Given the current geopolitical turmoil – Russia’s war on Ukraine and an accelerating reversal of globalisation – the world is facing huge energy shocks.
In response, Europe has accelerated efforts to decarbonise its economy. Despite the darkening economic outlook our research over the last three years on European heavy industries – including some of Europe’s largest corporate greenhouse gas emitters in the steel, chemical, and power sectors - indicates that there is in fact a new economic order on the rise, in which climate action is increasingly seen as an opportunity. Business history suggests that advantage goes not to the first company that starts up, but to the first ones that scale up - but scaling up relies on a number of accounting, strategic and technical innovations.
Strategies to decarbonise
Step 1: Reconfigure the business portfolio
The first step for many companies has to be to reconfigure their portfolios of assets and businesses, abandoning carbon-intensive products, production methods, and business units and developing low-carbon products with clean production processes.
This strategy is readily available to companies in countries whose governments support the transition. Among the first to switch to green were state-supported entities such as Equinor (formerly the Norwegian oil company Statoil) and Orsted (formerly Danish Oil and Gas Energy). Both are rebranding and are partially or fully divesting from oil and gas, with Equinor aiming at a 50–50 split between fossil fuels and renewables and Orsted becoming one of the world’s first 100% renewable (wind) energy companies.
Among non-state enterprises, in 2002, DSM (Dutch State Mines) sold its petrochemical business and then acquired Roche Vitamins and Fine Chemicals, making its move into nutrition.
But although portfolio management strategies like these may help a given company with its green transition, at an aggregate level, the fact that it is simply shifting carbon emissions elsewhere is no longer a sufficient response.
Our research shows that leading heavy-industry companies in Europe have clearly switched from defensiveness to climate-policy activism, pushing for stricter standards rather than resisting or ignoring them.
Step 2: Select the right differentiation strategy
We find that companies are deploying two types of innovation strategies that offer significant opportunities for differentiation: carbon lightweighting and circularity.
Borrowing a concept from the auto industry signifying the design of lighter vehicles for better fuel efficiency, carbon lightweighting helps customers meet their own carbon-reduction goals by providing them with low-emission components and products; for example, by replacing the energy used in manufacturing with energy from renewable sources. ‘Green steel’, once the holy grail of heavy industries, is becoming a reality via rapid innovation in the industry’s energy infrastructure and production technologies.
First-mover energy companies such as E.ON are now poised for a major role in European project partnerships such as H2.Ruhr, the aim of which is to make Germany’s industrial heartland a hydrogen (clean-energy) region. Similar examples of green hydrogen ventures can be found elsewhere in Europe, often enabling low carbon steel production projects.
The second strategy, circularity aims at keeping natural resources in economic use for as long as possible through zero waste and full recycling in the value chain. Salzgitter, a 150-year-old German steelmaker, for example is now embarking on the ‘biggest change in its history’ by implementing circularity in its operations and across its entire value chain.
Both lightweighting and circularity require substantial investment. The higher the green ambition, the higher the capital expenditure. Accordingly, firms vary the speed and extent of their decarbonisation depending on technological constraints. For example the Belgian chemical giant Solvay earmarked €1 billion of its investments for decarbonising all business units other than soda ash by 2040 and an additional €1 billion for decarbonising the soda ash - a key component used in glass manufacturing and other industrial applications - business by 2050.
Step 3: Factor in the carbon cost
Traditional investment appraisal tools do not capture the cost of carbon emissions that a company is not yet liable to pay, but many companies in anticipation of tougher carbon-tax regimes in their investment horizon are already factoring in a carbon charge, thereby internalising hitherto invisible carbon costs and making them affect the internal rate of return of green – and less green - investments.
The benefits of applying internal carbon costs to investment appraisal are several. Firstly, a carbon-cost–adjusted valuation examines whether the business case (likely to be a long-term project) will be resilient against external carbon taxes, once they bite in earnest. Secondly, making the cost of carbon visible in monetary form stimulates new conversations and actions on emissions.
Step 4: Account for the impact
Companies need novel accounting practices not only to measure but also to market the climate benefits of their new low-carbon products. For example, at the British chemical company Croda, the finance function took the practice of internal carbon costing right down to product level and into the supply chain. They developed a methodology to allow the consistent calculation and reporting of the carbon emissions that customers could avoid by using the company’s products. Certifying low-carbon or green products requires not only expertise, but also outsiders’ trust so an externally audited certification is needed - ArcelorMittal is trialling one such system to certify its low-carbon steel products.
However the trouble is that these initiatives are challenging to develop because as we outline in our report, the methodology behind the current Greenhouse Gas (GHG) Protocol needs to be improved. Creating a reliable, complete, and transparent picture of companies’ GHG emissions, is essential for further accelerating the ascent of climate action as a source of competitive advantage. This brings us to the fifth step.
Step 5: Engage in corporate activism
As decarbonisation strategies are generally costly short-term, in most cases, they are yet to deliver higher financial returns to investors. Without support from governments, customers, and investors, early movers run the risk of seeing their investments in green technologies go unrewarded. Therefore, supportive industrial policy is crucial.
Government subsidies can be an important source of funding for decarbonisation technologies via direct funds or indirect allowances – the free allocation of emission allowances in Europe’s Emission Trading Systems (ETS) is one such example. The innovative activities of the German copper producer, Aurubis, are a case in point. Aurubis’s copper-production process produces a waste product ('slack') containing iron, which Aurubis used to sell to road-builders. Recently, a partner company came up with a new technology that extracts iron and glass from this slack—at half the carbon-intensity of normal pig iron production. The new technology is expensive; the price of pig iron alone does not justify it. But once policymakers and the ETS system allow Aurubis to include these emissions reductions in its financials, the company will be able to recoup its capital outlays and continue to develop such innovative technologies.
So responding to the decarbonisation challenge is not simple; it involves a multi-faceted approach - part strategic differentiation, part accounting and part corporate activism. But what is clear is that Europe’s heavy industries are gradually recognising that instead of framing the green transition as an existential risk it offers strategic opportunities, even in these turbulent geopolitical times.
