Sustainability fervor – which has been building in importance over the past few years – has reached a new height in 2020. Chemical industry leaders made lofty statements at the World Economic Forum in Davos about the importance of engaging in sustainable development. Despite that, the chemicals industry is big, conservative, and typically slow to move.
This raises the question: "What factors will really force change in the chemicals industry, and what does that change look like?"
In this blog, we examine three possible drivers of change – carbon taxes, investor pressure, and supply chain pressure – and discuss their possible implications. We specifically focus on chemical companies, as highly carbon-intensive industries like cement and steel face a very different picture with respect to sustainability challenges.
Carbon taxes are all bark and no bite:
Carbon pricing – either in the form of a carbon tax or an emissions trading scheme – is gaining momentum globally. Despite that, mapping chemical companies on the Lux Carbon Canvas, a framework for evaluating companies’ levels of resilience to a future global carbon price, (see below) using 2018 financial and CO2 data shows that these policies are unlikely to make a major impact on the chemicals industry. In general, companies having higher critical carbon prices are less likely to be impacted by a carbon price. Of the companies we assessed, only LyondellBasell fell below our $200/MT eCO2 critical carbon price threshold. Every other company was above this mark, meaning that end-of-pipe technologies like carbon capture will be enough to address their future needs for emissions abatement. What's more, many materials companies' critical carbon prices were well above the $1,000/MT eCO2 mark. For example, paint companies PPG and Sherwin-Williams were both above $10,000/MT eCO2; these companies' direct CO2 emissions will never really be a major operational concern. Fundamental changes to the business, or decisions about future investments, are unlikely to be driven by carbon taxes.
Mapping chemical companies on the Lux Carbon Canvas. Based on publicly available 2018 emissions information
Investor money walks the walk:
While carbon taxes lack teeth, evolving investor expectations are beginning to incite real change in the chemical industry. Environmental, social, and governance (ESG) investing has reached a tipping point where boards and executives are being pressured by major shareholders to implement more sustainable practices. For example, State Street recently put three companies on notice for lackluster ESG performance and will continue to vote against companies in the S&P 500 and other large indexes that are failing to manage their sustainability risks. In particular, asset management firms will be looking for chemical companies to minimize the negative externalities of their operations and take additional steps to ensure the long-term health of their organizations.
Companies can look to well-recognized standards like the Sustainable Accounting Standards Board (SASB) for guidance to understand the ESG issues most material to their industry and how they will be evaluated. For example, greenhouse gas (GHG) emissions, air quality, and energy management are among the environmental issues investors will use to evaluate the chemicals industry, according to SASB's Materiality Map. Still, numerous studies have shown that the metrics and standards used by different rating agencies are often not aligned.
Unlike credit ratings that converge to provide a uniform outlook on an individual's credit history, current ESG ratings give a mixed bag of outlooks. Yet, as ESG investing will only gain momentum in 2020, companies must proactively take steps to work with investors and other stakeholders to ensure more informed industry guidelines and expectations are set. For example, BASF hosts one-on-one meetings and roadshows in an attempt to keep institutional investors and rating agencies informed. By controlling the conversation, BASF is giving itself a leg up over its competitors.
Brands redistribute responsibility:
With the internet and the rise of social media, consumer expectations of brands are at an all-time high, and brand loyalty is at an all-time low. Given the increased pressure, brands are proactively taking steps to steer away from negative publicity and strengthen their public image. Understanding that consumers are beginning to care more about where their products come from, brands are working to offer greater transparency along their supply chains.
Consumer pressure, in combination with policies like extended producer responsibility schemes and/or quotas for the use of recycled or bio-based materials in products, is causing brands to be more selective about where they source their raw materials and ingredients. All else being equal, brands will choose to work with companies adopting more sustainable practices.
A report by the CDP (formerly the Carbon Disclosure Project) discusses this redistribution of responsibility along the supply chain. Of the CDP Supply Chain program members (representing 115 member organizations with $3.3 trillion in procurement spend), 73% reported that they would deselect suppliers based on environmental performance. L'Oréal, for example, has already upended its supply chain to source 100% of its palm oil derivatives from providers certified by the Roundtable on Sustainable Palm Oil. Additionally, L'Oréal is integrating CDP data into its purchasing processes and is looking to collaborate with suppliers for reducing its value chain emissions and improving its packaging to be more aligned with the Ellen MacArthur Foundation's New Plastics Economy. As such "cascading commitments" continue to rise in number, material and chemical companies would be wise to understand the sustainability issues most material to their customers and align themselves as much as possible to avoid being crossed out of the equation. Companies that take steps to disclose relevant ESG data and develop products that meet their customers' sustainability goals will have a long-term competitive advantage.
Despite the lack of impact from carbon prices, the rise in ESG investment and the redistribution of risk along the supply chain will have a direct impact on how chemical companies define their sustainability strategies in the coming years. The Carbon Canvas shows that chemical companies are locked into their assets, which will be an increasingly large concern, as the long-term pressure on carbon emissions and plastic waste may drive down demand for petrochemicals and commodity plastics. If chemical companies do nothing, they may end up saddled with unprofitable assets. Yet companies (and even industries) still have time to engage with stakeholders to define the narrative for how they will be evaluated.
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