Addressing the Cost of Corporate Climate Plans
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More corporate leaders are taking a long-term view on the energy transition and treating climate change as a business risk requiring a discrete strategy.
The latest BMO Climate Institute Business Leaders Survey found the share of U.S. companies with climate mitigation plans rose sharply to 38% from 28% in the previous survey. Furthermore, the share of U.S. decision makers who say their company is better run by addressing climate change rose six points to 33%.
However, financial costs associated with forming and implementing climate strategies are a persistent source of concern. In the survey, costs are the most frequently cited barrier to executing a climate plan. Of course, every company, large or small, must manage costs. It will also be increasingly necessary for executive and board management to balance costs against achieving energy transition milestones in a timely manner.
McKinsey had estimated that capital investment to reach net-zero emissions would need to rise to $9.2 trillion annually over the next three decades.1 That represents an exponential increase over current investment levels. In 2023, global investment in the energy transition rose 17% to a record $1.8 trillion—still well below where it needs to be.2
Why is the cost of forming and implementing a climate strategy getting more expensive?
The costs associated with climate mitigation and adaptation vary by industry and by company. However, BMO’s research suggests a broad perception that setting in place a climate plan is getting more expensive. Let’s explore the perceptions and some underlying factors of this reality. Two factors may be contributing to these rising perceptions.
Expectations for more disclosure requirements
First and foremost is the increasing cost of climate risk disclosures. Reporting key metrics used to be voluntary, where companies would disclose metrics on their environmental impact and exposure to physical risks with good intentions.
However, this has changed in the past few years. Standards have become a regulatory requirement in the European Union, U.S. and other jurisdictions. This shift will necessitate acquiring deeper legal and regulatory expertise, corporate finance controls, and use of external assurance on key climate risk metrics.
The U.S. Securities and Exchange Commission adopted final rules in March, requiring companies to disclose material climate risks as well as provide explanations in financial reports on what they are doing to mitigate or adapt to them.
Complexity of climate impact
A second factor is that as more companies progress on their sustainability journey, they realize how deep and complex the impact of climate change is. Let’s think about it for a minute. Companies may operate in different locations and have multiple product lines. Climate risk mitigation potentially requires significant changes to physical operations, business processes, manufacturing processes, sourcing and supply chains.
To manage this complexity, sustainability mandates can no longer be siloed and require more management and board oversight. Each corporate area will require some level of sustainability expertise, necessitating new hiring and resources with relevant technical skills and competencies. These add to cost considerations, in addition to expenditures related to new technology adoption and shifting product mixes to become more sustainable.
Will costs keep rising as more business leaders implement climate action plans?
As more companies take further climate action, they will prioritize acquisition of low or zero-carbon alternatives for power, fuel, raw materials, services, and their transportation and distribution footprint. This demand signal should help mobilize additional investment in the resources and value chains producing low-carbon solutions.
"In turn, the increasing scale of direct investment in clean energy solutions, along with government measures to encourage conservation and energy efficiency, should over time drive down the cost of implementation.”
The green premium
We use the “green premium” as a concept to illustrate the price difference of choosing low-carbon options. Bill Gates, philanthropist and founder of Breakthrough Energy, has articulated how essential it is to increase demand for low-carbon solutions even if it means paying a premium in the short-term. For example, Breakthrough Energy estimates that the green premium for a ton of steel produced with carbon capture technology to mitigate carbon pollution is 16% to 29%.3
An example perhaps many of us can relate to is electric vehicles (EVs). While passenger EVs are still selling at a premium to internal combustion engine cars, their prices fell some 22% in the past year as production and market penetration have increased.4 Price parity is getting closer in some segments of the market, showing how supply and demand dynamics can compress green premiums. It is also important to keep in mind the overall cost of ownership of an asset when comparing green alternatives with incumbents.
What’s to prevent some companies from putting off climate strategies until green premiums shrink?
We realize many companies may need upfront capital for continuous and accelerated improvement in their decarbonization efforts.
“Consider that beside EVs, green premiums have come down significantly and even reached cost parity for other technologies and alternatives, such as solar panels, heat pumps, and renewable natural gas.”
In addition, new innovative payment models and financing vehicles, such as “pay as you go” or “pay as a service,” have emerged that spread acquisition costs over time and reduce ownership risk.
The real estate industry has examples of achieving cost efficiencies with low or zero-carbon solutions when considering the long-term horizon of new investments. Among U.S. real estate professionals, 80% say the top benefit of green building activity is lower operating costs.5 On average they expect retrofitting buildings for energy efficiency will result in a 13.5% reduction in operating costs one year following implementation and an 18% reduction after five years.
What’s entailed in the decarbonization journey of companies?
We have talked a lot about a decarbonization journey, so what is involved? As the eighth-largest bank in North America, BMO supports a wide range of commercial banking customers and their sustainable investment needs. We aspire to be their lead partner in the transition to a net-zero world, and we see the process that many companies take to reduce their emissions as part of a climate strategy. While every company is different, these are best practices at a high level.
Early in the journey
Many companies have yet to form a climate strategy or publish a sustainability report. The foundational work for them often involves establishing environmental impact and focus with input from different stakeholders. For companies at this stage, we help them by gathering insights about the energy transition and related risks and opportunities in their industries, as well as examples of corporate climate actions and technology-based decarbonization approaches.
Once focus areas are defined, the priority becomes forming a baseline of key metrics including carbon emissions and mapping their sources, both of which are critical to understanding the environmental impact of the company. This assessment, depending on organizational complexity and operational scale, may take between six months to two years.
As the saying goes, you cannot manage what you cannot measure. Carbon accounting tools, such as BMO’s Climate Smart, can help companies baseline emission sources, help reduce emissions with quick-hit actions, improve energy efficiency, and reduce operational costs.
Mid-way in the journey
Once companies have established a formal climate strategy and have a strong handle on their emissions data, they can set annual goals to improve key operational metrics.
Companies at this stage may consider new technology solutions related to manufacturing and sourcing or distribution and transportation to help achieve their goals. They typically seek longer-term contracts, such as power purchase agreements for commercial solar, financing for commercial EV fleets, or scaling logistics solutions. Senior finance decision makers would become more involved, as companies form their medium and long-term financing roadmap for sustainability.
Companies may also at this stage of their journey explore sustainable finance vehicles available for their green investments or in support of their decarbonization goals that can provide differentiation on the cost of capital.
Advanced in the journey
Companies that are at an advanced stage look beyond their operational improvements and consider product line changes and bringing new products to market to lower their emissions intensity. Companies at this stage may work collaboratively with their top suppliers to reduce product and materials emissions, making decarbonization investments in their supply chains, and/or using carbon credits to offset remaining emissions.
Realistically, meeting corporate climate commitments will often be a multi-year or decades-long effort, requiring significant investment and capital expenditures. Nonetheless, we would like to see every company, no matter where they are on their sustainability journeys, have a positive environmental and social impact.
1 How big business is taking the lead on climate change. (7 mars 2022). McKinsey & Company.
3 Where to innovate first: the green premium. (6 février 2024). Breakthrough Energy.
4 Grieve, P. (10 janvier 2024). The average electric car is 22% cheaper than a year ago. Money.
5 Dodge Construction Network. (2021). World Green Building Trends 2021.
