Changing the C-Suite Mindset on Scope 1 and 2 Financing

This blog was coauthored by Viktorija Stojcheva and Michael Pita.

Decarbonization Projects Drive Reduction of Scope 1 and 2 Emissions but Experience Financing Challenges 

Companies are setting net-zero emission targets and aiming to reduce Scope 1 emissions onsite and Scope 2 emissions of procured electricity to limit the world’s temperature increase to 1.5°C compared to pre-industrial levels. However, most decarbonization projects require capital investments and are often complex. For Scope 1 emissions, projects often include electrification of fossil fuel-dependent operations, such as replacing boilers, furnaces, and thermal processes. For Scope 2, transitioning to renewable energy requires understanding geographical markets and regulatory frameworks, and also involves additional costs in procuring or generating guaranteed renewable electricity.

Decarbonization Projects Operate Outside Typical Financing Parameters

Misconceptions exist around decarbonization projects as they typically do not fall within regular financing parameters. Historically, capital investments from companies must be paid back within 3 years; for more aggressive companies this may be required within 18 months. Decarbonization projects generally do not adhere to these timelines. For example, commercial solar PV installations are site- and geography-dependent and typically have a payback period of 5–10 years. This timeframe puts them outside of conventional investment parameters, despite having the ability to reduce electricity costs in the long-term. Besides, decisions on electrification in manufacturing companies are often challenging as complex process changes are needed. However, when electrifying production processes, setpoints (temperature and velocity) are rarely affected when reducing costs and carbon.

Recalibrate Investment Criteria to Include Carbon 

As decarbonization projects are often beneficial financially and strategically, the challenge for organizations is changing conventional mindsets. This starts at the C-suite level. Investing in decarbonization is rarely prioritized, as payback periods and ROI can differ from regular investments and changing processes can result in unforeseen complexities. Further, internal competition for capital is present in many industries. Capital in manufacturing industries historically has been spent on process-related improvements such as overall equipment effectiveness. 

C-suites need to recalibrate these investment criteria and see carbon as both a risk and cost in capital evaluations. Inactivity can also result in financial risks, such as transition risks related to societal changes as we move toward a low carbon economy. If C-suites look at alternatives to finance decarbonization, then it leads to innovative financing solutions and expands long-term planning. Companies can decide to put these investments on- or off-balance sheet. For on-balance sheet investments, the company recognizes that traditional criteria on topics such as payback should be changed. For off-balance sheet investments, the company recognizes they are entering a long-term engagement with third parties that could exist for more than 10 years.

Guidehouse supports companies willing to invest in innovative off- and on-balance sheet solutions, helping companies confirm the investment they put into decarbonization activities pays off faster, minimizes future risk, and avoids effects on internal capital. The following six elements often determine decisions for financing decarbonization projects:

1. Weighted Average Cost of Capital of the project
   
2. Internal competition for capital
   
3. Risk appetite of the business
4. Importance of decarbonization for the future of the business
   
5. Competitor and market behavior
   
6. Consumer attitude toward decarbonization
   

Changing the C-Suite Mindset Opens Opportunities

Companies’ C-suites must think long-term to foster decarbonization projects. Traditional investment parameters like payback periods often put decarbonization projects at a disadvantage compared to other investments. Using the six elements listed above, companies can finance innovative solutions off- and on-balance sheet, supported by third parties and financing partners.