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Chris Hagler

Welcome to Sustainability Matters, a podcast series of EY. My name is Chris Hagler. I’m one of the leaders in our Climate Change and Sustainability practice and your host for this series. We’ve designed this podcast series to provide leading trends and practical advice around environmental, social and governance, or ESG, issues and opportunities facing businesses today.

The science behind climate change is well established and widely accepted. The surface temperature of the earth has risen by unprecedented amounts and humans are responsible for this change. The Paris Climate Agreement, which was established in 2015, is an accord between major emitting countries to reduce greenhouse gas emissions with the goal of limiting global temperature rise in this century below 2℃. This need for action has been reinforced by the latest update from the Intergovernmental Panel on Climate Change, the IPCC, whose research identified a shorter time frame and stronger action required. As businesses do their part in slowing down the climate crisis, we are seeing many organizations make climate goals, such as using 100% renewable energy; committing to a science-based target, where they pledge to do their fair share to keep global warming to 1.5℃; or committing to being carbon neutral. One major company recently committed not only to carbon neutrality but also to taking back any carbon they have put in the environment since the inception of the company. But what do these goals really mean and how are they achieved? Today’s podcast will be a discussion of practical approaches to achieving your organization’s climate goals. I’m so pleased to be joined by Stephen Auton - Smith. He is one of the leaders of the EY’s Infrastructure Advisory practice, who will give us some insight into infrastructure. Things like solar and power purchase agreements and other things related to renewable energy. Also, with me is Rich Goode, one of my colleagues from the EY’s Climate Change and Sustainability practice. And he will share with us some of the strategic approaches that companies are making towards their climate commitments. Thank you both Stephen and Rich for joining.

Hagler       

Before we get started, Stephen, can you introduce yourself — a little bit about your background and the work that you do here at EY?

Stephen Auton - Smith   

Yes, hi my name is Stephen Auton - Smith. I’m a managing director in the infrastructure advisory practice here at EY, and I spend most of my time advising government clients and corporations on the sourcing and development of infrastructure for energy — primarily clean energy, which encompasses onsite distributed energy resources and renewable energy transactions, including power purchase agreements and virtual power purchase agreements.

Hagler       

Awesome. And Rich, I know you’ve been on a couple of podcasts before, but could you remind our listeners what you do here at EY and a bit about your background?

Rich Goode        

Sure, I would be happy to, Chris. Good to be here again today. So, my name is Rich Goode. I’m a managing director in the EY’s Climate Change and Sustainability services practice based in the Northeast. My job is really to assist clients in figuring out the myriad of issues in that they face in the burgeoning area of ESG or environment, social and governance. The environment is sort of what I call the usual suspects — wastewater, greenhouse gas emission, things like that. Social is really becoming a more and more important issue with things like our pandemic, worker safety. We’re seeing also diversity inclusion and social justice issues really bringing companies, putting companies in the forefront to figure out their response to that. And then governance issues — it’s really who’s in charge? Are companies putting the right people in the right place to make the right decisions. That’s a little about my background and what I do to assist our clients here at EY.

Hagler       

So, let’s get started. What does it even mean to be carbon neutral? And when companies make these types of commitments, what are they thinking? What do these commitments look like?

Goode       

I’ll kick us off, Chris. This is Rich. “Carbon neutral” is one of those terms that isn’t really fully clearly understood. Like many things you really need to define it and have some strict criteria about what you are talking about. I think carbon neutrality — what I’ve seen when some companies make these pledges — it ranges everything from a really carefully thought out description of exactly what part of their business they are going to reduce or become carbon neutral on. Meaning, however, many tons of carbon we emit in our operations, we will offset that in some other way so that our net carbon footprint is zero. And it’s neutral, carbon neutral. Meaning, whatever we put in the environment we somehow take out. And that ranges everything, like I said, from a carefully thought out description of exactly what parts of your operations you are going to become neutral on to an in-the-moment excitement of a CEO who gets caught up in a passion about the environment, says we are going to become carbon neutral, and really doesn’t have a good idea about what that actually means. So, it could be a bit tricky if you are not fully clear about what it means. And as we go along, I’ll talk a little bit more about just the different parts of an organization where carbon is incurred, and what it means to become carbon neutral in different parts of an organization.

Hagler       

Rich, we also hear companies talking about science-based targets. How is that different than a carbon-neutral target?

Goode        

Science-based targets really run out of the Science-Based Target Initiative, is an idea that the earth has a carrying capacity of carbon. The earth can absorb and sink carbon in various means. So, the plain old dirt can do it — trees, oceans — and some of it is dissipated. So, there are natural carbon sinks. So, the idea is that we want to stay within the capacity of the earth to absorb the carbon that we emit. That prevents excess carbon from going into the atmosphere and exacerbating global warming. So, the idea of a science-based target allows companies to carefully go through a structured approach guided by criteria for the Science-Based Target Initiative to say based in your industry, whether you are in cement manufacturing, steel manufacturing, consulting, health care, what have you, what is the carbon budget for your industry? And from that, what is your budget based on the size of the industry? So, if you are an industry that has 100 million metric tons as an annual budget and you have 10% of the market share, then you’ve got about, you’ve got your 10-million-ton budget. That allows you to keep within the earth’s capacity for absorbing or sinking carbon emissions. Carbon neutrality goes a little bit different. It says, rather than this budget that I’m allocated or that I’m allowed to emit to keep the earth within its comfortable temperature range, I’m going to go beyond that and actually bring it all the way down to zero. So, that is the key difference. Science-based targets are really about what is the budget that I need to stick to in order to help the earth stay below 2℃ of warming vs. carbon neutrality basically says I’m going to go far beyond that and bring it all the way down to zero.

Hagler       

Do we have examples of where an organization might do both? Say, I’m going to be carbon neutral by 2030. I’m also going to work to reduce my carbon footprint using a science-based target or some other approach?

Goode       

 Companies that eventually want to be carbon neutral always need a starting point. It’s like that old analogy — how do you eat an elephant? One bite at a time. And that first bite to become carbon neutral could easily be a science-based target, where you say okay, here is the budget I know I have to work with. This is my ceiling. My floor, of course, is carbon neutrality. So, let’s target the ceiling first and not go above that. And that gives you good indication of just exactly how much work you have to do to meet becoming carbon neutral. And then over time, carbon neutrality is often stated as an aspirational goal. We will stay within our science-based targets by 2025 and we’ll strive for carbon neutrality by 2030. And there are different ways to get there. But science-based targets are a good way to kind of take that first bite of the elephant.

Hagler       

Great! That is really helpful to think about that. One of the things that I’ve noted lately is some companies are saying well we are going to go carbon neutral this year. Several major organizations have done that. So what approaches are companies taking to becoming carbon neutral?

Goode        

Whenever I’m advising a company that wants to become carbon neutral or even reduce their emissions, not even become carbon neutral, I often use the acronym RSIO. And that stands for reduce, switch, innovate, and offset. Let me explain a little bit about each. Reduce simply means getting your own house in order. So that means starting with simple things like making sure you’ve switched your lighting. Making sure you’ve got recyclability targets. Making sure you’re looking at your water consumption and other sort of what I’ll call traditional sustainability metrics. These things tend to be money-saving, which is a good sort of quick win for companies on their road to carbon neutrality or even reducing their emissions — just starting with the basics. After reduction, we move to the “S” or switch or substitute. And that’s substituting low-carbon activities for high-carbon activities. So, rather than flying you are looking at video conferencing. Rather than using gas powered vehicles you are using electric or hybrid power vehicles. So, substituting technologies or switching technologies that have a lower carbon impact is the “S” piece. “I” — innovate, that’s the fun part, right? That is where you really get to think outside the box. And for your industry, your company, what are innovative things that will really move the needle that will have a significant impact on not only our carbon footprint, but our business? All businesses are really looking for that unfair sustainable competitive advantage over their competitors. Innovation is the way to get it. And remember, not all risk is bad. So, innovating is a great way to look at that. And then finally offset. That’s the “O” piece. Offsetting is whatever is left over. If I’ve started from this large baseline of carbon emissions, and then I’ve reduced, I’ve switched, I’ve got some innovation going. I still have some left to offset. That’s where you come in and through a combination of renewable energy credits and carbon offsets and things like power purchase agreements that Stephen Auton - Smith , I think, will pick up and talk about next, that is a thoughtful area. Now it doesn’t mean it’s the end of the line, that’s the last thing you do. It can be a really thoughtful part of this RSIO all the way through your carbon reduction process.

Hagler       

Stephen's work fits in certainly at the switch, so he’s helping to provide low-carbon activities instead of high-carbon activities. And then also assisting with offsets. Stephen, can you share a little bit more for us about how you go about helping our clients with their carbon neutrality commitments?

Auton - Smith   

I think you’ve got it absolutely right, Chris, that the switch and offset components are probably where I and my team operate most often. And we work with companies who either have set a carbon-neutrality goal and are seeking to address their emissions from electricity consumption or may have set a separate renewable energy goal to achieve 100% of their energy from attributable renewable sources by a given date. The work that we do is primarily focused on developing effective strategies and then executing transactions to make that happen both in the US but also globally. But I think what we’ve seen in recent years is actually an explosion in corporate purchasing of renewable energy. In 2019, about 19.5 GW of new capacity was procured by corporate, which is about 60% of all renewable energy added to the grid in the United States last year. So, corporate purchases of renewables are a very significant driver of market activity. I think what I would say is there has been a material evolution in thinking in recent years about the role of switching and offsets. Offsets a few years ago were viewed as a holding-pattern activity to claim renewable energy or contributed to carbon neutrality without really doing very much. So, buying unbundled renewable energy certificates and using that as an offset. Whereas the orthodoxy has moved much more in favor of positive, transaction-specific actions, which connect the renewable purchaser to specific assets which are additional to grid capacity, which are genuinely contributing to the decarbonization of the grid in which are contractually connected to a specific corporate purchaser. So, I think offset has historically been rather a kind of derogatory term for green washing. I think that is a very different story now. I think we can chart the evolution of that offset market over the last few years. Carbon offsets are a very different beast now from what they were a few years ago, missing corporates entering the carbon offset market with very specific value additive projects. Whether that is mangrove restoration, or salt land marsh restoration or tree planting or whatever it may be. So, it’s no longer just purchasing generic certificates and claiming carbon neutrality. It’s much more about having a direct positive impact.

Goode        

Yeah, that is absolutely right. I’ve even was on a few calls this week with yet another interesting idea whether a couple of companies tried to come together to actually create yet another third company whose sole charter was to buy up mangroves and farmland, reforest it as cash crop to go into permanent wood carbon sink. So instead of using the wood for say burning it would go into furniture and other sustainable sort of uses but then the carbon offsets would then be created, used by the companies and/or sold on the open market. That’s part of the innovation piece there rather than like you say, Stephen Auton - Smith , just buying a generic carbon offset. I wonder, too, if maybe we take a moment to talk about a little bit about the differences between RECs and offsets for some of our listeners. One REC, a renewable energy credit, says that there is 1 MW hour of renewable energy that has been created. So, that can be from a wind turbine somewhere in west Texas to solar panels somewhere. One unit of renewable of energy has been created that you can then purchase and take title to, to reduce your electricity purchases. Your scope two or indirect greenhouse gas emissions. When you come looking at carbon neutrality, however, there are other parts of your operations. There is all the fossil fuel say from heating your buildings, process you use in your plants, fuel used in your vehicles. Those direct carbon emissions, those cannot be offset by renewable energy credits. You need carbon offsets for that. And carbon offset is a financial instrument that certifies that one ton of carbon has been offset by some technology. And that technology or use — it could be as low-tech as planting trees, it has “additionality,” meaning the carbon offset was beyond business as usual. Your purchasing the offset enabled that project to go forward, and those offsets tend to be significantly more expensive than renewable energy credits. Carbon offsets can vary widely in price, and since they are technically a financial instrument, they have supply-and-demand issues. More and more companies are saying they want to become carbon neutral can actually cause a supply shortage of carbon offsets and drive the price up. So, if you are looking at a strategy exclusively of carbon offsets to become carbon neutral, you may look at carbon offsets being a $1 or $2 per ton this year, going up to $10 or $20 or $30 a few years down the road. And that could really put a crimp in your ability to become carbon neutral.

Hagler       

Rich, I heard you say a couple of interesting things. One is you just defined additionality much more broadly than I think most companies think about. Certainly, a renewable energy credit is one new unit of renewable energy off created in the market because of that. But you are also talking about some other benefits that might come from buying offsets or specifically being more thoughtful about how you create the offsets and what you invest those in.

Goode        

Yeah, so we could look at this from a couple of different ways. One is some companies, and there really isn’t nothing wrong with this, they go to a clearing house or a broker and they’ll just say I need this many tons of carbon offsets, what can you do for me? And here is a low-price high-quality carbon offset and we’ll take it. But there can be other social co-benefits to carbon offsets that really help companies tell their stories. So, there is everything — if you look at something like the UN Sustainable Development Goals, some of their goals about alleviating poverty and clean water and clean air. Companies that align as part of their ESG and sustainability strategy and messages to the UN Sustainable Development Goals can then back up their commitment to those goals by purchasing high-quality carbon offsets that actually help enable those goals. So, for example, clean water or reduce poverty or reduce hunger, you can invest in carbon offsets that actually help accomplish those things. As these offsets that you may want become harder to get or more expensive, I think we are seeing companies saying, we are not going to rely simply on a market that we don’t really understand. So, often they are kind of saying, if I’m saying I’m going to be carbon neutral and I’m putting together a budget for $5 million a year for carbon neutrality to buy carbon offsets and then three years from now that $5 million may turn into $30 million? Well, I may have to rethink this as a strategy. And rather than reneging on a very high-profile public strategy, public commitment, you might want to go back and say we are going to do this ourselves. We are going to invest in reforesting farmland. We are going to protect this and the carbon offsets that come from it would simply be mine, and I’ll retire them rather than selling them on the open market. And that is sort just a few different strategies that we are seeing companies take on this.

Hagler       

I’m thinking that there is also the employee engagement side of this. So, I think you are right as companies set their ESG strategies and they can do some projects, they can implement some offsetting-type strategies that help support their more broad ESG strategy. Stephen, you and I worked on a project for EY Americas. We actually have implemented a virtual power purchase agreement to buy wind energy, and actually, I’m going to let you explain that project, Stephen. But would you also talk a little bit about the employee engagement side of it? Because our team really likes our windfarms.

Auton - Smith   

So, one of the ways in which you as a corporate entity can engage in the market is to enter into power purchase agreements with renewable energy developers. For entities which have a wide geographic spread of consumption, including and regulated and deregulated markets and for assets where we may not necessarily control the meter in our offices, a virtual power purchase agreement is often the way entities go and that is effectively a financial product term for contract for difference, whereby a corporate entity effectively guarantees a renewable developer a fixed-strike price for its energy. And that renewable asset is then financed off the back of the fixed-price commitment that the corporate makes, so the corporate gains the benefit of additionality. So, something new is built off the back of that contract. But it is a financial arrangement, and the location of that renewable energy asset can be completely independent of where the corporate’s energy consumption profile is and the arrangement sits on top of whatever existing utility arrangements of physical supply that the corporate might have. And the basic idea is that the renewable energy asset will sell into its local market in the real-time or the potentially day-ahead markets, and if the strike price for that energy that’s been agreed with the corporate is below the wholesale market price at that time, the renewable developer will pay the corporate the difference. And if the wholesale price is less than the strike price then the corporate will pay the developer the difference. So in effect, what the corporate is doing is selling a hedge to the renewable energy developer to enable it to build the asset and supply renewables to the grid, and the corporate gets project-specific renewable energy credits as part of that deal so that it can claim it is powered by renewable energy but can also point to a specific renewable generating asset from which it is powered. So, that’s the basic theme. There are a multitude of issues and risks associated with these kinds of agreements, which would probably be a spin-off podcast in its own right. But it’s been a key way in which major corporations can actively intervene in the renewable energy market to bring forward new capacity. And I think what is really compelling about this is you can point to something physical happening as a result of your actions. So, whilst it is a financial agreement and maybe accountants get excited about that, but most other people don’t. Being able to point to wind farms that are in construction and then in operations and then spinning is very energizing because people can see that something real has happened as a result of the actions of the entity. And I think whilst EY is engaging in many different activities to further its carbon-neutrality objectives, the wind farms are probably the most visible sign of that just by virtue of being able to see pictures of them in action. And I think that is quite inspiring for people.

Hagler       

So, you two have pulled out two things that I don’t know that I had anticipated going into this podcast. One of them is the reality of market forces. So, like everything else, like the business that we all operate in, market forces operate in the offset market, in the renewable energy credit market. The market supports renewable energy, more carbon neutrality — certainly it probably will make it easier for companies to achieve these goals. The other thing that we have really talked about is defining additionality more broadly. In terms of thinking about, yes, additionality in terms of reducing carbon, but also additionality from achieving other types of goals as well, whether they are specifically related to the Sustainable Development Goals or employee engagement and, potentially, Rich, as you were talking about, innovation. Some company business goals, as well, is a different definition of additionality. So, I really appreciate those two key thoughts that you all have really put a fine point on. I want to shift to really talking about what’s next. I feel like the market has shifted so much in the last two years. Companies making carbon neutral commitments, committing to science-based targets, 100% renewable energy, shifted so dramatically. Stephen, I would expect that there are new instruments that are being developed. Things that are coming down the pike. So, let’s shift to what do we see next as it relates to corporations making climate commitments and taking additional initiatives.

Auton - Smith

Sure, I can have a go at that first. I think the dominant form — I suppose the front end of a lot of sustainability strategies to date has been renewables. Taking us back to Rich Goode’s reduce, switch, innovate, and offset. What we have seen is a lot of that stuff happening in parallel. So, I think in many bigger organizations, the renewable energy offsetting or switching has either preceded or gone alongside the reducing and innovating, because in a way a large virtual power purchase agreement is a kind of a quick way of getting up the curve and making visible progress in a relatively simple and straightforward way. Whereas some of the — particularly if you are a manufacturing business, then some of the demand-side reduction stuff is much more complex and much more integral to your core business, which is an uncomfortable position for many to be in. But what I think we are seeing is those other aspects, reduction and the most sophistication in offsetting, catching up. So, I think renewables will continue to form a core part of corporations’ strategies going forward. And what we are seeing is a diversification of people participating in that part of the market. More and more corporations are starting to participate in that market at lower volumes using ever more sophisticated products. And those products are to some extent a response to risks, which were either not fully appreciated in the deals, but also, the increasing penetration of renewables into the grid, which are creating new volatility and price feedback loop risks which just didn’t exist a few years ago. But I think what I would say is the move will be to a greater mixed economy of product risk profiles and solutions, which corporates will need to utilize in order to manage their risk profile in the round. So, whilst maybe people were relying primarily on virtual power purchase agreements today, I think we will see people seeking to own renewable energy assets, invest their own capital to a greater extent; a great mix of virtual and physical delivery power purchase agreements; new retail products and green tariffs coming from regulated utilities as a way of meeting their customer demands. And we have seen a lot of that in some of the regulated markets in the US, where again, major tech companies have been lobbying utility commissions and their regulated utilities for renewable products that they can buy. And then I think at the end of this REC-purchasing will remain part of a top-up strategy to make sure that it all sums to 100%. But I think probably beyond all of that, there will be a much greater focus on Scope 3 emissions because many companies, the largest carbon impact is in the supply chain, and that supply chain is really where people are turning their attention to as a way of reducing the whole-life carbon impact of their business. And that is a much more complex, much more sophisticated series of actions than buying renewables or offsets for scope 2 emissions alone.

Goode        

Yeah, I couldn’t agree more, Stephen. The supply chain is one of those sort of areas that I think companies — like you said in the very beginning, my opening comment: sometimes you have an overenthusiastic CEO that just shouts we are going to become carbon neutral. Okay, great. What part of your business? All of it. Alright, let’s break that down. Just as a greenhouse gas primer 101, there are three types of greenhouse gases. Scope 1, your direct fossil-based emissions. Scope 2, your electricity purchases. And scope 3 is pretty much everything else. That’s where your supply chain is. And for most companies, supply chain is 80/90 even 95% of their overall emissions, right? So, if you are going to try and say I’m going to become carbon neutral even in our supply chain, you are talking about offsetting the emissions from other companies. So, you do have to be careful and deliberate about what you are saying you are going to offset. But for some companies who don’t have any manufacturing, they rely on outsourced manufacturers, they don’t own their own transportation, they don’t own their own warehouses, they don’t own their own retail stores. Really, they’re just a very, very large company that just is more about the innovation, has other people manufacture and ship and service their products. And I can think of several high-tech companies that have this exact same model. Becoming carbon neutral just in your own operations is really not very exciting, right? The advice I like to give to clients is be very deliberate about what parts of your business you are going to try and offset. Because you could really bite off more than you can chew or on the other side really come up with a goal that’s really not that exciting. So, supply chain is a key in part of this. And Chris Hagler  going back to your question, what’s next on the horizon for corporate climate initiatives. I also see a few other things that maybe fall into the category of risk. The first is the impact of the European Green Deal. And even though we’re here in the United States, most, if not all, of our clients are multinational corporations. You could foresee a future where you have corporations competing with country-level obligations under the Paris accord and the European Green Deal for carbon offsets. One famous coffee company says every year they get a shareholder resolution that says we want you to buy 100% fair-trade beans. And their response is the same every year. It says even if we bought every single fair-trade bean on the market, that would only account for 15% of overall coffee needs. There just isn’t enough out there, right? You could foresee something similar to that on carbon offsets. Where there is a dearth or a shortage of carbon offsets for companies simply because country-level commitments have purchased them all up. And that is where I also agree with Stephen, that you are going to see more and more innovation from companies. Just the example we used early where three or four companies developing and opening really what amounts to a shell company, but in the legal sense not the illegal sense, where the company’s sole purpose is to buy land, plant trees, harvest the timber, and create carbon offsets and then give those carbon offsets back to the founding companies to help them meet their carbon neutrality goals. That’s a really interesting way to spread risk and develop some carbon instruments to help them meet their carbon neutrality goals. So, in short, I think you are going to see more and more innovation, and it’s going to become integral to manage your risk while also meeting your public carbon neutrality obligations.

Auton - Smith  

I absolutely agree with that. And I think what we’re also seeing kind of aligned to that is a redefinition of what shareholder value, or value, means in some of these cases, because to pick up on a couple of your points, Rich, we were working with clients four or five years ago who just wouldn’t contemplate investing in renewable energy assets or offset projects because they couldn’t meet the threshold ROR, or rate of return, of a new product in a consumer products business, which is incredibly high. But suddenly, people are starting to redefine value in a way which allows them to deploy capital, or to contract with others who can deploy capital, in a way that facilitates the development of these projects. And I think that enormously encouraging because if you can bring a corporate kind of attitude, balance sheet, and mentality to some of these problems, you can make a great deal of progress. And thinking beyond a threshold rate of return on purely financial metrics is a great step forward.

Hagler       

A couple of the things I really heard you say, both of you, is first of all is how we see companies addressing and managing risks in their operations, in their value chain, and in their application of some of these climate solutions. I think it’s becoming more sophisticated, and it’s actually helping to create some innovation and some new ideas. I also heard you say we should expect to see much more innovation going forward as companies consider doing things on their own. Creating new products or new ways to sink carbon, and really, that suppliers will be creating new types of solutions for renewable energy that will help companies. Probably, we expect to see them have more of a mix of solutions as they go forward. Just some of the many things that I will think we will see, and I am looking forward to having this conversation with the two of y’all in a year or so to see what has changed. As you can imagine there are so many other things we can talk about, and I just want to remind our listeners that we actually have another podcast that we did with the CEO of the Rocky Mountain Institute, which will give you some other ideas as it relates to addressing climate commitments and climate change. But I think we could talk for hours about this, and I, again, look forward to talking to you all again in the near future as the market seems to be changing very, very quickly, and the options seem to be increasing as the market changes. So, thank you to both you, Stephen and Rich, for giving our listeners some practical advice, some ideas. Everybody, hopefully you wrote down RSIO to reduce, switch, innovate, and offset. Rich gives me a nickel every time I say that, so please continue to use that phrase going forward. If you would like to know more on this, EY has thought leadership in a couple different places on our website. We have the Sustainable Impact Hub, which has a lot of insight just in general on climate and sustainability. We also have a section on infrastructure, so it’s worth it to see what’s there. Please also follow me @Chris Hagler hagler on Twitter and send me your feedback on this podcast and any other topics you’re interested in. Please also follow @EY_Sustainable for all of our thought leadership there. And subscribe to this podcast series wherever you get your podcasts. Thank you.

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