Optimizing vehicle circularity could increase profitability by 50% across the value chain

The World Economic Forum and Accenture recently released a new study modeling and analyzing the financial and environmental impacts of optimizing vehicle life cycles using a circular economy approach. By moving to a vehicle value chain that is fully circular, the industry could achieve massive emissions reductions—up to 75% emissions reduction, consistent with Paris Agreement reduction goals for 2030—and divert both valuable materials and waste from landfills. The study found that a shift to a fully circular value chain could increase overall profitability by 50% and tap into revenues that are 15 to 20x higher than the car’s sales price.

The term circularity has become one of the latest buzzwords in the ESG space and seems to have many definitions. But what does it actually mean? The circular economy concept refers to a system that decouples economic activity from use of finite resources. We currently operate in a linear economy; we create, sell, use, and dispose of products with little-to-no recapture of existing value or material. The circular economy would hinge on three principles: designing out waste and pollution, keeping products and materials in use, and regenerating natural systems.

Many companies are taking early steps toward circularity—often in the form of educational campaigns to tell consumers how to properly recycle or dispose of products, or programs that offer recycled-content versions of traditional products. While these steps are promising, they are only the tip of the circularity iceberg.

So what would movement toward a truly circular economy look like? Let’s take a closer look at vehicles. A “circular” car would have completely maximized materials efficiency. This vehicle would produce no emissions, no waste, and no pollution during production, use, or disposal. Largely achieved through early changes to manufacturing and design, since over 80% of a product’s environmental impact is decided during the design stage, these circular vehicles would also be completely modular. While shifting to modular design would initially present a cost increase, it would enable profits of 1.5 to 4x through repairs, and profits of 2 to 5x during recycling and end-of-life processing. Beyond design and production, a fully circular vehicle value chain would offer sale, but also emphasize leasing, rental, and “as-a-service” use options to maximize the amount of efficient use of each vehicle. Finally, nearly all components of the car would be reused and recaptured at the end of its life, and the cycle would start again.

Circularity is already coming into play in other industries too. PepsiCo, in order to meet a 2030 target of producing 50% recycled material packaging, had to take a creative approach to material sourcing. Since global plastic recycling rates are so low, PepsiCo’s target would’ve been impossible to attain without a drastic intervention, but by investing in recycling infrastructure globally and partnering with governments, waste management companies, and NGOs, the company is sourcing new material and lowering the negative effects that their products generate at disposal and end-of-life stages. In addition to these efforts, they are promoting low- and no-packaging items as well as offerings like the SodaStream, which allows consumers to avoid single-use servings in favor of a carbonated beverage machine.

It is clear that these transformations will not be cheap nor easy, and will require involvement of the full value chain, buy-in from many external stakeholders, and a frank reconsideration of how businesses operate. But the movement from a linear to a circular economy is inevitable. Those who move to circularity early—and who do it well—can capture the type of gains to profitability that this transformation holds. Companies can be leaders or be dragged along by other stewards that seize the most benefit. Business leaders must take a nuanced look at where in their value chains they can push for circularity, and prepare themselves to face hesitation or opposition from incumbent stakeholders.

In the most “sustainable” cities, per capita consumption-based emissions constitute up to 12x their Scope 1 emissions

In the so-called “most sustainable cities,” per capita consumption-based emissions constitute far more than per capita Scope 1 emissions. Similarly, evidence suggests that, among US firms, an increasing proportion of Scope 3 emissions compared to Scope 1 points to outsourcing. Without proper accountability outside of Scope 1, both responsibility and emissions are misplaced. Incentives should be put into place to improve transparency and re-evaluate how we define what makes a city or company “sustainable.”

What do the most sustainable cities have in common? Apparently, that their Greenhouse Gas emissions from consumption constitute far more than their Scope 1 emissions on a per capita basis. This probably comes as little surprise. When you picture a sustainable city, you might imagine a place with clear air and high quality public space (i.e., a consumer city that imports rather than produces many of its goods and services). But maybe this relationship should be shocking. Shouldn’t the most sustainable city be the one that is circular and self-sustaining, internally managing its food, water, and energy needs?

Based on data and rankings from Corporate Knights Sustainable Cities Index, we find that among the cities ranked highest in sustainability, per capita consumption-based emissions constitute as much as 12x their per capita Scope 1 emissions[1]. In other words, in cities deemed the most sustainable—including Stockholm, Oslo, and Copenhagen—direct emissions (Scope 1) tend to make up a very small portion of total per capita emissions. This particular ranking is not unusual, as these places consistently appear at the top of sustainable city lists. And it’s not to say these cities are not sustainable—after all, some (though not all) do have low per capita consumption-based emissions. But maybe there’s more to unpack about the relationship between direct and indirect emissions.

Before diving into why we should care about what counts as sustainable, it’s worth noting and understanding a parallel that exists at the corporate level. A recent study found that, among US firms, the proportion of Scope 3 emissions relative to Scope 1 is rising. Further evidence suggests that firms are outsourcing their emissions to foreign suppliers (controlling for factors like operating efficiency and assets). There are a number of reasons a company might outsource emissions, such as maintaining social reputations domestically and avoiding regulatory stringency.

So, why does it matter that the per capita emissions of “sustainable” cities are largely consumption-based, and that companies are outsourcing emissions? As lecturer Marcelle McManus puts it, just because they are meeting certain targets, doesn’t mean they aren’t responsible for emissions elsewhere. Without the proper incentives to drive accountability, companies and cities may be less likely to invest in green technology or reduce emissions locally. Furthermore, these factors make it possible for companies and cities to hide (intentionally or unintentionally) behind their impressive Scope 1 performance (which is the most observable), while remaining silent on Scope 3, where much of their emissions lie.

The answer to these challenges lies in regulatory and reputational incentives. Regulatory changes—like the SEC’s proposed climate risk disclosure rule—can mandate the disclosure of upstream and downstream Scope 3 emissions. Not only would this compel companies to reassess efficiency within their supply chains, but also, it could reveal reputational incentives (as observable efforts expand to include Scope 3).

Additionally, it is worth re-evaluating what we consider “sustainable” and paying more attention to hidden emissions. Perhaps the most sustainable cities and companies are not the ones we think they are.

 

[1] The report defines scope 1 GHG emissions as those occurring within the city boundaries. Consumption-based emissions are those (1) from final consumption and (2) embedded in both domestically produced and imported goods and services that ultimately are consumed within the city.

 

3% predicted decline in global GDP by 2100 without climate mitigation

The relationship between climate action and economic health is complicated. Periods of decline often resultin short-term emissions reductions while simultaneously hindering long-term systematic change and the development of technological solutions. On the other hand, climate change itself may fuel economic decline; a report published in Science in 2017 predicted that if carbon emissions continue on the current trajectory, we’ll see an irreversible 3% drop in the world’s GDP by the end of the century. In 2008, when the economy took the deepest plunge since the Great Depression, the downturn pulled climate and sustainability concerns with it as both businesses and consumers shifted their attention to making ends meet and pushed longer-term problems to the back burner. Policy momentum suffered as well; COP15 in Copenhagen generated small, unenforceable carbon reduction commitments instead of the anticipated binding limits on emissions. Now fears of another recession are growing, and rising inflation has proven unresponsive to the Fed’s efforts to gently cool the economy. This begs the question: will the next recession present another huge setback in the race to drive down carbon emissions and mitigate economic consequences in the decades to come? Despite many uncertainties, we’re optimistic that 2022 will be nothing like 2008, either for the planet or the economy. For one, some experts predict that if a recession develops, it will be far less significant than the crisis of 2008. Moreover, the corporate climate and ESG landscape has grown at a remarkable pace since then, and though a downturn may not result in a transformative green recovery— as many had hoped in the early days of the COVID pandemic— there are guardrails in place to ensure sustainability remains among the majority of business leaders’ key priorities:

  • Urgency. The effects of climate change are taking shape with more force and speed than expected even a few years ago, contributing directly to our inflation and supply chain woes. Costs to human life and global development are already piling up, and executives face escalating pressure from grassroots activists, consumers, investors and supply network partners to take appropriately swift action to decarbonize their value chains.
  • Accessibility. Technological climate solutions, from cleaner energy to carbon capture and storage, have forged ahead on the path to widespread use. The costs of renewable energy generation, for example, are reaching parity with more carbon-intensive mainstay technologies, a vast improvement from 2008, and electric vehicles can compete with conventional vehicles in much of the U.S.
  • Collaboration. Global coalitions and information-sharing networks dedicated to climate and sustainability have sprouted, from the U.N’s Race to Zero to the We Mean Business Coalition, making it easier than ever for business leaders to learn from and build on the progress of their peers.
  • Planning. The business infrastructure tailored to decarbonization is more comprehensive than ever before. SBTi wasn’t founded until 2015, and countless companies are just beginning to deploy capital and talent to facilitate decarbonization, from empowering internal Chief Sustainability Officers to engaging organizations like The Climate Board and external consulting firms that offer climate expertise and business guidance.
  • Transparency and Accountability. Promising net-zero is crucial but no longer enough. A tide of climate journalism, watchdog NGOs, and higher expectations from stakeholders mean that companies’ climate promises face greater scrutiny than ever before. Relatively new norms of ESG reporting and disclosure through platforms like CDP and TPI are pushing companies to uphold their commitments to reduce emissions or face real-world losses.

Investing in science-aligned decarbonization strategies may seem easier in periods of economic growth, when the specter of climate change-fueled decline looms larger. In reality, businesses will inevitably be faced with cyclical pressure to shed lower-priority spending, which historically included environmental sustainability investments. We suspect this ecosystem of climate actors and motivators is strong enough to withstand this round of economic challenges.

$12.8 billion of sovereign green bonds sold by EU issuers in the past two weeks

Over US$12.8 billion of sovereign green bonds have been sold by EU issuers in the past two weeks, displaying a promising surge in the already thriving EU green bond marketsAustria’s issuance of its first green bond on Tuesday, representing US$4.3 billion of sovereign debt, was only the latest report of a green bond selling with a “greenium”—in this case, with a spread of 2.5 basis points over their conventional debt.

ESG and business newsfeeds have been flooded with reports on the so-called “greenium,” the higher price (and therefore lower yield) seen on a green debt instrument as compared to an otherwise identical non-green offering.  We’re seeing surging demand for green bonds, confirming that investors are both willing and eager to pay marginal greeniums for sovereign, municipal, and corporate green-labeled debt. (For some of our takeaways on the what rising issuance means for companies, check out Jacqueline Kessler’s recent post on the growth in global green bonds.)

Growing greeniums, increasing volumes of ESG-labeled securities, and swelling demand for such offerings are all encouraging signs. But beyond influencing this year’s capital raise or investment strategy, what do these trends mean? How do green bonds fit into the larger puzzle that is the net-zero economy? We see three scenarios for how green bonds and green finance might evolve over time. It’s too soon to tell if all or none of these paths will become reality, but we at The Climate Board hope to see aspects of each take shape.

Scenario 1: The greenium persists, spurring higher levels of corporate climate action via new financing. As issuers continue to see high demand for green bonds compared to other debt, the supply of green bonds will continue to grow. The current spread between green and non-green offerings is small—usually ranging from just a few to around 11 basis points—but could grow large enough to incentivize more companies to engage in decarbonization projects.

Scenario 2: Climate risk and climate action criteria will have more influence on credit ratings, bringing larger spreads between more and less “green” securities. Rating agencies like Moody’s and Standard & Poor’s are already beginning to factor ESG criteria into ratings. We have yet to see exactly how much this integration will impact overall creditworthiness and ratings, but when less environmentally responsible firms start to see formerly top-rated securities slide from triple-A downward, issuers will be under greater pressure to respond with climate action.

Scenario 3: Climate and ESG factors don’t have to be integrated into investment decision-making—because they are reflected in core business criteria already. In the most dramatic evolution of the global economy toward prioritization of decarbonization and climate action, green bonds, ESG investing, and climate risk disclosure would lose relevance. Investors, consumers, regulators, and companies would not need distinct ESG data or ratings because companies that do not act to protect their supply chains, fortify their businesses against climate risk, and comply with climate regulations will face increased business disruptions, difficulty attracting top talent, and reduced revenue. Business outcomes will inherently reflect ESG performance.

One theme holds true through all of these scenarios— companies that take definitive action now will be rewarded. Through marginal but increasing greeniums, issuers who take advantage of the vast demand for green offerings will be ahead of the decarbonization curve as the market moves toward fuller ESG consideration. For those who want to lead the pack and reap the rewards, the time to act is now.

For those in search of a partner and resource for any part of the journey, The Climate Board is here. We can support your company on your climate action path. Reach out to us for more information.

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