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Net zero at any price?

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Sebastian Twining

August 31st, 2022

Net zero at any price?

With inflation running at a 40-year high in the UK, and rising globally, we consider how the pursuit of net zero could affect energy prices and why businesses and investors need to fully understand the impact of decarbonisation.

 

The UK’s commitment to achieve net zero by 2050, and to reduce emissions by 78% compared to 1990 levels by 2035, is ambitious and will require robust action. The costs of transitioning infrastructure have been well-documented, but there will also be operational costs affecting every business and consumer of energy, as well as longer-term value impacts – many of which are already starting to be felt.

As the transition to a low- or zero-carbon future progresses, so too will scrutiny from stakeholders, and the effective measurement of a company’s carbon footprint will become an intrinsic part of company value. Research shows that “almost half (45%) of valuation experts believe a lack of a standardised and recognised measurement system is the biggest threat to effective environmental, social and governance (ESG) disclosures for businesses.” When it comes to securing investment or achieving a sale, that can be a serious headache.

“Throughout the investment chain – from end investor to private equity provider, to fund manager – there’s an increased demand for accessible data,” says Hugo Kimber, Founder Director of data-driven advisory Carbon Responsible. “The penny is starting to drop and repeat clients of ours who have assets that are about to go through an exit process, for example, are keen to understand what their ESG exposure is like and how that will impact asset value.”

Energy costs fuelling inflation

At a time when spiralling energy prices are driving higher inflation, posing a risk to household incomes, business profitability and economic growth, the friction between short-term cost management and long-term ESG strategy, has never been higher. “The consequences of having a net zero strategy are rising cost-risk,” says Kimber, “but the invasion of Ukraine has accelerated that process and we can clearly see how inflation and energy are interconnected.”

The infrastructure to produce and refine fossil fuel is dissipating, with investors keen to avoid the risk of stranded assets. Our energy capacity is falling in tandem and many of the alternatives are still some way off meeting demand year-round.

Couple that with supply and weather-related constraints; the wholesale price of gas reaching a level four times higher in January 2022 than at the beginning of 2021; plus the sanctions against Russia – and the inflationary direction of travel is clear.

Reconciling cost and commitment

UK businesses have felt the full force of rising energy prices, unlike consumers who are partially insulated. Even in the face of increasing cost, firms are being challenged to reduce their carbon footprint. Looking forward, the prospect of carbon ‘taxes’ beyond the climate change levy contribute to even greater operational expense anxiety.

Energy efficiency is one answer to reducing costs and meeting their ESG responsibilities but, says Kimber, that means understanding where you are now, setting targets for reduction, and knowing how you’re progressing – which makes measurement and data critical.

“Lots of people have signed commitments to reduce their emissions, so the intention is there, but there’s very little in terms of measurement. Investors increasingly want to know what ‘good’ looks like, and are more aware of greenwashing, so if your claims aren’t backed by good, externally validated data that’s reasonably intelligible and accessible, you’re in trouble.”

Unlocking corporate value

Businesses need investment to successfully navigate the transition but with investors increasingly integrating ESG into their analysis, accurate and robust measurement and reporting is vital. Externally validated reporting will move into sharper focus as regulation increasingly comes into force, explains Kimber: “When you start to look at your potential risk costs around legislation, allowances, and so on, it gets really painful. The risks are already here today, but we can see it coming.”

These are just some of the reasons why, he says, “commercially relevant and actionable intelligence from quality data, is the key to corporate value.” Over the past decade, he continues, business and investor understanding of what carbon means has increased, accounting for it has become more commonplace, and the role of Scope 3 emissions within a company’s value chain has become clearer.

Understanding measures and meaning

The challenges lie in both data availability and the expertise to analyse it. “There’s a hunger for knowledge on this but there's a massive deficit at the executive level. The questions that are being asked are, where do we start?”

While firms like Carbon Responsible can do the heavy lifting when it comes to delivering measurement and analysis, there are clear risks in firms’ ability to understand and use the data to evolve their strategies.

Board members in listed companies, whether they are ESG ‘specialists’ or not, often lack the necessary experience required to effectively enact change and keep abreast of the changing regulatory framework.

Indeed, a US study into board make-up, for example, found that only 6% of board members had environmental experience relevant to ESG, while in Europe, 37% of board members feel that ‘limited board diversity or knowledge in key areas’ affect their ability to generate long-term value through ESG.

At Drax, this discrepancy is a key focus for us. We know that 75% of FTSE100 companies have an ESG/Sustainability director, but our research shows that only 44% of those specialists have a functional background in ESG. Our leadership modelling helps to address a similar imbalance –in the unlisted environment – by mapping agenda-driven c-suite talent to the boards of PE-backed companies.

With compliance requirements and awareness likely to move down the business chain, Kimber says he is seeing demand from businesses of all sizes. “Even if clients aren’t needing to be compliant, they’re part of a supply chain that might be, and they’re increasingly being asked for emissions data. It’s now a value criterion and a procurement pressure.”

Growing demand for intelligible data

Data too can be difficult to come by. “Often a business will be motivated by strategic change that requires them to report on emissions,” says Kimber. “But without a full range of data, setting a robust baseline to set targets against can be difficult. Many don’t have building management systems in place to gather that data. These are by-products that can help a business create a robust emissions reduction policy, with measurable targets and transparent progress.”

Combined with recruiting board-level personnel that understands how to navigate ESG reporting, effective measurement will be an increasingly potent tool in the hunt for value creation. Because, as Kimber concludes, despite high inflation, energy supply issues, and slowing economic growth, the long-term trajectory is clear.

“We may be dialling back on our energy policy in relation to net zero in the short term, but the hangover from taking the foot off the gas now will be another phase of rapid acceleration.” And that will make measuring and reporting carbon usage and understanding its impact on ESG policy and corporate value, even more important for businesses and investors.

Sebastian Twining

Director, Consumer Practice

stwining@draxexecutive.com

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