How CEOs Can Win in a Carbon-Regulated World
Posted on January 6, 2010 |
Guest-blogging today are two partners with Bain & Company, Jorge Leis and Peter Parry. Leis is head of Bain's Americas Oil & Gas Practice while Parry is head of the firm's global Oil & Gas practice.
The heat generated by heads of state in Copenhagen rises from the noisy debate over how their countries can build carbon competitiveness. But CEO’s confront a different question: How can I use carbon-competitiveness to gain an edge over my competitors? The right answer can ensure the longevity of a company in an increasingly regulated world. Answering wrong—or worse, ignoring the question—could lead to a company’s extinction over time.
Most CEOs get the big picture on carbon competitiveness. Many attend industry forums and contribute their perspectives to the development of government policies. Many CEOs also track how green their company is, but mainly in terms of compliance with regulations, avoiding negative publicity from activist organizations, or branding products and services to appeal to eco-conscious customers. Few CEOs take a close look at their rivals and try to beat them at carbon competitiveness—by identifying the relative strengths and weaknesses of their carbon footprints.
In reality, the battle over carbon competitiveness is no longer simply a national issue, or even an industry issue: Increasingly, it’s a battle that pits one company against another. Across industries, the relative size of a company’s carbon footprint will define one of its key competitive advantages. Consider utility companies for example. At the industry level, even a modest regulatory regime for CO2 emissions will result in annual liabilities well in excess of current profits for all companies. But within the industry, some power companies will be much better positioned due to more efficient operations. Florida Power & Light Company, for example, produces 2.14 MT CO2 per 1000 MW of installed capacity, and Entergy just 1.71 MT CO2. By contrast, many large utilities exceed 5.5 MT CO2 per 1000 MW of installed capacity.
Most companies are vulnerable to carbon exposure in one of two ways: from direct emissions, that is, carbon emitted by production assets during operations, or from indirect emissions, carbon emitted by the products they manufacture. In a carbon-regulated world, utility companies are more vulnerable to the amount of carbon they emit directly from generating power; automobile manufacturers, on the other hand, are most vulnerable based on the indirect emissions from the vehicles they produce. As demand shifts towards more fuel-efficient vehicles, some companies are better off than others. Under the CO2 regulatory regimes proposed so far, automakers such as Toyota and Honda have an advantage because they make the lowest-emission vehicles.
One challenge for most CEOs is that the problem of managing carbon competitiveness is rooted in the past. Historically, companies acquired productive assets or built product portfolios under an older less-regulated environment. Today, within the same industry, each company has a distinct carbon footprint—usually to manufacture the same product or deliver the same service. In such an environment, carbon regulation does not affect each company within an industry equally; instead, it has the potential to alter the rules of competition. A firm’s competitiveness within an industry is determined by legacy assets and products that are more CO2 intensive than those of their competitors. Alternatively, a company that has lower CO2 exposure than its competitors has a chance to dramatically strengthen its position within an industry.
In the power generation business in the US for example, Florida Power & Light, Progress Energy and Entergy are well-positioned to adjust to CO2 regulations because they produce power through “cleaner” production assets. For these companies, CO2 regulations are likely to improve their relative cost position, and in certain deregulated markets such as New York and Texas, improved cost position can translate into expanded market share. On the other hand, companies that rely more on coal-fired power plants are likely to see their relative cost position worsen over time. If the carbon tax rises to more than $60 per ton, for instance, the operating costs of some large utilities in the US could increase by between 70 percent and 90 percent.
Or, take oil producers: As a group, they are vulnerable to policies that place constraints on carbon emissions. But when we compared the quantity of CO2 emitted by six different oil firms from extraction to refining, we found substantial differences between companies. The most CO2 intensive of the companies that we studied emit more than twice the quantity of CO2 as Exxon Mobil, the industry leader, for every barrel of oil that they bring to market. We found that the difference is mostly due to upstream operations. These companies have substantial holdings in unconventional fields that require many pre-refining steps. That results in large quantities of fuel being burned, and that in turn, leads to relatively higher CO2 emissions per barrel sold. At a $60 per ton CO2 price, these producers would face about an $8 per barrel tax while the industry leaders in terms of carbon efficiency would face only about a $3.5 per barrel tax.
Understanding the new balance of carbon competitiveness is the first step. Adjusting to that reality by repositioning a company with less competitive legacy assets and products can take several years. The scale of change may seem overwhelming, but for many companies, a good starting point is to take stock of how the company is currently consuming energy—and then identify the alternatives that could help reduce emissions. Most companies prefer to pick the highest-return options based on the potential reduction benefits and the costs to achieve those benefits. But even a quick review often points out changes that will help companies reduce the cost of carbon emissions. Often, these are hiding in plain sight; sometimes, they require more evaluation to uncover. By building carbon competitiveness into their strategies and taking steps to shrink their carbon footprints, companies can get ahead of the competition.
