Even as COP26 delegates conclude negotiations, it is clear that the climate commitments launched in Glasgow will reshape the agenda for global business. Hopes were high that COP26 would be where the world delivered action on the goals of the Paris Agreement. Debate will go on about whether official talks accomplished enough. To focus only on those developments, though, is to miss the other story that unfolded during COP26, as public-, private-, and cross-sector pledges signaled that the direction of travel is toward net zero. And in hundreds of conversations in Glasgow, executives told us and our colleagues that they expect an acceleration of climate action across the real economy: at the system level, throughout industries, and within organizations.
Our conversations made something else apparent, too: net-zero commitments are outpacing the formation of supply chains, market mechanisms, financing models, and other solutions and structures needed to smooth the world’s decarbonization pathway. For businesses, these conditions will create opportunities to innovate and to lead coordinated action by industry peers, value-chain partners, capital providers, and policy makers. They also introduce added risk that commodity prices will spike. With these opportunities and risks in mind, we offer a look at five fundamental considerations that can help executives define an effective net-zero program for the next few years.
Commitments to systemic change mean that net zero is now an organizing principle for business
Coming out of COP26, many observers will focus on whether the commitments made there imply a temperature increase of greater than 1.5°C. That analysis is important; it helps show how much more must be done to cut emissions and adapt to warming. For executives, it also matters that the aims of countries and companies are converging on 1.5°C targets. The net-zero imperative is no longer in question—it has become an organizing principle for business.
Why do we say so? Because many of the net-zero commitments made in Glasgow came from coalitions of the stakeholders—governments, financial institutions, companies, multilateral organizations, and others—who must participate if systemic problems are going to be solved. For example, the transition to clean shipping would require customers to request the service, shipping companies to invest in vessels that run on zero-emissions fuels, fuel producers to make more of those fuels, and banks to provide capital for these endeavors. And when these activities are coordinated, they shift the entire operating context for companies.
CEOs can get ahead of such shifts by joining coalitions that exist now, such as the Mission Possible Partnership. COP26 also saw new commitments from groups such as the Glasgow Financial Alliance for Net Zero (GFANZ). CEOs who see a pressing and unmet need for cross-sector effort may wish to organize a coalition. They might also choose to engage the public sector in setting rules that favor a more orderly net-zero transition.
Companies can gain advantage from translating net-zero pledges into net-zero plans
In many instances, net-zero commitments are running ahead of companies’ own plans to meet them. Relatively few businesses have yet to make clear, detailed plans for how they will achieve net zero. That must be what leaders focus on now; investors and regulators expect them to do so. UK chancellor of the exchequer Rishi Sunak reiterated at COP26 that the Treasury would require UK-listed companies to release net-zero plans by 2023. It is only a matter of time before regulators and supervisors elsewhere follow that example.
Until then, leaders who put convincing net-zero plans in place can distinguish their companies from peers. To put that another way: the basis of competition has changed, and there is now a premium on sound net-zero planning and execution. Such plans will vary in their specifics, of course, but well-formed ones will feature certain elements:
- emissions targets for Scopes 1, 2, and 3 (the hardest to meet); these should include long-term targets, as well as near-term goals for 2025 and 2030, all aligned with science-based mitigation trajectories or sector-specific trajectories from credible authorities
- a strategic view of climate risks and opportunities for each part of the company’s portfolio, covering both competitive dynamics and environmental exposures
- an assessment on the spending of transition capital that will be required to reduce emissions, especially from existing emissions-intensive assets, coupled with a credible stance on the use of high-quality carbon credits
- a program for building capabilities to monitor external conditions, make decisions about how to update the company’s plan, and implement it
Plans take time to prepare—but business conditions are changing quickly, as we explain below. Companies should not wait to act. Most can make no-regrets moves even while drawing up their long-term agendas. Start with straightforward moves that are sure to generate value; investing in energy efficiency, for example, usually does.
Explaining the company’s plan to stakeholders is important, too. Leaders will want an investor-relations and external-engagement program that puts the company on the front foot by explaining how they see the future, what they are doing now, and what they will do next.
The money to finance the transition is forming; markets and institutions are needed to channel capital
Financial institutions have been at the forefront of the drive to net zero, and they continued leading at COP26. GFANZ brought together more than 450 institutions, representing $130 trillion of financial assets (40 percent of the global total), that promised to align their portfolios with net-zero goals. To put that in perspective, McKinsey analysis indicates that a net-zero transition would require $150 trillion of capital spending, two-thirds of it in developing economies. While there is justifiable debate about what the GFANZ pact might mean in terms of capital investment—and far more capital will probably be needed—the commitment shows that capital is starting to form.
Deploying sufficient capital quickly enough to achieve net zero is now the challenge. At a system level, focus should be on scaling markets and institutions that can channel money into decarbonization and adaptation. This involves scaling voluntary carbon markets, restructuring multilateral development banks, developing country platforms, and creating futures markets for green commodities.
At the company level, leaders will need capital to decarbonize their holdings and to build businesses that serve the growing markets for zero-emissions goods and services. Companies that own carbon-intensive assets might work with financial institutions that have net-zero goals on securing funds to retrofit or retire these assets responsibly. Except when dealing with the most carbon-intensive assets, this approach may deliver greater emissions reductions than divesting assets or taking them private.
Securing green(er) materials will mitigate risk amid shortages and price volatility
Extreme weather won’t be the only climate-related threat to supply chains in the years ahead. One consequence worries many: as demand increases for materials with low emissions intensity, such as green steel, production capacity may not expand quickly enough to keep pace, at least in the near term. For example, McKinsey analysis suggests that shortages of high-quality iron ore could constrain production of zero-emissions steel.
Or consider potential shortfalls in the supply of climate technologies. Zero-emissions trucks are one example. A report from Road Freight Zero, a cross-industry coalition that is part of the Mission Possible Partnership, and McKinsey indicates that projected growth in sales of zero-emissions trucks in Europe won’t be enough to put the continent’s road-freight sector onto a 1.5°C pathway.
Executives will want to prepare now for tightening supplies and for upward pressure on their costs. Some businesses are locking in purchasing contracts for commodities such as green steel. It may also be possible to hedge the gap in price between conventional materials and zero-emissions substitutes—though this would require trading capabilities that few companies outside the financial sector now possess.
For makers of steel, cement, and other materials, growing demand for zero-emissions goods constitutes an opportunity, which can be met only if they decarbonize their base of installed assets. Doing so will take significant capital, as noted above, as well as technology and time. Until these companies actually achieve net zero, they might pursue other ways of satisfying customers’ demands for green materials. One stopgap approach involves securing high-integrity carbon credits from nature-based projects.
Measurement and disclosure are unavoidable; using digital to create cost and price transparency can have benefits
Financial institutions and governments are asking companies to disclose more information about their exposures to climate risks and their climate-action plans. A company’s first impulse may be to disclose only the required minimum, but it can be beneficial to describe performance more openly. This would involve closer monitoring of value chains—an approach that digital technology can enable. The experience of leading companies suggests that sustainability management will be the next frontier for digital transformation.
Distributed sensing and computing technologies lend themselves well to value-chain management—and lowering emissions represents one of the thorniest value-chain issues we have witnessed. At each point in a company’s value chain, cost increases could result as suppliers and business partners reduce their emissions. Digital systems for tracking and tracing goods could help reveal where emissions are concentrated so that companies can take steps to lessen them.
Digital technologies also have powerful applications within a company’s own operations. Research by McKinsey and the World Economic Forum on 90 technically advanced factories around the world shows that digital transformations had boosted sustainability performance at roughly two in every three facilities.
Investments in resilience can protect people and companies from physical climate hazards
Further warming will have physical consequences, and warming is set to continue. The Sixth Assessment Report of the Intergovernmental Panel on Climate Change concluded that further changes to the Earth’s systems are locked in, no matter how much more warming takes place. What’s more, multiple climate-modeling efforts based on COP26 pledges suggest that continued warming will raise temperatures to more than 1.5°C above preindustrial levels.
The physical hazards posed by climate change have manifest humanitarian impacts. For example, in scenario-based analysis for Race to Resilience, a campaign led by the UN High-Level Climate Champions, McKinsey found that in a 2.0°C world, roughly a billion more people would be exposed to climate hazards than in a 1.5°C world. In a scenario where 1.5°C of warming occurs by 2030, almost half the world’s population could be exposed to a climate hazard related to heat stress, drought, flood, or water stress. And compared with high-income nations, lower-income countries have larger shares of the population that are likely to be exposed to at least one climate hazard.
Companies, too, could experience more frequent interruptions as physical risks from climate hazards increase. But by building greater resilience, they can improve their ability to maintain business continuity—which can be a source of confidence, not to mention competitive advantage. Indeed, using the same warming scenario described above, the McKinsey Global Institute estimated that downstream electronics companies could lose up to a third of annual revenue if their supplies of chips were disrupted for five months.
Notwithstanding any debate about whether COP26 was a success, the general direction for business has been established. Momentum has shifted toward net zero, providing businesses with a new organizing principle. The transition to net zero will be complicated. The best leaders can hope for is that it will be relatively orderly, rather than punctuated by sudden, unexpected shifts. And in any case, the basis of competition will change as stakeholders reward companies that exhibit high levels of preparedness—not for sheer strategic uncertainty but for the bounded volatility that the transition is certain to bring.
Courageous leadership will therefore help companies navigate the transition. Leaders will need to cut through the noise and articulate a North Star for their company’s future, supported by a detailed plan to get there. Focusing on the five fundamentals described in this article can help them achieve the clarity of thought that will be required to plan effectively.
