In an age of
activist consumerism and investment, and the apparent effects of climate
change, moving towards net zero emissions is the stated goal of many
businesses. The questions is how do we
evolve it from slogan to reality? The
following is taken from “Net Zero or Bust: Beating the Abatement Cost Curve for
Growth”. This article was written
collaboratively by global leaders in the McKinsey Sustainability and
Manufacturing & Supply Chain Practices, including Pauline Blum, Stefan
Helmcke, Ruth Heuss, Thomas Hundertmark, Sebastien Marlier, Dickon Pinner, and
Ken Somers.
Companies can both decarbonise and
boost long-term growth, but it means pushing beyond abatement curves’ focus on
cost and instead empowering people, while making a few big, strategic bets.
Before the COVID-19 pandemic, environmental, social, and governance
(ESG) issues had become priority concerns for governments, businesses, investors,
and consumers. As the world looks forward
to the post-pandemic next normal, these themes are likely to return to the top
of executives’ agendas. Among them, the
need to eliminate emissions of greenhouse gases may be the most difficult to
address. Many companies have already
committed themselves to deep, long-term reductions in greenhouse-gas emissions.
Others will be forced to act by
customers, investors, and governments. Almost
300 large companies have joined the highest tier of the Science Based Targets
initiative, for example — that is, ramping up pressure on suppliers to cut
their own emissions or risk losing business. Business leaders are already telling us that
some of their biggest customers are warning that future contracts will be contingent
on significant emissions reductions.
A growing share of investment capital is also being channeled into
the fight against climate change. Between
2012 and 2018, investment in assets with explicit sustainability goals grew by
15% a year. By 2018, such investments
accounted for 11% of professionally managed assets globally. More broadly, investors are increasingly
concerned about the potential impact of climate-related risks across their
portfolios. In January 2021, BlackRock,
the largest asset manager in the world, asked the CEOs of companies in which it
holds shares to explain how they plan to achieve net-zero emissions by 2050.
And policy makers are piling on further pressure. The European Union, for example, appears
ready to proceed with plans for a cross-border carbon tax, using the proceeds
to fund sustainability initiatives within the bloc. Such policies mean companies are no longer
shielded from environmental legislation by virtue of their location. Any organisation participating in global supply
chains will need to cut its emissions.
Together, these forces mean that decarbonisation is no longer an
option. Across most of the world, companies
with ambitions to stay in business over the long term are already on a 30- or
40-year journey to net-zero emissions.
Like any change journey, the road to net zero involves several
distinct steps. Companies must
understand their current carbon footprints, identify strategies to reduce and
ultimately eliminate carbon emissions, and implement the necessary changes.
These steps would be straightforward, were it not for one catch. Emission-reduction plans tend to be created
using standard “abatement curves,” which take a top-down view and focus on
large-scale technological shifts. These
curves often predict that transition risks, such as falling demand or asset
devaluation or regulatory shifts, will lead to cost increases great enough to
put many organisations out of business long before they reach their net-zero
goals.
In our view, organisations should not let the scale of the
challenge derail their sustainability ambitions. Contrary to what cost curves suggest, big
cuts in emissions can be achieved without large-scale value destruction. What is more, the climate transition will
create historic opportunities for environmentally sustainable businesses to
build new markets, reinvent old categories, and become magnets for top talent. Unilever, for example, says that in 2018, its
Sustainable Living brands grew 69% faster than the rest of its portfolio. And by 2030, the reuse and recycling of
plastics could drive profit-pool growth of US$60 billion for the chemicals
industry, according to McKinsey analysis.
For the journey to become value creating rather than value
destroying, however, companies will need to rethink the conventional approach
to carbon reduction. Moving beyond the
abatement curve involves a combination of top-down and bottom-up activities:
empowering frontline personnel to drive emissions reductions while making
significant long-term strategic bets on markets, technologies, and production
footprint (Exhibit 1).
Even the first step in the carbon-reduction journey — determining
baseline emissions — presents significant complexities. An organisation can use internal data sources,
such as energy bills and procurement records, to calculate its emissions in the
Greenhouse Gas Protocol’s Scope 1 (direct emissions from its own activities)
and Scope 2 (indirect emissions attributable to the organisation’s energy use).
Scope 3 emissions are more difficult to ascertain.
The necessary data are not always available
from suppliers and customers, forcing companies to rely on models or
approximations to build an estimate of their full carbon footprint.
Even a less-than-perfect picture of emissions could still act as a
useful catalyst for improvement. Understanding
the largest sources of greenhouse gas emissions across value chains can help companies
identify quick wins and target energy efficiency improvement efforts. Few organisations make that link, however. Emissions analyses remain locked in the
boardroom, while any improvements made by the front line are simply a byproduct
of efforts to reduce waste and drive up productivity using well-established
lean approaches.
To establish a potential pathway to net zero, companies must
identify the changes that could eliminate emissions from their value chains, then
rank them in ascending order of cost per ton of abated carbon. Today, it is common to map these changes in
the form of abatement curves, which provide the boardroom with a top-down view
of the potential capital investments (often large) in known technologies that
could trim organisation’s emissions.
For business leaders, these abatement curves can be frightening,
especially for industrial companies with energy-intensive processes. Exhibit 2 shows an illustrative
carbon-abatement cost curve for the full value chain of a European automotive
player.
The x-axis of the chart sets out, in ascending order of cost, the
available options for reducing the organisation’s carbon emissions. The y-axis shows today’s cost of each option
per ton of carbon emissions reduced. At
current costs, less than 25% of the path to zero emissions is positive net
present value (NPV).
For this company, the chart’s implications are stark. Eliminating the company’s upstream emissions would
reduce its profits by around €1 billion.
At many organisations, the implications of the carbon-abatement curve
have been daunting enough to stall progress on the deep emissions reductions
that will be necessary over the coming decades. The imperative for today’s leaders is to find ways
to break this deadlock.
Beating the cost curve and building a successful long-term
decarbonisation strategy will depend on big moves in two areas (Exhibit 3). The first operationalises emission-reduction
efforts using known technologies and approaches, moving from theoretical
discussion in the boardroom to pragmatic action in the control room, on the
shopfloor, and throughout the organisation. The second entails big bets on options that
don’t currently appear on the abatement curve, exploring new technical,
strategic, and market opportunities to capture value while reducing
environmental impact.
Translating emissions-reduction goals into a practical reality
involves working on three fronts at once: redefining the decarbonisation
business case in finance, building an integrated sustainability production
system into the organisation, and assembling an infrastructure to support
tactical innovation in operations.
Increasingly, organisations looking to finance emissions-reduction
initiatives can access the necessary capital at low cost. Governments and private investors are showing
a greater willingness to offer long-term loans at favorable terms to fund such
projects. Sustainability-linked bonds
worth more than US$200 billion were issued in 2020, for example, pushing the
total market for such securities above US$1 trillion for the first time. Some programmes even offer borrowing costs
linked to the carbon-reduction impact of investments. In February 2021, drinks maker AB InBev agreed
to a US$10.1 billion credit facility that links interest margins to several
sustainability goals, including group-wide carbon-emissions reductions. Using such structures, companies can often
secure funds for investment at less than half of their existing cost of
capital. That is enough to shift the NPV
of plenty of emissions-reduction projects from negative to positive.
In the context of the transition to net zero, companies can also
revisit their project-investment criteria. At many organisations, projects that improve
efficiency or reduce emissions must today pass the same financial tests as any
other capital investment. That usually
entails a maximum payback period of two years. Extending the maximum payback period to five
years, for example, allows organisations to take a longer-term perspective on investments
that could make a meaningful difference in their climate-change impact.
Alternatively, companies can explore new funding and ownership
models for low-emission assets. Original-equipment
manufacturers or third-party operating companies may be willing to retain ownership
of equipment such as biomass boilers, for example, while the end user pays by
unit of energy consumed. In Romania, for
example, specialty chemicals company Clariant is building a 50,000- ton
capacity plant to produce ethanol from agricultural residues. Steam and electricity for the facility will be
provided by a dedicated biomass cogeneration plant installed and operated by German
energy company GETEC.
Another option for companies is to introduce an internal form of
carbon tax by including the cost of the carbon emissions explicitly as a line
item on the profit and loss accounts of their plants and business units. The funds collected through this mechanism can
then be ring-fenced for use in emission reduction projects. Dutch chemicals company Royal DSM, for
example, introduced such as scheme in 2016, setting an internal carbon price of
€50 per ton.
Many organisations have dozens of potential emission-reduction
projects sitting on their shelves because their business cases failed to meet
the requirements for investment, sometimes by narrow margins. The combination of cheaper, more accessible
capital and a full life-cycle perspective can unlock multiple opportunities to
simultaneously reduce emissions and improve financial performance.
Designing, running, and improving a low-carbon manufacturing
network and supply chain is an intricate task. Organisations will need the skills, processes,
and data to identify and implement efficiency improvements across their
operations. Today, all three are in
short supply.
The development of an end-to-end sustainability production system
will require a systematic approach to the acquisition and development of capabilities
across the workforce. Companies will also
need appropriate supporting infrastructure across the wider organisation. That might include investments in new
analytical tools to help staff interpret sustainability-related data, and
changes to KPIs, targets, and incentives to promote continuous improvements in
energy and resource efficiency.
Several companies are already pursuing this approach. A large-scale, ten-year operational energy-efficiency
programme at one major chemicals player focused on capability building among frontline
process engineers. Hundreds of staff across
the organisation developed the skills to understand the root causes of losses
and process inefficiencies, aided by new analytical tools that helped them
identify and evaluate the impact of detailed process changes.
The programme has reduced carbon emissions by 10% while generating
savings of about €100 million per year. That impact was achieved not through big
investments in new equipment but through dozens of smaller measures scattered across
the business. One site alone implemented more than 30 separate projects. Notably, the company made no special financial
provisions for efficiency improvements; projects had to demonstrate a
three-year payback like any other investment.
The road to net zero involves several distinct steps. Companies must understand their current carbon
footprints, identify strategies to reduce and ultimately eliminate carbon
emissions, and implement the necessary changes.
The drive to reduce Scope 3 emissions generated in the upstream and
downstream value chain, meanwhile, will require companies to extend their sustainability
production systems to include functions such as procurement, product development,
supplier development, sales, and logistics. Measuring, monitoring, and improving Scope 3
emissions in the upstream supply chain will demand extensive changes to current
approaches to supplier selection and management, for example, along with new
analytical skills in the responsible teams. Companies will want a comprehensive carbon
accounting-and-control system that runs alongside its financial equivalent. Such systems are in their infancy today, but
development is accelerating. In
mid-2020, chemicals company BASF began to publish full details of the carbon footprints
of the 45,000 products in its portfolio.
The transition will also require effective cross functional coordination.
Carmakers are already exploring
opportunities to replace high-quality, high-footprint virgin aluminum with
lower-grade, low-footprint recycled aluminum. That calls for collaboration between product
development, sourcing, and manufacturing teams. The ability to demonstrate better
environmental performance can boost sales too. Some materials companies are already using
their sustainability credentials and long-term improvement plans as an argument
for their products over rivals’.
The third critical element required to operationalise a company’s
carbon-reduction strategy is tactical innovation. Many of the moves required to drive down
overall emissions will involve the adoption of new technologies and approaches,
the costs and benefits of which may be highly site-specific. Half of the carbon emitted in ammonia
production is pure CO2, for example — and therefore could be ideal for carbon
capture and storage (CCS). In Europe, ammonia
plants located close to ports have opportunities to transport this gas in
marine tankers for storage in depleted offshore oil and gas wells. Our calculations suggest that this approach
was cash-flow-positive even at the February 2021 carbon price of €40 per ton.
Similarly, advanced heat recovery, zero-carbon electricity,
hydrogen, biomass, and geothermal and nuclear heat are all potential
substitutes for the fossil fuels used to produce process steam. The best choice for a given site will depend
on the local price, societal acceptance and availability of each fuel type.
Companies will need the ability to pilot and scale up new and
unproven technologies within their existing production networks. That will involve partnerships with start-ups
or research organisations to pursue breakthrough innovations — and it will also
require adequately funded and supported in-house capabilities. Government support for such initiatives is
increasingly available. The EU
Innovation Fund, for example, plans to invest €10 billion on low-carbon innovation
over the next decade, with funding earmarked for small-scale projects alongside
flagship innovation efforts. One
candidate for such tactical innovation might be the development of high-temperature
heat pumps to reduce energy consumption in the food industry’s sterilisation
and cooking processes.
Capex-replacement cycles present another opportunity for site-level
innovations and technology investments. A
steelmaker facing a €500 million investment to replace a coke oven battery, for
example, might consider a switch to more efficient alternative technologies, such
as a jet-process basic oxygen furnace. It
could also choose to invest in electric arc furnace technology, switching the
feedstock to direct reduced iron produced using natural gas with CCS, or using
hydrogen.
Once again, these are decisions that cannot be left to the
boardroom alone. The best answers for
any site will depend on specific factors, including its location, the
availability of low-cost capital or government support, and the strength of the
organisation’s long-term commitment to the technology or market segment.
Proven and emerging technologies and operating approaches, if applied
at scale, will be enough to take energy-intensive companies perhaps 40% of the
way along the emissions-abatement curve. The remainder of the journey will require big
bets and big steps into the unknown. As
they consider those choices, businesses will need to decide the strategic
posture they wish to adopt in the carbon transition. Some organisations will seek to play a leading
role, pioneering the adoption of sustainable technologies and business models. Others will adopt a “last man standing” strategy,
seeking to retain their existing approaches for as long as customers and
regulators permit. Between those
extremes, companies may choose to pursue fast-follower or slow-follower
strategies, holding off on major shifts until approaches have been proven
elsewhere (Exhibit 4).
Based on their strategic postures, companies will want to
reevaluate their existing portfolios, potentially disposing of assets or
exiting certain businesses. In other
areas, they will likely need to place their big bets across one or more of
three key dimensions: geographies, products, and processes.
— New geographies: Locating manufacturing facilities for less
energy-intensive products closer to the point of end use can significantly reduce
carbon emissions generated during transportation. For energy-intensive products, proximity to
new feedstock sources or sources of low-carbon energy can be even more advantageous.
Saudi Arabia, for example, has announced
plans to build a new green hydrogen plant powered by 4 gigawatts of wind and
solar energy. Much of the plant’s annual
hydrogen output will be converted to 1.2 million tons of ammonia and exported
worldwide as a low carbon energy source and chemical feedstock. Australia, which has abundant ore resources
and significant renewable-energy potential, could become an advantageous
location for the production of iron using green hydrogen, for example. The move up the value chain, shifting from an
exporter of ore and coking coal to a producer of iron, would generate new value
for the region. And, by halving the mass
of exported materials, it would have a positive knock-on effect on transport
emissions.
— New products: Organisations may choose to shift into
lower-emissions product and market segments. Manufacturers of cement-based building
components might migrate into engineered timber alternatives. Materials players could invest in novel
chemical-based recycling technologies for plastics. Meat and dairy producers could enter new food
categories derived from plants, cultured meat, or insect-based sources of
protein. That shift is already underway,
with major food companies making large investments in the sector. In 2016, dairy products maker Danone made its
largest acquisition in a decade with its US$12.5 billion purchase of WhiteWave,
owner of the Alpro brand of plant-based foods.
— New processes: In many industries, the known technologies
required to deliver net-zero operations are value destroying, if they exist at all.
To remain viable, therefore, companies
will want to radically reinvent their processes. Heavy industrial sectors face a multiyear
effort. Brazilian metals company
Tecnored is developing a more energy-efficient process for production of pig
iron that uses pellets of powdered ore combined with coal or biomass char as a
reducing agent. It has been operating a development
plant since 2011 and, having proved that its process is cost-competitive with conventional
methods, is now working on a commercial unit with a planned annual capacity of
500,000 tons. In the production of
ethylene, Dow and Shell have announced research into electrically powered
steam-cracking technology. Elsewhere,
laboratory-scale demonstrations have shown that replacing the conventional high-temperature
steam-cracking process with chemical looping–oxidative dehydrogenation could
reduce carbon emissions by almost 90%, cut operating costs, and debottleneck existing
assets.
To succeed in these moves, organisations will want to move more
R&D expenditure into sustainability related topics. They have room to do so. In 2020, global R&D expenditure on
technologies to fight climate change was estimated at around US$80 billion. That is less than 5% of the world’s US$1.7
trillion R&D budget.
The transition to net-zero emissions will have a profound impact on
almost every aspect of business. Success
will require a transformational approach.
For industries that have relied on the same fundamental technologies for
a century or more, the degree of change required in the next three decades may
seem formidable, but it is not without precedent. Neither the internet nor the mobile phone had
achieved large-scale adoption at the beginning of the 1990s.
Such a transformation must begin with a decarbonisation vision,
determining the role the organisation seeks to take through the carbon transition
and beyond, and laying out the scale and scope of the operational changes and
strategic big bets required to reach it.
Achieving that change at the necessary pace to meet global climate
goals will still require companies to juggle thousands of initiatives and
develop entirely new technologies, all in an environment of significant
uncertainty. That will require careful planning,
with development of new decarbonisation “playbooks” that help business prioritise
and sequence their carbon-reduction actions. Whatever their strategy, companies must also
adapt targets, performance metrics, and decision-making processes across the
organisation to ensure that staff at every level are motivated and supported to
achieve emissions goals.
Finally, to successfully operationalise their emissions reduction
efforts, companies will need to develop new capabilities at a transformational
scale. That capability-building effort
needs to be broad, equipping the majority of staff with the skills they need to
understand and act on sustainability related sustainability data. It also needs to be deep; developing a task
force of process optimisation and sustainability specialists that can help site
teams to drive rapid improvement, for example.
For any company with ambitions to remain viable beyond the middle
of this century, the race to net zero emissions is already under way. Yet, the formidable technical and economic
barriers they face has left many organisations stuck in the starting blocks,
paralysed by the abatement curve.
Surmounting those barriers will require a transformation mindset
with two primary elements. Beyond the
boardroom, companies will need to operationalise at scale, capturing short-term
value creation opportunities by equipping their frontline staff with new
skills, new tools, new processes, and new infrastructure. Within the boardroom, meanwhile, leaders will
need to rethink their strategic positioning, adapt their existing portfolios, identify
the growth opportunities emerging from the disruption of decarbonisation, and
place big bets on their long-term futures.
