Corporate net zero is a heavy lift - emission reduction pools could help

The idea of net zero is only about a decade old and followed the IPCC report which stated in 2013 that net anthropogenic emissions of CO2 would have to reach zero in order to eventually stop global warming. Between 2015 and 2020, countries like Sweden and the UK incorporated midcentury net zero targets into law. Today net zero pledges cover 91% of the global economy and 2050 is the universal target year by which all of these pledges must turn into actual net zero emissions. But getting to that endpoint or even to the near-term target of 20–40% reduction in the next decade is a heavy lift for many companies.

Going from planet-level to country-level net zero emissions

The IPCC report was referring to net emissions for the planet as a whole. Major greenhouse gases such as CO2 and methane are well-mixed in the atmosphere, and thus a unit of emission reduction or carbon removal anywhere in the world contributes equally toward the net zero target. This was the logic behind the original Clean Development Mechanism, which allowed industrialized countries to meet their emission reduction targets by funding projects located in developing countries where the cost of carbon abatement might be lower.

The Paris Agreement includes a similar market mechanism in Article 6.4 that countries can use to trade emission reduction credits. A classic example is where one country benefits from switching to more abundant clean energy while another country gets credit for the emission reductions by financing that energy transition. The IETA estimates that trading in carbon credits could reduce the cost of meeting national targets by $250 billion per year by 2030 (provided of course that these reductions meet additionality and other criteria). A carbon trading regime creates a pool of countries with a larger menu of emission reduction options compared to individual countries.

How the corporate net zero problem is framed today

The economics of emission reductions are well understood and have been a part of international climate agreements for decades. But this logic hasn’t extended to companies and organizations.

Lacking a universal cap-and-trade scheme, many companies are now setting emission reduction targets in a silo using the net-zero standard from the Science Based Targets initiative (SBTi) with no clear path to achieving those reductions. As much smaller entities than countries, companies naturally have fewer ways of reducing emissions and a significantly reduced ability to finance those reductions. Since the standard requires emission reductions to occur within a company and its value chain — with carbon credits used only to neutralize residual emissions of 5–10% — there is no pooling effect here analogous to what we might have at the country level.

So, what can companies do to meet this target? They can of course electrify heating and transportation, become more energy efficient, switch to renewable electricity that meets additionality criteria, etc., within their own corporate boundaries. These steps could address their scope 1 and scope 2 emissions, which are typically not more than 10–15% of total emissions.

Scope 3 emissions dominate the greenhouse gas inventories for companies that depend on supply chains to produce and distribute their products. Scope 3 reductions will have every company looking up and down its value chain and often finding very few ways to make big cuts. Companies generally use secondary data to model purchased materials in their emissions inventories because primary data from suppliers is hard to come by. This use of industry-average or typical data makes it difficult to choose between different suppliers with any confidence that scope 3 emissions would decline as a result. Even if the data problem could be fixed, simply switching between suppliers is unlikely to lead to immediate and additional emission reductions.

Can companies work with existing suppliers to reduce upstream emissions? Actual experience with consumer product companies of all sizes suggests that it is challenging to even identify the exact source and production methods associated with most of the raw materials and ingredients sourced by these companies, let alone reduce the emissions associated with the sourcing. A case in point is the effort by some of the world’s largest food and beverage companies to reach net-zero deforestation in their supply chains by 2020, which produced decidedly mixed results. Mars, one of the largest users of cocoa, was able to trace only 43% of its cocoa to specific farms after a decade of effort. In the meantime, agriculture-driven deforestation continued in the tropics with a 12% year-over-year increase in 2020.

For companies in the retail sector that source most of their non-food merchandise from countries like China, greening the supply chain depends so much on the climate and energy policies of those countries. Scope 3 emission reductions are largely dependent on how fast those countries transition to renewable energy and electrification. Downstream emissions in the distribution and use of a company’s products are generally not actionable at all except by radically redesigning those products to minimize energy consumption in refrigeration, cooking, and other product use.

The final barrier for most companies embarking on the net zero journey is cost. Emission reductions, like anything else in business, are not free and will require investment. While carbon credits play only a minor role in the SBTi net zero standard, companies — at least in the near term — are scouring the carbon offset market to find good quality credits at an affordable price. This is an indicator that their internal cost of carbon abatement is higher than the market price of offsets at the present time, and therefore the cost of making a company carbon neutral through offsets can be seen as a floor for the cost of net zero.

At a modest price of $15 per tonne of CO2 equivalents, the cost of full carbon neutrality ranges anywhere from 0.5% to 3% of gross revenue for companies in consumer sectors such as food, clothing, and personal care products. This will only increase as the demand for carbon credits grows and buyers chase a limited supply of high-quality credits. The cost of carbon neutrality — and net zero in the long run — will be a non-trivial impact to a company’s bottom line and a significant business risk if it is not proactively addressed.

Is there a viable path for companies to reach net zero emissions?

Given the intractability of reducing scope 3 emissions — which typically make up upwards of 85% of total emissions for many companies — and the fact that emission reductions will require real investments, it is fair to ask if there is a viable path for most companies to get to a sizable emission reduction in the next decade and reach net zero by 2050.

Companies could always benefit from larger changes in the economy. Depending on the implementation of the Inflation Reduction Act passed last year, the US as a whole could see a 40% reduction in emissions by 2030 (relative to 2005 levels) through incentives in areas like cleaner electricity, electrification of transportation and heating, carbon capture technologies, and hydrogen fuels. These incentives could help pay for a part of the scope 1 and scope 2 reductions for many US-based companies as well as some scope 3 reductions if suppliers are located within the US. But supply chains are global in many cases and companies that are serious about their net zero targets will need more definitive tools to help them get there.

Collaboration could be key to reaching net zero targets

One way to find a path forward is to discard the model of companies working on emission reductions in silos of their own and revisit the proven logic of creating large pools of participants. Companies could form consortiums in order to create and expand emission-reduction pools, with standards-based commitments to reduction targets for 2030 and 2050. Consortiums could be regional, national, or even international — the geographic locations of member companies would not matter.

Member companies would cap their total emissions in alignment with consortium-level targets and then trade verified emission reduction credits amongst themselves, effectively seeking the lowest-cost emission reduction pathways within the consortium. Companies that are able to exceed their reduction targets could monetize the excess reductions by making those opportunities available to fellow members. Other companies could buy these credits if they are unable to cut emissions on their own at a lower cost – just like how countries can meet their targets at the lowest cost by trading carbon credits.

Companies would also be able to use insetting projects within their organizations or supply chains to both meet their own reduction targets as well as generate credits for sale to other members. If companies across the supply chain join a consortium, that would enable sharing of primary data between companies and potential supply-chain optimizations that would otherwise be difficult to undertake.

Ideally all annual company-level emissions inventories and emission reduction calculations within the consortium would be done using a common set of tools and protocols. The same group of internal or external experts would run the calculations for all companies, and another independent group would conduct peer reviews. This would increase standardization and transparency while alleviating the reporting burdens on member companies.

What if a consortium needed an infusion of lower-cost credits to help members meet their targets? The combined purchasing power of the consortium could be used to fund vetted carbon removal projects in parts of the world where it makes economic sense. Member companies would simply buy into these projects and pay for verified carbon credits. This also means that net-zero standards would need to provide more flexibility around the use of carbon removal credits for meeting targets.

Consortiums could also address the procurement of renewable electricity, which is often a poorly understood tool. Purchase of renewable energy certificates is easy but does not provide any guarantees of additionality. Consortiums could use their size and purchasing power to directly negotiate power purchase agreements (PPAs) for procuring renewable energy in bulk, which would allow member companies to address their scope 2 emissions with more confidence. A concrete example of this is Walmart’s renewable energy accelerator known as Gigaton PPA which puts together aggregated PPAs that Walmart’s suppliers can participate in. Suppliers will eventually be able to claim scope 2 emission reductions as the PPA projects are implemented while Walmart will benefit from the aggregated scope 3 emission reductions as a result.

In addition, consortiums could trade verified carbon credits with other similar groups, dramatically scaling up the effective size of the pools and the available emission reduction opportunities. Management and governance of the consortiums would of course need care and attention.

How much of a paradigm shift is this?

The paradigm shift I am proposing here is that most companies would no longer work toward net zero on their own but would collaborate with other companies — big and small, in the same or different industries — to tackle a huge, common, and previously intractable problem. This is not a new paradigm for reducing emissions — it has been tested and proven at the country level dating back to the Kyoto Protocol. In the absence of a global cap-and-trade scheme, adapting this model to create large pools of companies voluntarily working together to achieve net zero could be a practical and viable solution, but one that has been largely overlooked so far.

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