Action on climate change hastens an energy transition that was potentially going to occur naturally
This change from the current economy to a new, low-carbon economy must happen relatively fast (given the scale of change required) to meet the goals of the Paris Agreement
The change presents both risks and opportunities to businesses today and it's wise to take a strategic approach and be prepared for what may happen
It's clear, and I've written many times, that the energy system is undergoing a (relatively) rapid transition. I would argue that this transition to a lower carbon economy would happen anyway, in the same way that the energy system has moved from wood and biomass based to coal, to oil and then to natural gas. This has been a story of decreasing carbon atoms over time and it's natural to think that there would have been a transition to electrification, renewables and hydrogen anyway. However, climate change - and the global agreement that something needs to be done about it - hastens this transition and will require a profound change from all parts of society. Such a change will create winners and losers as there are risks and opportunities ahead from the transition.
In this part of the series of articles looking at risks other than the regulatory risks associated with climate change, I explore market opportunities and risks. First of all, it's important to consider once again what the Paris Agreement actually means. The goals of the Paris Agreement are relatively simple to convey but at the same time difficult to achieve - due to the scale of change required. One can distill the Paris Agreement down to six key points:
Limit temperature increase to well below 2 degrees C whilst pursuing efforts to limit the increase to 1.5. degrees
Reach global peaking of emissions as soon as possible to achieve net zero emissions between 2050 and 2100
Nations commit to communicate their reduction targets every five years, increasing ambition
Develop frameworks to allow nations to co-operate using market based and non-market based mechanisms
Nations communicate their adaptation plans with developing countries receiving enhanced support
Technology, capacity building and finance flows from the developed world to developing countries
The key point, particularly when it comes to climate risk - and market risks and opportunities - is the emissions trajectory that is considered by the second point, to support the overall aim of limiting global temperature increase. To achieve net zero emissions in the second half of the century (and negative emissions according to almost all 2 degree pathways) requires significant change to the makeup of the global economy, especially primary energy systems. Virtually everything that occurs in the economy currently causes emissions at some point along the value chain.
What this means in terms of market risk is that markets for some products may be eroded in future. A product that is relatively emissions intensive over it's value chain may see its market change due to a number of different reasons. If a company or a facility has an emissions intensive input, this may be more expensive in a carbon constrained world, increasing the unit cost of production for that facility's products and ultimately the sale price - which could have a market impact. Similarly, a product that is used for an emissions intensive purpose may see its market eroded as a result of consumer preference. For example, a user of that product may choose to use an input that generates fewer emissions when used to minimise their own potential carbon liability.
Ultimately, different products are affected differently and the market related risks will be realised in a different manner. An understanding of the emissions associated with each point of the value chain - that is, actual and forecast emissions associated with production (Scope 1 emissions) as well as emissions associated with inputs (upstream) and outputs (downstream). This will then give some idea of where and how market related risks may materialise. In most cases however, the impact of these market related risks will be reduced revenue (from erosion of demand) or increased costs - which may ultimately lead to reduced revenue if prices for products are increased by a greater proportion than other products that the business is competing with. In the event that the market price for products is inflexible then any increased costs will act to reduce profit margins.
The flip side to market risk are the market opportunities that come about as a result of climate change. To understand what the opportunities are, narratives that describe the future, low-carbon economy are built. Companies can then explore opportunities that reflect their strengths and see whether they make sense. Climate related opportunities are then analysed for potential business cases in the same way as other business opportunities - with the added advantage that some of these opportunities may attract support from investors and governments in the form of grants, lower cost of capital, research and development support etc. Some examples of potential opportunities are:
Gas companies may choose to explore hydrogen supply chains as an alternative to natural gas
Power companies may choose to diversify their energy supply systems to include renewables and incorporate energy storage
Upstream exploration and production companies in the oil and gas industry may have an opportunity to utilise their skills to advance carbon capture and storage
Refining companies may have opportunities in advanced biofuels
Vehicle manufacturers may consider electric vehicles or hydrogen fuel cell vehicles
Oil and gas companies may see an opportunity in providing electric vehicle charging infrastructure, to piggy-back off their current network of retail outlets
Mining companies may focus on critical minerals for the energy transition such as copper (for electrification), nickel, cobalt, lithium (all used in batteries), aluminium (for light weighting of vehicles) etc.
Mining companies may diversify into recycling and recovery of metal rich e-waste, or processing of old tails sites, for valuable materials
Airlines may see opportunities through providing a point of difference to consumers through use of biofuels or provision of offsets
IT companies and other service providers may develop technology solutions to improve efficiency and productivity of companies and facilities such as digitisation, block chain applications, automation solutions and remote operations
All companies may have an opportunity to reduce costs through energy efficiency programs to reduce energy consumption and emissions
Companies may also be able to reduce costs, and provide a hedge against future price rises in energy, through use of renewable energy and storage
And there are potentially many more opportunities available to businesses through the transition. Obviously, it's difficult to make large scale changes overnight - and shareholders may not necessarily appreciate very rapid change in business plans. Giving consideration to these opportunities is important now however - as well as having an answer to the question "what needs to change to provide a positive business case for these opportunities?". For example, is there a threshold carbon price before these opportunities become viable, or a floor in the product price before an alternative becomes more effective, or even what level of support from a government or investor is required. Many companies are starting to make strategic investments now, albeit at a small scale, so at least they are not playing catch up if things change rapidly.
Overall, the way in which markets are affected by climate change is varied and complex. The most important thing companies can do is take a strategic approach and, using scenarios, explore what the risks and opportunities might be. Companies can be prepared with strategic plans for a number of different scenarios and complete a signpost exercise to give them some clarity as to which scenarios are playing out.