Who will pay to make companies carbon neutral?
California is expected to require corporations with more than a billion dollars in revenue to disclose their full greenhouse gas emissions, including the upstream emissions generated by their suppliers and downstream emissions occurring in the distribution and use of the company’s products or services. These are collectively known as scope 3 emissions and often account for the vast majority of the emissions for most companies.
The Securities and Exchange Commission (SEC) is working on a proposal requiring climate-related disclosures by public companies. While the initial SEC rule might not go as far as requiring disclosure of scope 3 emissions, there is no question that the future for large public companies will involve disclosure and scrutiny of their climate risk.
As challenging as it may be for many companies to accurately account for and report out their annual emissions, disclosure is just the first step. Once companies establish their baseline emissions and begin publishing their annual inventory of emissions, their climate risk will be assessed by investors — and perhaps even regulators at some point — based on their year-to-year reductions in emissions.
Companies can cut their emissions in principle by switching to renewable energy, increasing energy efficiency, electrifying manufacturing processes that currently consume fossil fuels, replacing conventional vehicles with electric vehicles, and so on.
While each of these steps will require some investment and resources, reducing the emissions generated by a company’s direct use of fuels and electricity (known as scopes 1 and 2) is easier than cutting the much larger amounts of scope 3 emissions that occur outside of the company’s control. Only the largest companies might have enough leverage with their suppliers to be able to set emission reduction targets for them. Even when suppliers are amenable to the idea of cutting emissions, it can be a difficult and expensive proposition for many of them. Global supply chains with suppliers located in multiple countries add to the complexity of managing climate targets.
This is where carbon offsets come in. The rapid growth of the voluntary carbon offset market suggests that many companies are finding it easier to purchase carbon credits to offset their emissions than to implement emissions reductions across their supply chains. But high-quality offsets are not inexpensive.
The cost and quality of carbon credits can vary widely in the voluntary market, with the cost of nature-based offsets (which utilize forestry and agricultural projects to capture and store carbon) currently averaging about $15 per metric ton of carbon dioxide equivalents. Higher quality offsets generally cost more, with $100 per ton being the threshold below which carbon dioxide removal (CDR) technologies are considered commercially viable.
Calculations based on data from the Environmental Protection Agency’s environmental model of the US economy show that the $15 price point for carbon offsetting translates to anywhere from 0.5% to 3% of gross revenue for companies in consumer sectors such as food, clothing and personal care products. As the demand for carbon credits grows and buyers chase a limited supply of high-quality credits, the share of gross revenue needed to make a company carbon neutral will likely increase.
Shareholders are increasingly demanding that companies come up with credible steps for addressing their climate impacts and climate risk. If carbon offsetting is the very first step in making a company climate friendly, then shareholders may have to accept that the cost of carbon neutrality is a non-trivial impact to the company’s bottom line.
Consumers are the other group that has skin in this game. They want to know that the products they consume are climate friendly and are increasingly willing to make choices with their purchase dollars. The problem so far has been a lack of information about the climate credentials of companies producing consumer goods. As new climate rules kick in and the information barrier diminishes, consumers will finally have the tools they need to support the companies that are climate leaders. But would they be willing to pay slightly higher prices in return for products that have no net climate impacts?
Most companies will see a real and quantifiable cost to achieving carbon neutral status, and perhaps even more to actually reduce emissions. As climate disclosures and risk assessments become mainstream, the question that will need to be answered is who will ultimately pay for reducing or neutralizing a company’s emissions.
