This article is from the latest Good Investment Review, which you can download free here.
Climate leaders are the companies who are leading their industry when it comes to cutting harmful greenhouse gas (GHG) emissions. If the world economy is to meet the Paris Agreement target of limiting global warming to 2 degrees (or preferably 1.5) above pre-industrial levels, then companies in every sector will need to play their part. This is commonly referred to as ‘net zero’ – achieving a balance between greenhouse gas emissions and absorption.
We think those companies who are leading the way in decarbonising (the process of reducing or eliminating the amount of carbon dioxide and other greenhouse gas emissions that are produced by human activities) their operations should prove to be good long-term investments.
There are three main reasons for this:
- Firstly, they should be lower risk investments as government regulation and societal action increases.
- Secondly, they should have a cost advantage as the cost of polluting rises via carbon taxes or higher prices for carbon permits. Both
carbon permits and carbon taxes are designed to encourage decarbonisation and reduce greenhouse gas emissions, but they work in slightly different ways. Carbon permits, also known as carbon credits, are tradable permits that allow companies or countries to emit a certain amount of greenhouse gases. Carbon taxes, on the other hand, are taxes levied on the production or consumption of fossil fuels based on the amount of carbon dioxide or other greenhouse gases they emit.
- Thirdly, climate leaders can increasingly benefit from “network effects”. The term network effect describes a phenomenon whereby a product or service gains additional value as more people adopt it. In this context a network effect is created as companies looking to reduce their overall emissions will seek suppliers and other partners doing the same. That leads to a virtuous circle in which being a climate leader will help accompany to win new business, putting pressure on competitors to decarbonise too.
Why do supply chain emissions matter?
Businesses who are on the front foot and take action before falling foul of regulatory change or rising penalties for causing pollution will be more sustainable from an operational and profitability perspective in the long term. The carbon emissions from a company’s operations are categorised in three different ways. Firstly, there are the direct emissions from sources the company owns or controls, such as emissions from company vehicles or boilers. These are scope 1 emissions.
Then there are the indirect emissions, known as scope 2. These are emissions from the production of the electricity or energy that the company uses.
However, to make a real impact, scope 3 emissions also need to be prioritised. Scope 3 emissions are the indirect emissions released up and down a company’s value chain. They include the emissions created when suppliers make the products/materials/components that are then provided to the company.
Scope 3 also covers the emissions created when customers use the finished product. For most companies, scope 3 emissions tend to be the largest. Therefore, companies seeking to de-risk their businesses as the world economy transitions to net zero need to focus on their supply chains. These companies will seek out suppliers who are similarly taking steps to decarbonise their operations. Those suppliers who don’t
decarbonise face losing business.
Examples: climate leaders creating network effects
In the technology sector, Apple is one such company with targets in place for carbon neutrality (achieving net zero carbon emissions by balancing existing emissions with carbon offsets) and cutting scope 3 emissions as part of that. Back in 2020, Apple’s CEO Tim Cook pointed to the ambition to drive positive network effects, saying “With our commitment to carbon neutrality, we hope to be a ripple in the pond that creates a much larger change.”
This statement is backed up with tangible action: Apple will track and audit the scope 1 and 2 progress of its suppliers, and commits to “partner with suppliers that are working with urgency and making measurable progress toward decarbonisation.” In 2022, Apple cited ST Microelectronics as an example of a major manufacturing supplier which had already committed to 100 per cent renewable energy sourcing, supporting Apple with its ambitious plan to become carbon neutral across its global supply chain by 2030.
The car industry is among those on the front line of the decarbonisation push, given the emissions generated by internal combustion engines. But reducing emissions isn’t only about making electric cars. Materials as well as fuel sources need to be considered. BMW is one automotive manufacturer looking to reduce supply chain emissions in order to meet its commitment to reduce emissions from purchased products and
services 22% per vehicle by 2030. One initiative to meet this commitment is to source “green” aluminium in which no direct CO2 emissions are created in the smelting process.
On the supplier side, metals and mining firm Rio Tinto is one that has recognised the demand from carmakers for low carbon aluminium. Earlier this year, it signed an agreement to work with BMW on aluminium car parts. Rio’s chief commercial officer highlighted the importance of demand from automakers for sustainability in the supply chain, saying “As global demand for responsibly sourced materials continues to grow, automakers are increasingly looking to partner with suppliers who share their commitment to traceability and sustainability.”
Food value chain
GHG emissions from food production account for c.26 per cent of global emissions but are often somewhat invisible to end-consumers. However supermarkets concerned about their own carbon footprint will need to act on them. For example, Tesco has committed to reduce its scope 3 GHG emissions, including purchased goods from suppliers, by 17 per cent by 2030 . In a 2021 statement, Tesco said “Emissions from Tesco’s products and supply chain make up more than 90 per cent of the retailer’s total emissions footprint … The retailer has today written to all of its suppliers to ask for their support in the transition to a low carbon economy.”
Pepsico is a food & drink supplier to Tesco that has accepted the problem in its own value chain, with a focus on agriculture, packaging and third party transportation and distribution. Pepsico said that “Combined, these three sources accounted for 78 per cent of our global GHG emissions in 2021 and meeting our net-zero goal requires that we move quickly and significantly on these in collaboration with our upstream and downstream partners from whom these emissions originate.” Pepsi have now committed to reduce their direct emissions 75 per cent by 2030 and their supply chain emissions 40 per cent by 2030.
Influencing the supply chain
Achieving these goals involves specific initiatives including working with farmers to move to regenerative farming practices, switching to recycled packaging, reducing packaging per product, and using waste product as part of the manufacturing process including turning waste potato cuttings into fertiliser for their potato crops. This example shows how network effects can spread all the way along a supply chain. Decarbonisation demands from a supermarket can encourage a food producer to examine its own supply chain. That food producer can then encourage farmers to adopt more sustainable practices.
The key thing is that the commitments to decarbonisation by downstream companies creates confidence in the supply chain that there is a market for those lower-emission products. As a result, more suppliers will realise that they too need to decarbonise their own operations and supply chains. That can then have a transformational effect on the status quo of how products are made across an industry. But the contract wins and extra revenues generated will be greatest for those who move first.
Risk warning: Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.