Joined-up opportunities for forerunners in energy transitions

This is part 2 of a two-part series on the energy transition. You can find part 1 here.

Introduction and preamble

Being a forerunner can seem daunting and risky, but it can also be smart business, smart policy and smart politics. In turn, this can accelerate energy transitions to the broader benefit of everyone.  

In Part 1, I highlighted structural reasons why individual transitions “take-off” at pace once initiated, the role of forerunners in catalysing this, and the under-appreciated economic potential of being such a pioneer. In this part, I highlight a specific focus area for would-be pioneers that is potentially very attractive but remains under-recognized.

It is already an important step towards deciding to invest to be a forerunner to simply appreciate that take-offs will occur at some point and that this will create value-generating opportunities. However, of course, general appreciation is insufficient to justify specific investments, and actual opportunities need to be developed in granular detail. For energy transitions, this will inevitably involve a degree of alignment across non-traditional boundaries, whether public-private or between business sectors.  

An aspect of being a pioneer is, in reality, developing such alignments e.g., as Tesla did with battery suppliers and premium vehicle-driving IT enthusiasts or Orsted with turbine manufacturers, offshore installation companies, and government policy-makers. The alignment of offerings with the interests of target customers is particularly critical. In fact, orchestrating alignments can be one of the most powerful means of securing the competitive advantages that generate value for pioneers. On the other hand, poor alignments lie behind many disappointments for would-be pioneers. 

The significance of premium markets

A critical feature is aligning the financial arrangements that enable the prospect of early-stage profitability or just simply breaking even for pioneer businesses – the “quick wins” that motivate investment. A significant challenge, however, is that many of the emissions-intensive, hard-to-abate activities in the economy are in business sectors that are highly commodified, competitive and globalised, such as steel and cement manufacture. The actions required to reduce the emissions in these sectors are now relatively well-understood but these bring cost increases of, for example, 50-100% that simply cannot be recovered readily from their customers in globalised commodity markets. Premium markets are required to fund and reward decarbonisation in these sectors.

There is, however, some light in the darkness. As you look down supply chains toward end-user activities, there are clearly premium markets that can be sustained.  For example, consumers that can afford it are willing to pay for premium passenger cars or personal-care products at prices well above raw manufacturing costs. Profitable businesses that successfully provide such premium products have established value-generating competitive strongholds that are worth far more than the underlying costs and capital involved, and are strongly motivated to defend these through innovating improved value propositions to customers. Indeed, such premium markets also create economic space for disruptors to flourish through innovation despite the high costs they may initially carry, as seen with Tesla originating the “computer on wheels” premium electric car in California.  

Indeed, although helped by supportive environmental policy, this battery-electric vehicle example wasn’t actually motivated by considerations of emissions-reduction or energy transitions at all but, nevertheless, initiated the take-off deployment of a key technology that is indirectly bringing these benefits. As a more direct example of targeted decarbonisation, premium vehicle supplier Volvo Group is partnering with steel producers SSAB and Ovako to produce “green steel” for some of the vehicles it manufactures, with an eye towards providing either an attractive new proposition for its customers or being prepared for future regulations that may require this.  

The main point, however, is that even though it is much more expensive than “commodity steel”, using fully “green” steel will increase the manufacturing cost of a typical car by only about 2% or ~$500. This is well within the range of discretionary choices people make when making such a purchase e.g., by upgrading seat coverings or wheel hubs. With about 16% of all steel heading towards the overall automotive market, there is plenty of room for the premium vehicle sectors to be innovative by including green steel within value propositions that are attractive to their customers and, in this way, create a substantial initial demand for the cleaner product.  

Looking back up the supply chain, therefore, attractive and innovative propositions can motivate end-users to fund premium vehicle manufacturers, who can thereby be motivated to pay premia to low-emissions steel producers, who can thereby be motivated to pay premia to low-carbon iron-ore suppliers, etc. This arrangement can work to fund the initial decarbonisation of hard-to-abate activities upstream in supply chains through finance flowing from premium downstream activities. Over time, of course, the take-off in the volume of activity will drive many costs down learning and mass-production curves, steadily enabling more low-emissions activity to spread beyond the initial limitation to premium markets. The premium segment opens the path to mass markets.

Identifying attractive markets

So which markets have the best potential to be engines for such premium value supply-chain transformations? The focus should be on companies that have been able to generate market value well in excess of capital employed and so must have premium competitive strongholds they wish to sustain. With such advantages, many of these companies will have grown to become large enough to join indices such as the S&P 500. Within this index, the non-financial sectors with the highest percentage of so-called “intangible assets” are healthcare including pharmaceuticals; information technology and communications; industrials including construction and professional services; and consumer sectors including fashion, personal care, restaurants and hotels, food retail and automotive. These are all areas that can touch individual people very closely and have important brands and networks to sustain.  

It is also important to recognise which supply chains have the biggest impact on emissions. While there are any number of supply chains in the global economy, just eight are responsible for over 50% of greenhouse gas emissions. The Food supply chain makes the largest contribution currently, largely because of the land-use changes that the industry generates. After this comes Construction, Fashion, Fast-Moving Consumer Goods (FMCG), Electronics, Automotive, Professional Services and (other) Freight.

What is striking is the overlap of these two lists. There are clearly multiple sweet spots with opportunities for premium end-user markets to be developed that can channel funds to motivate upstream supply-chain decarbonisation activities with substantial impact. At the heart of this is the recognition that zero-emissions supply chains will only increase the end-user cost of vehicles, fashion, food, buildings and electronics by less than 2-4% (e.g. $1 on a pair of jeans), that this can be absorbed within premium market sectors, and that this can finance initial decarbonisation activities within even hard-to-abate sectors in the supply chain.

The urgent challenges now are to build the supply chain alignments that actually function in this way, working back from premium offerings to the end customer. Pioneers in each of the relevant segments should be reaching out to each other to achieve this and, in doing so, also securing the initial competitive advantages that will subsequently generate enhanced economic value for themselves. This should all be possible and attractive within the private sector straight away without waiting for changes in government policy. When they do arise, however, supportive government policies will simply enhance the rewards for forerunners and further accelerate take-off.

Developing new partnerships

Various sector-specific coalitions have been performing very important work together in assessing effective ways to decarbonise activities within their sector, for example the Global Cement & Concrete Association (GCCA). Because many energy-using technologies are sector-specific, this has been a critical enhancement to the previous types of climate-related deliberations which were largely aggregated at the national level because of the nature of processes convened by the United Nations. While national government deliberations do still remain important because regulatory jurisdictions and policy-making largely occur at the national level, it has been a critical enhancement over the past several years to adopt sector-specific perspectives. This has generated a deeper appreciation of the specific technical requirements to decarbonise different sectors, particularly the harder-to-abate heavy industrial and heavy transport sectors.

The next enhancement to alignments and deliberations now required is the critical supply-chain perspective, particularly the premium value-chain perspective beginning from the downstream end-uses that can command a premium. This will help to align the upstream emissions-intensive, hard-to-abate supply-chain sectors that incur significant decarbonisation costs and so need access to premium markets, with the downstream sectors that may generate only modest easy-to-abate emissions in themselves but can generate financial premia. Through aligning and developing attractive new offerings for premium customers, pioneer company partners in both the different types of sectors will be able to catalyse take-off growth in specific low-carbon activities in which they will be competitively and economically advantaged. Starting with premium offerings to the middle classes, this approach finances a pathway to serving mass markets at scale, with global impact.  

Concluding remarks

Bringing the whole picture together, explosive take-off growth in attractive low-carbon businesses should be expected as conditions become aligned, forerunners can catalyse and benefit economically from this significantly more than is generally appreciated. Such forerunners can align the required conditions through collaborating along premium value-chains, and there are multiple sweet spots for achieving this.  

The timeline for decarbonisation is very pressing, and smart partnerships along premium value chains can dramatically accelerate critical transformations in the global economy while generating economic value for the partners themselves.  

Which forerunners will join up to seize these opportunities?