Companies have a critical role to play in achieving the global aspiration of net-zero emissions—one that comes with vast business opportunities. In this episode of the Inside the Strategy Room podcast, Michael Birshan, global coleader of McKinsey’s Strategy and Corporate Finance Practice, and Anna Moore, who coleads the Sustainability Practice in Europe, discuss their recent research on ways organizations can seize the initiative to foster, and benefit from, a net-zero future. This is an edited transcript of the discussion. For more conversations on the strategy issues that matter, follow the series on your preferred podcast platform.
Sean Brown: How would you summarize the main message coming out of your net-zero research?
Michael Birshan: Our thesis is that companies should move from playing defense on climate change, which many have gotten quite good at, to going on the offense with the right net-zero strategies. Strategy fundamentals can guide companies through this era, just as they guided value creation in the dot-com era. There was genuine value-creation potential then but also value destruction, and the difference lay in those fundamentals.
Sean Brown: The world has become challenging this year, with the war in Ukraine and growing economic headwinds. Has that affected the momentum of this transition?
Michael Birshan: The situation is uncertain, but in the short term, we can expect more use of coal and shortages of some critical minerals given the proportion that come from Ukraine or Russia. At the same time, rising gas prices make renewable power and green hydrogen projects more attractive than before. Policy makers are recognizing the trade-off between cost-efficiency and resilience, which may well accelerate the energy transition momentum long term.
Sean Brown: What will it take to reach the international commitments around climate and what role do businesses need to play?
Anna Moore: We will need to spend much more on the transition than many were expecting, but that spending will create a lot of new value. We estimate that meeting the commitment to hold temperature increases below 1.5° Celsius would require $9.2 trillion a year in investment in transition technologies. That’s redirected investment, new investment, and continuing low-carbon asset allocations. This amount accounts for about 7.5 percent of global GDP. It’s the single largest asset reallocation in history. What that will create, however, is $9 trillion to $12 trillion in sustainable market value—new green growth value pools.
Sean Brown: Where do you see this investment being focused?
Anna Moore: There is the transition of existing technologies in various sectors but also in creating new services to facilitate the transition. For example, we see the emergence of entirely new markets such as carbon management and natural capital, which we estimate will be worth $100 billion to $200 billion annually [Exhibit 1]. Think of carbon accounting software, blockchain-based carbon traceability for materials like iron ore, carbon trading platforms—these are being developed as auxiliary services. Also important is a shift toward different end markets, such as a machinery-and-tooling business pivoting from serving oil and gas to serving renewables players.
But these opportunities aren’t one-size-fits-all. There will be successful last-man-standing strategies, for example. We anticipate that the share of conventional fuels in our energy mix will go from 84 percent today to 43 percent in 2050, but somebody will still have to supply that 43 percent. Furthermore, the total market cap of oil and gas players is rising even while this asset reallocation occurs.
Second, the transition will be spiky and there will be winners and losers. Even though we see ESG [environmental, social, and governance] funds outperforming, the headlines mask a lot of nuances. Take construction, for instance, where we expect an $800 billion to $1.9 trillion green construction market to emerge, yet you still see recent collapses of players that provide services for green construction.
Sean Brown: How urgent is it for companies to start making these investments now?
The window of opportunity on some of these green value pools is closing or will close by the end of this decade.
Anna Moore: The urgency point is critical. First, the window of opportunity is closing for us to rectify the climate problem as a society. Second, the window of opportunity on some of these green value pools is closing or will close by the end of this decade, because some of that value is created by supply-demand gaps that will disappear as people bring forward investments. That creates a first-mover advantage in many industries.
Sean Brown: How should companies approach the sustainability strategy that will guide their investments?
Michael Birshan: Ultimately, our guides are the fundamentals of value creation—free cash flow, return on invested capital, and growth. Business leaders need to evaluate how the transition will affect market attractiveness and their competitive position at a granular level.
Then, it’s about the corporate posture. There is an opportunity to move from what we might call “fatalistic” to “futuristic” mindsets in terms of the ambition. You often hear the transition presented as a headwind in sustainability strategy announcements: “We will lower our free cash flows but ensure we remain a going concern through the transition. We’ll survive but not necessarily thrive.” It crystallizes lower expectations. The opportunity, and the imperative, is to make the net-zero transition a tailwind. How does it drive up free cash flow and therefore valuation?
There is an opportunity to move from what we might call ‘fatalistic’ to ‘futuristic’ mindsets in terms of the ambition. The opportunity, and the imperative, is to make the net-zero transition a tailwind.
Sean Brown: What’s involved shifting from playing defense to playing offense?
Michael Birshan: In our view, playing offense involves pulling four levers [Exhibit 2]. The first one is portfolio strategy—what is in and out of your business portfolio. Do you have the insight and foresight about what will happen to the market structure and competitive landscape and therefore to the value creation in each of your businesses? Second, are you a natural owner of that business that can enable the next stage of its evolution?
Sean Brown: Great. What is the next lever?
Anna Moore: Many companies are building new green businesses. Some sustainability unicorns have multibillion-dollar valuations and many of these players are reaching scale faster than the incumbents. Established companies do face some challenges. For example, they have legacy brands that come with perceptions that are hard to shift, and building a new business requires a lot of capital investment. But incumbents also have three natural advantages. First, they can overcome that investment requirement by making use of existing assets. They may have product architecture platforms, for example, that they can piggyback on—which start-ups lack. Second, they can also tap existing capabilities, and finally, they have relationships both with suppliers, which can be hugely helpful, and with customers.
Sean Brown: Incumbents also have large staffs who have long focused on particular markets and a particular way of doing business. How do the leaders reorient the organization to different opportunities?
Anna Moore: First, including sustainability in the corporate purpose can be a huge advantage for attracting and retaining talent. Some businesses are also establishing nerve centers around sustainability. Think of the transition that safety went through 20 years ago, where previously one person in a plant was responsible for safety and now it’s part of everybody’s job. Similarly, we’re starting to see companies transition sustainability from a niche ESG topic to being embedded in how they operate.
Michael Birshan: Related to the safety analogy, that shift shows colleagues that there is a strong overlap between sustainable operations and efficient operations. I also wouldn’t underestimate education. There are many technical elements in this area, and people need to be brought along without being embarrassed that they can’t distinguish scope 1 emissions from scope 2 and scope 3.
Sean Brown: Michael, you earlier compared this transition to the digital transition. Do you find incumbents willing to cannibalize their legacy businesses as they try to build green businesses, as some did in the transition to the digital era?
Michael Birshan: It’s hard. When you look over the history of major transitions, most companies do not navigate those well. What’s easier for chief executives and boards is essentially to manage a gentle, stately decline, and it takes real leadership to not take that path.
Anna Moore: It’s an even harder choice when the risk to the business is not existential. If oil and gas becomes 43 percent of our energy supply, that’s half as many oil rigs in West Texas, so you need to evolve your business to become an energy player, not just an oil and gas player.
Sean Brown: Do you see many joint ventures and alliances in this arena? It seems a way to combine the best of what start-ups and large companies bring.
Anna Moore: Yes. In the aluminum sector, there are some interesting partnerships. We see research and innovation partnerships between incumbents and their customers, such as automotive OEMs partnering with more forward-leaning aluminum suppliers to create net-zero vehicles. There is also partnership across the industry through the Aluminum Stewardship Initiative [ASI], which is the industry standards body that enables aluminum producers to define what constitutes low-carbon and ultra-low-carbon.
Sean Brown: Let’s move on to the third lever, which is around green premiums. Could those premiums be a way to convince the skeptics to get on board with the transition?
Anna Moore: We are starting to see the premiums materialize. In plastics historically, virgin materials were worth more than recycled materials. Now, recycled polyethylene [PE] is worth over $1,000 a metric ton more than the virgin product. That’s driven by emission-reduction commitments of consumer products companies and by consumers preferring more sustainable options. It is a true green premium that is driving a shift in the plastics industry.
You see green premiums in heavy industries, too. In steel, we expect a 50 percent gap by the middle of this decade between green steel demand and green steel supply. That demand is driven by automotive OEMs, construction players, and government procurement—the UK, Canada, and Germany, for example, have committed to purchasing green steel as part of the Industrial Deep Decarbonisation Initiative, and account for about 25 percent of the steel sold in their markets. Consequently, we expect a green premium for steel of $200 to $350 a metric ton by the middle of this decade.
However, such premiums aren’t necessarily present in all industries. For example, we expect a less distinct green premium in copper, because the copper market overall is quite tight, it’s easier and cheaper to decarbonize copper than some other commodities, and it’s a smaller portion of emissions so manufacturers place a lower premium on it.
But, as I mentioned earlier, the window on the demand and the green premiums companies can charge will close. Over the past 24 months, multiple new green steel projects have been announced in Europe and as those plants come online, you will see the price gap close. By the end of the 2030s, we anticipate oversupply of green steel, so this is a time-bound opportunity that requires investment now.
Sean Brown: What types of products and services are generating the highest premiums? And are there some categories where consumers are not willing to pay more?
Anna Moore: It’s not as simple as consumers demanding green products. Time and time again, consumers have said they wanted green products, but they did not buy them if they had to pay more. However, we are starting to see more of consumers’ stated preferences materializing in spending and that will likely accelerate. We see consumers willing to pay premiums when there are supply shortages. However, the premiums need to be small enough shares of wallet.
I also want to call out the role of carbon pricing in many markets. For example, we expect that as EU Fit for 55 rolls out in Europe, €90–€100 per metric ton of CO2 would drive about a 70 percent increase in cement cost, at least until new green-cement investments come online. That would fundamentally reshape behavior and pricing, and together with border adjustment mechanisms, will reshape cost curves in many industries.
Sean Brown: Are the opportunities to play offense on net zero available across all regions or principally in the advanced economies?
Michael Birshan: There is opportunity in all regions but it is region-specific in terms of supply–demand balance and consumer preferences. We are absolutely seeing ambitious sustainability transformations in emerging markets. Incidentally, this was also true in the digital transition, where some emerging-market companies looked to what others were doing, then did it bigger, faster, and better. Additionally, as you think about security of supply, carbon border adjustments, and other potential challenges, net-zero strategies become part of the industrial logic of trade.
Anna Moore: The net-zero transition is a truly global phenomenon backed by serious global commitments. Many supply chains that are needed to unlock these opportunities are global supply chains. Within extractive industries, there will also be a need to ensure that this is a global transition rather than an end-point-of-production transition. CBAM, or the Carbon Border Adjustment Mechanism in the EU, and similar legislation reward suppliers globally for decarbonizing their operations, so Brazilian steel becomes more competitive in Europe than a lot of domestic production because of Brazilian producers’ reliance on hydropower. These policies serve as incentives for decarbonization globally.
Sean Brown: Let’s move to the last value-creation lever—green operations. What opportunities does that present?
Anna Moore: It is trite but true that green is lean. Throughout this conversation, we have been trying to convince you that the opportunity is on the top line. Net zero is an opportunity on the cost side, too. Many abatement technologies already pay for themselves, or more than pay for themselves. We estimate that more than two-thirds of emissions globally can be mitigated with technologies that already exist, and companies should keep an eye out for efficiency gains in addition to decarbonization impact.
Sean Brown: How should business leaders convey the investments in the transition to the markets? In other words, how do you craft the value creation story?
Michael Birshan: The tipping point varies by sector, but we see companies starting to benefit from re-rating when they can credibly demonstrate that they have transitioned enough of their portfolio [Exhibit 3]. On the equity stories, three things can be helpful. One is demonstrating with rigor and in detail the continued resilience of the core business and where there might be price spikes, for example, that lead to periods of unusually high value creation. The second is about conveying that you are playing offense, being leveraged to the upside of the transition. The third is capital discipline, whereby management is hunting for value in both green assets and some brown assets.
Sean Brown: As business leaders weigh different net-zero strategies, what questions should they be asking themselves and their teams?
Michael Birshan: There is a competitive advantage in climate literacy, in really understanding the nuances. Is that capability being built up in the organization? Do you have a strategy for attracting and retaining sustainability talent? Also, many of the opportunities require experimenting. The partnerships Anna talked about can be creative and complex. Does your organization encourage innovation around the response to the climate crisis or does it stifle creativity?
Sean Brown: You talked about green premiums, which would come on top of spiking inflation today. How do we ensure that this transition doesn’t penalize the most economically disadvantaged?
Anna Moore: Fundamentally, we are pricing externalities—putting a price on carbon and other environmental effects. That has societal implications around who bears the cost. We are seeing more government subsidies for households and I think companies will be mindful about which goods to attach green premiums to and which costs not to pass onto the consumer. Another element is making sure that decarbonization investments benefit communities in developing markets—that you are decarbonizing the plant in Southeast Asia as well as the one in the US, and that you invest in well-paying jobs in sustainable industries throughout your global supply chain. Companies are facing public scrutiny.
Michael Birshan: The inclusion challenge requires deep focus. How can you innovate to make things cheaper for consumers? How does that link to sustainability? But employees, investors, and the wider society are expecting corporations to deliver sustainability and inclusion and growth. That’s the management challenge for this era.