Delivering decarbonisation

Corporates around the world are showing leadership by setting ambitious climate change targets. The drivers to decarbonise may be regulatory, linked to corporate purpose, reputational and/or financial. We are also seeing more scrutiny of and legal challenges to corporate decarbonisation strategies by consumers, NGOs and other stakeholder groups. Investors and debt funding providers looking to deploy climate aligned capital are also increasingly reviewing corporate decarbonisation commitments more closely.

As a result, a growing number of corporates are looking to set robust strategies to reduce their Scope 1, Scope 2 and Scope 3 emissions. The CDP in its The state of play: 2023 climate transition plan disclosure report found that over 5,900 of the companies surveyed reported that they have a 1.5°C-aligned climate transition plan in place - an increase of 44% from 2022 - with 8,600 companies reporting their intention to develop a climate transition plan in the next two years.

Transitioning to low carbon energy sources in respect of an organisation’s own footprint (Scope 1 emissions) and along its value chain (Scope 2 and Scope 3 emissions), is a significant contributor to the achievement of corporate decarbonisation goals.

Aligning decarbonisation strategies to the regulatory environment

To successfully roll out energy transition strategies, a business must first align its strategy with the applicable regulatory environment. In the UK and EU, regulation and market interventions seek to deliver national and international decarbonisation commitments in the context of liberalised markets. As a result, governments and regulators frequently use a "carrot and stick" approach to influence market behaviour. For example, both the UK and EU use "cap and trade" emissions trading systems (ETS) which seek to internalise the cost of carbon for operators in covered sectors (such as energy and energy-intensive industry), combined with capital payments or operating incentives to encourage capital investment in fuel switching. This helps to incentivise businesses to reduce their emissions both to avoid additional liability of purchasing allowances and to benefit from the available incentive schemes. An example of this includes the UK’s carbon capture, usage and storage (CCUS) business models which provide capex and opex support alongside the UK ETS.

This differs with other markets, where the downside of carbon pricing is often absent. However, the introduction of Carbon Border Adjustment Mechanisms (CBAMs) in the EU and UK means that exporters to these markets will need to account for the embodied emissions within products covered by the measures, essentially imposing a cost of carbon on imports.

To leverage energy transition opportunities, corporates must align their decarbonisation strategies to the applicable regulatory environment.

What transition strategies are being used?

A range of strategies are available for corporates across all sectors of the economy to implement their energy transition.

1. Capturing cost savings from energy efficiency measures

Reducing energy consumption by deploying energy efficiency measures is a natural starting point for many organisations to reduce Scope 1 and Scope 2 emissions whilst also delivering cost savings. Deeper energy saving measures often require either capital investment or technological advances. These can be supported by government schemes or tax incentives to encourage implementation. However, mismatched incentives can hinder action. For example, commercial real-estate landlords might struggle to make the case for expenditure to implement energy efficiency measures where the costs cannot be recovered under the service charge and the short-term financial benefit of the energy savings will accrue to the tenant. To overcome this, absent regulatory intervention, enforceable green lease provisions (where a landlord and tenant commit to improving the environmental performance of premises) are gaining traction in some markets.

2. Transition to renewable and low carbon power

Companies frequently consider onsite renewable power generation such as solar PV, sometimes alongside electricity storage. This can be managed by the business or outsourced to an energy provider. However, due to the need for a reliable supply, onsite generation is often supported by offsite supply via green tariffs or corporate renewable power purchase agreements (CPPAs).

Presenting renewable energy guarantees of origins to demonstrate the renewable quality of a company’s energy consumption has been subject to some criticism however where the regulatory framework does not guarantee temporal matching of renewable production and consumption. As a result, to tackle Scope 2 emissions, large energy buyers may prefer to contract directly with low carbon generators using CPPAs. This is a trend particularly prevalent in the digital technology sector where players such as Amazon, Microsoft and Google are significant offtakers under CPPAs. The collateral required to support termination payments coupled with low liquidity in the CPPA market however may make accessing the market harder for smaller buyers.

3. Investment in electrification of heating and transport

Electrification and the shifting of energy use from fossil fuels to renewable, nuclear and other low carbon power sources is a key aspect of corporate energy transition strategies across all sectors of the economy. Electrification also requires organisations to commit capital to transition their activities to power consumption. For example, this may require investing in electric vehicles (EV) and associated EV infrastructure. In addition, some corporates may be looking to deploy ground and air-source heat-pumps or connecting to local heat networks. In each case, solutions will need to be specifically designed, not only to meet the requirements of the organisation and the local regulatory regime, but also those of the site and its operating profile.

4. Increasing internal power procurement capabilities

Power procurement can be a business-critical issue in some sectors, particularly those in the manufacturing, technology, mining and food and beverage industries. For these businesses, we are seeing dedicated in-house teams being established to manage group procurement strategies. Energy management and data platforms are increasingly needed to track and optimise low carbon power usage. With demand for electricity forecast to rise across the global economy, power procurement is likely to move onto the board agenda.

5. Hard-to-abate sectors are turning to low carbon fuels and CCUS

In certain sectors where processes or activities may not be readily electrified, a range of other energy transition approaches are being considered.

Low carbon hydrogen (and its derivative products) is emerging as a feedstock or a fuel in some sectors, for example in heavy industry where it is used in processes such as in steel manufacturing or chemicals production or as a fuel for high heat. CCUS is also being deployed, particularly in sub-sectors such as cement, paper, refineries and in the waste sector.

In other sectors such as aviation and maritime transport, sustainable synthetic fuels are beginning to gain traction. Inputs such as low carbon hydrogen or other low carbon feedstocks can also be used to produce synthetic hydrocarbons to be used as "drop-in" fuels, compatible with existing assets and infrastructure. The high cost of these alternatives however, as compared to the counterfactual, high carbon alternative, means that government support is frequently required to support production and incentivise companies to transition to these lower carbon options.

6. Tackling residual emissions using carbon credits

For residual emissions, corporates are exploring opportunities to purchase carbon credits in the voluntary carbon markets to neutralise emissions. With work progressing to assure the integrity and quality of carbon credits by organisations such as the Integrity Council for the Voluntary Carbon Market, confidence in this market is expected to rise. And, following the agreement at COP29 of standards for carbon reductions and removals, and project methodologies, it is hoped that confidence will increase further. Robust monitoring, reporting and verification processes are a key element in protecting purchasers against greenwashing allegations.

Conclusion

The implementation of a successful decarbonisation strategy with effective governance and a compelling business case can drive external value in the long run as well as contributing to a company’s ethos, purpose and decision making. Whilst comprehensive transition plans are not yet a legal requirement for all companies in the UK and EU, they are expected to become mandatory requirements for larger companies in the coming years. Coupled with a growing focus on the development of industrial strategies in these jurisdictions, we expect the sharpening of incentives and penalties to encourage active energy transition planning, combined with increasing corporate reporting obligations.