion of their business (such as banks or oil companies), a high-level strategic discussion within the organization will be necessary to set appropriate benchmarks. Recently, Fogde helped conduct an analysis of the different types of key management KPIs that companies can use to meet their net zero aspirations.
For cement companies, for example, one of the main indicators to look at is whether they have a way to price the amount of carbon they emit when they make cement. This could involve different types of pricing mechanisms, and it’s important to see if the company is including the cost of emitting carbon in their investment decisions. For companies that make things like electric machinery, the focus might be on how they plan to make their products more efficient and use less electricity.
In other cases, to assess if a company is performing well, Fogde outlines that we need to examine their plan for reducing emissions caused by their products, particularly for those in industries that generate significant emissions from product usage, such as traditional gasoline-powered cars. In this instance, he says, we might be able to evaluate the effectiveness of their plan by the amount of information they provide on initiatives to increase fuel efficiency and decrease emissions, such as producing more efficient cars and using cleaner fuels.
It is true that some companies may face difficulties in measuring their emissions, especially if there are no existing models or calculations provided by industry groups for their production process or product usage. In such cases, the company may need to conduct their own research and analysis, which not all companies may be willing to invest the time and money in. Indeed, initial findings based on a test universe reveal that only 15%-20% of companies that have set 1.5 degree targets with the SBTi have the necessary governance structures in place to actually achieve these goals. However, the incentives to do so may be changing rapidly. According to Fogde, we’re “heading towards… questions such as the impact on climate change… [being] reported with the same vigor and seriousness as financial reporting.”
Why is that? Well until now, many companies have felt compelled to respond to consumer demands and self-imposed voluntary targets. However, new regulatory guidelines are expected to further increase pressure to deliver on commitments. Proposed SEC guidelines, for instance, would hold companies responsible for their public claims of meeting net zero targets, potentially even requiring them to disclose their scope 3 emissions.
Furthermore, pressure will continue to grow from investors who have set their own net zero targets. As Fogde outlined to me, one of several methodologies used by investors to fulfill their own net-zero commitments – the so-called Binary Metrics approach – involves ensuring that at least 50% of the companies in their portfolio have set science-based targets. As a result, investors who are “really committed to changing their investments to be in line with net zero” might be expected to proactively ensure that the companies they invest in are meeting their climate commitments, as this will determine whether they in turn can accurately claim to have achieved their own targets.
In one big shift late last year, Norway’s sovereign wealth fund, worth $1.2 trillion, unveiled a new climate action plan, which aims to achieve net-zero emissions by 2050 for all companies within its portfolio. The new plan requires portfolio companies to align their business activities with net-zero 2050 and establish science-based targets for reducing emissions in the short, medium, and long terms for their scope 1, scope 2, and significant scope 3 emissions.
According to Fogde, such investor pressure is expected to persist, despite emerging resistance in the US. The pressure may be especially prevalent among investors and large companies simultaneously operating in Europe, as the EU is already introducing strict regulatory guidelines.
In many cases, the motivation for action may merely be a matter of business common sense on the part of many investors due to the rise of so-called transition risk. Given the significant efforts required to reduce emissions and mitigate climate change, for instance, any company holding substantial fossil fuel assets is at risk of these assets becoming stranded in the long term as the world transitions to cleaner and eventually cheaper sources of energy. A cautious investor in such companies would arguably therefore want to see a clear transition plan from the business in question.
Companies undoubtedly face significant challenges in meeting their net-zero targets, and it requires transformation in various aspects of their operations. Effective management practices and performance benchmarks will vary depending on the industry, and will require significant leadership buy-in from those with high scope 3 emissions. Notwithstanding pushback in some quarters, pressure from consumers, investors, and regulators is increasing, and companies risk being left behind if they fail to act now.