How to reduce your CO2 footprint
How to reduce your CO2 footprint
or how Treasury Management can help achieve a competitive advantage with a reduced carbon footprint
Transitioning to a low-carbon economy is generally considered to be the most effective way to curtail climate change. The political engagement backing this up was confirmed in the 2015 Paris Agreement, which foresees that global greenhouse gas emissions should drop to zero by the second half of this century. At this time, the Agreement’s signatories are not obliged to reduce their emissions but have to report on these and explain the efforts made to reduce these. Such voluntary measures may lead to compliance with future legal provisions, especially if the signatories compare their actions and progress to those of their peers. As such, corporations that do not engage in lowering their carbon footprint may become subject to regulatory pressure to support the climate targets in countries where they are active. Moreover, it is becoming increasingly important for suppliers and distributors that their goods are used in climate-neutral production or have been produced in a carbon-neutral way. A good example are American retail chains that oblige their suppliers to use a significant proportion of electricity from renewable sources to manufacture the products marketed. Consumers have also become much more aware of their ecological footprint when shopping.
We are still at an early stage of this transition and it is still unclear where this journey will eventually lead us. What is clear, however, is that apart from actual energy corporations it is also energy-intensive industries that will play a leading role in significantly reducing emissions with their energy efficiency programs or by using renewables. Even without knowing the exact timetable of the global energy revolution, companies with an energy strategy will find themselves better prepared to adapt to new requirements regarding climate neutrality and the possibility of using alternative energies.
Corporations spend millions every year on energy alone. Companies that are not in an energy-intensive sector consider energy procurement more as an administrative cost rather than a strategic part of their value chain. Corporations that do not have a decarbonization strategy risk losing the trust of stakeholders, market shares, community support, investment opportunities and staff loyalty, thus jeopardizing the company’s survival. Even an insufficient consideration of the ESG strategy driven by the EU may lead to reduced corporate financing possibilities (see our Treasury Newsletter 88 from February 2019). Energy, which was previously measured solely as a cost, is now becoming a key driver of business success. If Procurement and Treasury Management cooperate in this area, this can lead to considerable success. Often, this happens with the conclusion of strategic PPAs or the so-called “greening” of purchased electricity. This describes the process in which a corporation voluntarily purchases CO2 certificates in order to fully or partially compensate the exhausts it emits when using gray or brown energy in production. In doing so, Treasury Management coordinates the definition of future needs (exposure) and then acts in a leading role when executing the corresponding strategy on the market.
It is also becoming increasingly clear that decarbonization strategies must be designed for the long-term even if the macro-economic environment surrounding decarbonization is rapidly changing. Using an appropriate strategy may lower the price and volume risks for energy procurement, and also makes for a certain independence from the volatile energy price effects of fossil fuels. Unpredictable energy prices may have an impact on energy costs and costs for liquid or gas-like fuels. A decarbonization also reduces a corporation’s exposure to potential CO2 emission charges. Corporations with a long-term strategy are much more resilient in times of crises. This means not only considering risks but also taking advantage of any emerging short-term opportunities and incentives for companies to drive change. After all, decarbonization and sustainability measures can open up profitable channels. Being an early user of low-carbon energy can result in competitive advantages. For instance, corporations with a certain sustainability accreditation (such as the CO2 Performance Ladder in The Netherlands) may receive preferential treatment when tendering for projects. The development of alternative solutions and the reduction of CO2 emissions will allow a corporation to outbid its competitors by securing a (short-term and) long-term cost advantage.
Improving the CO2 footprint
Corporations have several possibilities to reduce their CO2 footprint, from implementing energy efficiency programs to developing their own renewable energy production.
The intention of energy efficiency programs is to reduce a corporation’s CO2 emissions due to lower energy consumption or fewer emissions per energy unit. Such projects may be manifold and, depending on their design, can also take place without Treasury Management’s participation. For instance, it could mean a more economical use of fuels or a more efficient use of materials in order to bring about a reduction of CO2.
What is more complex, also in its implementation, is the acquisition and management of certificates or proof of origin with the intent of compensating CO2. Such projects require the treasurer’s expertise because these certificates are highly complex financial instruments.
A currently favored means to improve the CO2 footprint is the procurement of renewable energy with Power Purchase Agreements (PPAs)1. Generally, two main types may be found in the market. In a physical PPA, the producer feeds into the same pricing zone as the one where the counterparty draws its power. This means that there is a direct and physical delivery which is also relevant to the accounting grid. There are on-site PPAs (where the producer and the supplier are physically near) and off-site PPAs where energy is delivered through the public grid. The second type of PPA is called synthetic or virtual because it brings together energy producers and users from different pricing zones. PPAs not only define the regular parameters such as volume, delivery times and pricing, but also mutual codes of conduct, maintenance duties and termination clauses. Several factors make the valuation of PPAs a challenge for the contractual parties. Typical risks and questions to be answered concern counterparty risk, volume risk, foreign currency risk, the integration into already existing software environments as well as the mapping in the balance sheet – thus touching upon Treasury’s main areas of expertise.
Another possible element of a company’s decarbonization strategy could be to produce its own energy or manage renewable power systems. However, for this, you need profound knowledge on energy management as it requires relevant processes and structures that need to be in place or implemented.
Challenges encountered in procuring renewable energy
Procuring renewable energy is a complex business as it requires the management of numerous risk profiles because business activities may cover various regions and markets. Achieving the goals in regard to renewable energies requires much experience and extensive know-how within the corporation.
As there are many different technologies and contractual options to achieve decarbonization, the decision makers have to be in a position to evaluate the complicated selection criteria. Thought should also be given to an adequate financing or financing possibilities that will allow the corporation to reach its goals. Globally active corporations will have the additional onus of having to make investments in different companies, in consideration of local prices, taxes, subsidies and/or financial incentives. When planning their strategy, decision-makers will also have to consider how to handle lacking local infrastructure or their commitment at country level.
Essentially, corporations will have to think about strategic considerations necessary for success and they have to ensure the right combination of expertise across functions in order to develop the most adequate solutions.
Implementing a decarbonization strategy requires an integrated and step-by-step approach, which may be broken down into four steps.
- Assessment of corporate goals
Corporations need to clearly define and assess short-term and long-term goals that should be based on the most important measures to be taken, drivers for decision-making and corporate limitations. Be sure to think of aspects relating to strategy, financing and taxation as well as social and ecological acceptance already in this phase.
- Development of options and strategies
Once the corporate goals have been defined, it is a good idea to group options on how to assess and make decisions, and which projects belong in short-term/long-term procurement strategies. Developing a robust and dynamic financing model serves to improve assessments and predictability of the implementation by validating all options and listing the results at various levels of consolidation. Furthermore, an assessment of the financial structures should be performed for each jurisdiction (i.e. regarding equity, debt, climate bonds, etc.) that takes into account financial structures, partnerships and contractual strategies (PPAs, certificates).
From a Capex/Opex perspective, the technical options and the critical review of the overall deployment of technologies are as important as identifying technology risks and assessing performance under local conditions. Decisions must be taken on the type of technology to be used (wind, sun, water, biomass, geothermal) and the type of installation (off-site/on-site) and regulatory limitations must be taken into account. Moreover, market conditions (procurement options, pricing, taxes and incentives, readiness and social acceptance) have to be evaluated in order to define market introduction strategies and program governance.
- Evaluation and roadmap
The goals defined in the decarbonization strategy have to be evaluated for their feasibility and market introduction strategies, as well as their impact on decision makers. Developing a short-term and a long-term roadmap supports the implementation based on local knowledge as well as financial and operational criteria. The program and the governance model should identify procurement possibilities and scenarios as well as local solutions (e.g. availability of PPAs and market suppliers). An implementation roadmap serves as the base for managing the program’s implementation.
Thinking about and implementing a decarbonization strategy is complex and requires the involvement and knowledge of many divisions. Treasury is especially involved in the settlement (i.e. financing and liquidity planning) and in risk management (such as for foreign currencies and interest rate hedging). The issues range from the development and implementation of the strategy to the evaluation and capture of financial instruments (certificates, PPAs, etc.) in the operating business.
Source: KPMG Corporate Treasury News, Edition 101, May2020
1 Edition 95 included the following article: Purchasing Power Becomes a Treasury Topic –Risk Management for Power Purchase Agreements
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