The drawbacks of a blanket “Net Zero” adoption by companies

– There are numerous drawbacks to “net zero” pledges by companies, including capital inefficiencies, lack of skills, value chain effects, confusing signals.
– Investors should be digging deeper into corporate strategies to determine if they are “climate change resilient.”

Here’s an excerpt from this article by Impax Asset Management’s Ian Simm entitled “Corporate net zero: we need a more sophisticated approach”:

First, and most obvious, is the definition and interpretation of net zero. Apart from the ambiguity around each entity’s pathway to net zero (i.e. “how much, by when?”), the role for offsets is contentious – for example, should a cement manufacturer be able to account for the carbon benefits of its investments in peatland restoration, or if we allow this, does that create a moral hazard (to pollute)? And how should low-carbon technologies be treated: for example, when a new wind farm is built, does it really make sense that the entity purchasing the electricity gets the carbon benefit while the investor (or wind farm owner) receives no such boost to their own carbon accounting?

Second is capital inefficiency. To ensure there’s sufficient “creative destruction” as we reset our economy, we need to avoid hampering the essential sunsetting of certain activities in favour of new ones. The law of diminishing returns predicts that, as companies implement efficiency measures and cost-competitive technologies to reduce their emissions, they will need to consume more and more capital to save the next tonne of carbon, for example, steel manufacturers seeking to switch to direct hydrogen reduction. At the same time, companies producing alternative products, for example construction materials based on wood, may offer much higher financial returns on an equivalent amount of capital with much lower risk. Faced with a choice, investors are likely to prefer the latter.

Third, skills. To pivot successfully to entirely new activities, today’s companies need to harness alternative expertise. For example, can today’s oil majors with their competence in seismology and the handling of liquids, realistically develop a competitive advantage in the development of power projects and in electricity trading to outcompete today’s power generators?

Fourth, value chain effects. Notwithstanding the challenges of measuring so-called “Scope 3” emissions, a company that pursues a net-zero position without concern for its customers or even its suppliers may unwittingly hold back climate change mitigation across the “system” (i.e., the wider economy).  For example, if the renewable energy supply required to enable a manufacturer of insulation material to become net zero costs significantly more than the fossil fuel supply it used previously, the price of its product will rise, thereby reducing its potential to assist customers with their energy savings.

Fifth, the “someone else’s problem” effect. It’s too easy for today’s management team to commit a company to long-term targets that they personally won’t be around to deliver on.

And lastly, confusing signals. As decarbonisation progresses, management teams may be faced with a conflict between achieving financial objectives and delivering on the company’s net-zero pledge. This may not matter at the outset, but once the “early wins” in emissions reduction have been secured, difficult conversations about the trade-off between financial and environmental outcomes are, in my view, inevitable.