Being a forerunner can seem daunting and risky, but it can also be smart business, smart policy and smart politics.

Jeremy

This is part 2 of a two-part series on the energy transition. You can find part 1 <a href="https://illuminem.com/illuminemvoices/faf5a6c5-3391-4013-95b1-74c6b9ce4d43" target="_blank" rel="noopener">here</a>.
<h2>Introduction and preamble</h2>
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.&nbsp;&nbsp;
In Part 1, I highlighted structural reasons why individual transitions &ldquo;take-off&rdquo; 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.&nbsp;&nbsp;
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.&nbsp;
<h2>The significance of premium markets</h2>
A critical feature is aligning the financial arrangements that enable the prospect of early-stage profitability or just simply breaking even for pioneer businesses &ndash; the &ldquo;quick wins&rdquo; 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.&nbsp; 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.&nbsp; 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 &ldquo;computer on wheels&rdquo; premium electric car in California.&nbsp;&nbsp;
Indeed, although helped by supportive environmental policy, this battery-electric vehicle example wasn&rsquo;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 &ldquo;green steel&rdquo; 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.&nbsp;&nbsp;
The main point, however, is that even though it is much more expensive than &ldquo;commodity steel&rdquo;, using fully &ldquo;green&rdquo; 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.&nbsp;&nbsp;
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.
<h2>Identifying attractive markets</h2>
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&amp;P 500. Within this index, the non-financial sectors with the highest percentage of so-called &ldquo;intangible assets&rdquo; 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.&nbsp;&nbsp;
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.&nbsp; 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.
<h2>Developing new partnerships</h2>
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 &amp; 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.&nbsp; 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.&nbsp;&nbsp;
<h2>Concluding remarks</h2>
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.&nbsp;&nbsp;
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.&nbsp;&nbsp;
Which forerunners will join up to seize these opportunities?
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Joined-up opportunities for forerunners in energy transitions

To avoid extremely damaging climate turbulence, it has long been clear that decarbonising the global economy is an urgent priority

<h2>Accelerating investment and realising under-valued economic potential</h2>
<h3>Introduction</h3>
To avoid extremely damaging climate turbulence, it has long been clear that decarbonising the global economy is an urgent priority and that the world is nowhere near to following a pathway towards this objective at the necessary pace. This is a threat to the wellbeing of every person on the planet and their progeny.
This realisation is stimulating much hand-wringing and blame, as well as being used by governments to justify policy initiatives of variable effectiveness. None of this, however, is stimulating the levels and types of investment that are required.
Rather than throwing up our arms in despair, however, this essay asserts that good investments can be motivated at a much-accelerated pace because:
<ol>
<li>Technically we understand what needs to be done</li>
<li>We can escape from unhelpful financial metaphors that delay action and diminish economic potential</li>
<li>Forerunners can unleash smart business, smart policy and smart politics - securing better outcomes directly for themselves and, indirectly, for everyone else.</li>
</ol>
<h3>Well-established techno-economic considerations</h3>
Curbing climate damage requires completely rewiring the world economy to change the way we use energy from fossil fuels to operate, build and move almost everything we do, and also addressing our degradation of natural systems through deforestation and soil erosion. Approximately 2/3 of damaging emissions come from our use of energy and 1/3 from our abuse of nature.
These are not small tasks, but there is some progress and there are points of light such as the rapid pace of growth in power generation from solar and wind, sales of light-duty electric vehicles, and the spread of carbon markets and decarbonisation commitments. These are far from sufficient, but they were not happening 10 years ago and yet today they are. Our goal now has to be accelerating progress by continuing to promote these changes and, crucially, by lighting the blue touch-paper so that multiple additional changes take-off at pace as well.
Technically, we know what is required. Multiple scenarios from credible sources all highlight 5 core technical areas:
<ol>
<li>Energy efficiency. This is not just about efficient appliances but about integrating power, heat, waste, and water infrastructures far more effectively, integrating modes of transport, and developing more circular economies.</li>
<li>Power generation from non-fossil renewable resources.</li>
<li>Electrification of the economy - up from 20% of total energy use to 60%, so that power generation from renewables can grow to have much more impact on the whole system.</li>
<li>Substitution of liquid and gaseous fuels through electrification and through progressively shiftingfrom fossil oil to biofuels and natural gas to hydrogen-based alternatives in sectors that are hard to electrify (because energy-dense, portable, thermal, molecular fuels are required in heavy transport and heavy industry).</li>
<li>Carbon removals. Mopping up emissions through both technical approaches like Carbon dioxide Capture and Sequestration (CCS) and nature-based approaches like reforestation.</li>
</ol>
The detailed technical challenges are different in different sectors of the economy, requiring customised solutions and tailored investments. However, it should be well understood by now that the macro-economic drag of investing in energy transitions will be modest, and likely to be much less than the drag that would be imposed by damage from climate change itself if the shifts are not made.
The challenge is at the &ldquo;micro&rdquo; level as the &ldquo;costs&rdquo; and the &ldquo;benefits&rdquo; are not evenly distributed or aligned. This is the really tricky problem of coordinating and aligning the motivations of more-or-less everybody. This requires new policies and regulations, new market designs and pricing mechanisms, new business developments and changes in supply chains. Effective alignment demands much more vigorous collaboration across public-private, industry and business boundaries.
<h3>Competitive dynamics and explosive growth</h3>
Much of modern progress has been driven by a combination of collaboration in enterprises to get major developments accomplished and also competition in markets that give financial incentives for effective activities. We have seen both these mechanisms play out powerfully in the astonishingly fast development and deployment of Covid vaccines, with intensive collaboration and knowledge-sharing across world-wide scientific and clinical communities, and also competition among different organisations and businesses to deliver their new best vaccines to market as quickly as possible.
Similar mechanisms have been in play looking back at several energy transition developments that have already &ldquo;taken off&rdquo; and that we now take for granted. Alignments have created fertile ground, pioneers have acted decisively and demonstrated possibilities, then many competitors have followed to avoid being left behind. In this way, industries like solar and wind power have &ldquo;taken off&rdquo; growing at 20, 30 or even 40% per year globally as increasing deployment drives down costs and initiates a virtuous cycle.
This was also the case with the take-off in sales of light-duty Electric Vehicles (EVs). These had been toyed with for many years but then business pioneer Elon Musk recognised that attractive policy and market conditions had come together in California to enable Tesla to initiate a new kind of &ldquo;super-premium&rdquo;, &ldquo;computer-on-wheels&rdquo; electric vehicle business. This triggered a global EV &ldquo;take off&rdquo; as other vehicle manufacturers and policy-makers elsewhere responded to Tesla&rsquo;s early successes. This case is particularly interesting because it demonstrates not only high early-stage growth rates but the potential commercial value from being a successful pioneer in such a high-growth market with a niche premium sector. In just a short time, the market value of Tesla has grown to be an order of magnitude greater than that of traditional behemoths like General Motors or Ford.
Recognising the importance of both competitive dynamics and pioneers is the key to catalysing the multiple take-offs of additional developments required to decarbonise the economy. When developments &ldquo;take-off&rdquo; they really do so very vigorously because competitive dynamics flip the industry equilibrium as soon as a pioneer demonstrates even potential attractiveness. Multiple players then act quickly as &ldquo;Fear of Missing Out&rdquo; is activated, particularly if the existing industry equilibrium has already become highly competitive and typical returns have been driven to low levels (as is often the case in mature industries).
Businesses and policy-makers need to anticipate this fierce competitive dynamic, and not be misled into expecting slow and steady future changes. While it may take time for background policy or value-chain alignments to emerge, once they do then take-off growth can become almost explosive.
<h3>Misleading metaphors and the under-valued potential of trailblazing</h3>
As suggested above, pioneer businesses are also key in triggering take-offs.
However, the main uncertainty facing potential forerunners in the energy transition arena is uncertainty in the timing of when different new developments will &ldquo;take off&rdquo;. They are faced with the &ldquo;too early/too late&rdquo; investment dilemma. The key question is whether to pre-invest now in building a competitive stronghold for an industry that may eventually take several years to fly but, in so doing, potentially catalyse an early take-off. Or whether to delay investment and react later when industry growth is already established but competitive positions are more difficult to secure. In other words, whether to be a pioneer on the front foot or a follower
Unfortunately, human and organisational biases generally steer institutions towards acting late, but scenarios can help decision-makers recognise that acting early may, at worst, bring only mild economic disappointment but, at best, can lay the foundation for significant company or domestic industrial competitive advantage for years to come. The potential regret of acting late is often considerably greater than the potential regret of acting early.
One of the key challenges for many organisations is that they have become &ldquo;trapped&rdquo; by an unhelpful metaphor in the financial assessment of the potential economic value of future opportunities with relatively unfamiliar features. The British statistician George Box has noted that &ldquo;All models are wrong but some are useful&rdquo;, but the corollary of this is that some models are not useful, at least when applied well outside the limited area of their usefulness.
Whether senior decision-makers realise it or not, the dominant metaphor being used in most companies for assessing uncertain future financial returns is that of the corporate bond, particularly because it can be easily represented in the spreadsheets that now dominate analysis. A base-case of cash-flows is assumed, with the &ldquo;present value&rdquo; of future cash-flows discounted by a fixed percentage to account for the risk that the &ldquo;bond-payer&rdquo; may default. Some sophistication may be added through computing sensitivities or assigning probabilities to different elements of the calculation, but the underlying metaphor for the nature of future uncertainty remains the same &ndash; i.e. it looks like the risk of holding corporate bonds.
This metaphor may be reasonable in traditional circumstances but, of course, the type of uncertainty highlighted above for energy transition &ldquo;take-offs&rdquo; looks very different. We may be confident that the potentially &ldquo;explosive&rdquo; take-off of particular approaches will occur in the next 5, or 10, or 15, or 20 years, but just do not know precisely when. We may be able to secure long-term competitive advantage if we are a forerunner, but not if we are a later follower, and, indeed our own actions could trigger the take-off. The potential regret of investing to be a forerunner may simply be poor returns until take-off actually occurs, while the potential regret of waiting may be foregoing significant long-lasting economic value.
Scenario thinking is essential for grappling with the shape of uncertainty under these circumstances, and the simple discounted cash-flow (DCF) model is inadequate, even misleading. In contrast, even a simple model that considers DCF appropriately within the &ldquo;boundary scenarios&rdquo; of take-off occurring soon or alternatively after a delay of several years, combined with a business investing early or later, is already more illuminating. In fact, my own evaluations reveal that it would already be economically and commercially shrewd for businesses to invest seriously as pioneers in most of the technical areas identified earlier in the essay that are primed to take-off during the timescale of energy transitions.
A few businesses seem to be attempting this, but not as many, or as aggressively, as the type of commercial competitive perspective developed above should encourage. Of course, not all pioneering activities will succeed over the long-term if competitive strongholds can not be secured or if it takes forever for take-off to occur. Nevertheless, the vibrancy of the Venture Capital markets and the significant market value generated by companies like Tesla, Orsted, NextEra Energy and Neste indicate what can be achieved.
<h3>Smart Business, Smart Policy and Smart Politics</h3>
Adopting the perspectives outlined in this essay (e.g. already anticipating high-growth take-offs, scenario thinking, minimising regrets, surfacing niche premium market opportunities, and recognising the potential long-term competitive advantage of participating in take-off) will not only enhance commercial advantage for fast-moving companies but also drive faster energy transitions overall in a reinforcing cycle.
Similar considerations are pertinent for policy-makers seeking to build social capital by developing domestic economic competitive advantage alongside delivering environmental benefits. They should recognise the international competitive dynamic in policy-making between different economies. They should then focus on creating significantly favourable conditions to enable, motivate and reward more pioneer businesses in new target energy-transition areas while also encouraging lively competition in areas that have already taken off.
Finally, given the possibility of explosive take-off occurring within a political cycle, with resulting economic, job-creation and environmental benefits, then intelligent politicians should recognise the potential political capital that can be generated through promoting these approaches.
In summary, therefore, scenario thinking and stimulating take-offs in a targeted and well-designed way can be a sweet spot combining smart business and smart policy with smart politics.
Who will become the new forerunners in energy transitions, generating significant commercial, social and political value?
illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability &amp; Energy writers, their opinions do not necessarily represent those of illuminem.

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Jeremy Bentham

Jeremy Bentham

Joined-up opportunities for forerunners in energy transitions

Energy transitions: smart business, smart policy, smart politics and good outcomes

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