Leading through uncertainty in the energy and materials sectors

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Energy and materials markets are inherently complex. But today those complexities—and their attendant uncertainties—are multiplying like never before. Alongside classic risks, such as geopolitics and shifting regulations, new challenges and opportunities are emerging as the world transitions to a more sustainable, lower-carbon future.

The petrochemical industry is pushing to reduce its carbon footprint, while materials companies seek differentiated products based on green characteristics.1Capturing the green-premium value from sustainable materials,” McKinsey, October 28, 2022; “Decarbonizing the chemical industry,” McKinsey, April 12, 2023. New markets may demand new business models. Success in the emerging hydrogen economy, for example, is being facilitated by partnerships across the value chain, while in the minerals sector, companies and their customers such as OEMs are collaborating to invest in innovation. Overall, business models seem to be shifting from a commodity-based focus to a specialty product- and value-based approach.

Sustainability is a particularly important—and complex—topic for energy and materials companies and requires a heightened ability to discern substantial market shifts from industry noise. Today, investors want more than pledges and targets; they expect leaders to formulate concrete strategies and demonstrate a track record of capturing bottom-line value as the accelerating transition unfolds.

Against this dynamic backdrop, what is most important to help leaders build confidence and conviction to set a direction and take action? A key answer, we believe, is to adopt what we call the “strategy under uncertainty” approach.2The new imperative for green commodities,” McKinsey, August 18, 2022.

This approach requires more granular scenario-based methods of strategy formulation. Based on our work—and that of our colleagues—with leading energy and materials companies, we have codified a rich process for strategy development and capital reallocation that companies can use to respond more effectively to the forces of cyclicality, market complexity, and regulatory change, as well as trends such as material substitution and commoditization.

The payoff in getting this right is two-fold: first, the resulting strategy should be more robust across a range of future scenarios; second, it is more likely to be recognized as value creating by capital markets, which, in turn, translates into multiple expansions and higher valuation.

In this article, we highlight three steps that capture essential aspects of our larger, more complex strategy process. Specifically, these steps can help business leaders of energy and materials companies identify what opportunities to pursue, decide how to enter new markets, and determine when to act.

What to pursue: Take a granular look

Tried and tested strategy principles show that the best value-creation opportunities are usually company specific, rather than generic, as they tap a company’s true sources of advantage. A more granular view can map opportunities to internal capabilities and help companies assess the value at stake, for instance, by considering: i) risks to the core business portfolio, such as product substitution or demand decline; ii) opportunities for decarbonization and resource efficiency in core products and operations; iii) opportunities to attract premiums; and iv) opportunities for scaling new green businesses.

When it comes to evaluating demand and gaining an in-depth understanding of customers’ preferences for sustainability, factors for consideration include customers’ willingness to pay for sustainable offerings—which may differ by market segment, sources for regional or environmental, social, and governance (ESG) premiums, addressable volume, the timing of need, and the impact of policy. On the supply side, details could include materials and feedstock availability (as well as their accessibility), cost and economics of procurement, upfront investment, and the maturity and scalability of technology.

A granular look at Fortune 1000 companies in hard-to-abate industries shows how investments in the energy and materials transition can boost both the top and bottom lines. Companies that demonstrate strong exposure to sustainability-linked end markets, such as bio-based ingredients, uranium for nuclear, or lithium for batteries, enjoy valuation premiums (Exhibit 1).

The market appears to reward playing in the tailwinds of the transition.

How to enter: Factor uncertainty into strategic choices

Having identified and assessed opportunities, companies can categorize these according to three types of strategic choices, each of which balances sources of uncertainty, costs, monetization potential, timeline, and risk:

  • No-regret moves. Such opportunities are value-accretive across most, if not all, scenarios and can be acted upon at any time.
  • Shaping moves. These include strategic choices that need to be made ahead of time in the face of uncertainty (if the upside justifies the risk) and cannot be easily undone without financial or reputational consequences. Small positioning actions and investments—such as capability building, minority-stake investments, and carbon reporting—can help derisk shaping moves and preserve the right to act later.
  • Future moves. These include scenario-dependent choices that would be triggered by specific circumstances.
Solar energy and wind power stations - stock photo

The net-zero materials transition: Implications for global supply chains

Consider the example of an independent exploration and production company in the process of becoming a carbon-management company to diversify its portfolio and achieve Scope 3 emissions reductions, while maintaining its business in the oil and gas sector. The company made “shaping moves” by investing in carbon capture and utilization technologies, such as clean fuels, that aligned with its goals. Regulatory tailwinds such as the Section 45Q Credit for Carbon Oxide Sequestration that provides a tax credit for CO2 storage—and carbon capture, utilization, and storage hub funding—bolstered its position and the company is anticipating increasing demand for (voluntary) carbon offsets or reductions.3

To gain recognition by capital markets for creating value through sustainability, companies need to demonstrate that they have turned a sustainability-related proposition into a margin advantage that can scale. Rerating may take time to achieve. A material portion of the overall business portfolio in green investments could signal to investors that sustainability is a core strategic priority and that there is a pathway to scale (Exhibit 2).

For incumbents, recognition by capital markets for going green can take time.

In the energy transition, creating an enduring advantage that can support margins over time is a tough task to get right. There are three approaches companies can take to do so, outlined in the sidebar, “Three paths to creating value by making sustainability a core priority”. A strong environmental, social, and governance (ESG) proposition can also create value by helping companies tap into new markets, reduce costs (for instance, through energy and water efficiency), and reduce legal and regulatory interventions.4Five ways that ESG creates value,” McKinsey Quarterly, November 2019.

Companies could derisk market entry, for example, by rethinking business models across an ecosystem. An ecosystem of partnerships often distributes risk and reward among players—sharing the risk posed by uncertain price points, materials availability, technology readiness, and evolving policy, while ensuring access to potentially volatile or scarce segments of the value chain. For instance, in the hydrogen market, new entrants are forming partnerships along the value chain—in production, transport, and commercial infrastructure—to build the ecosystem and collectively develop the market for all players, defining business models along the way.

When to act: Identify potential signposts and trigger points

Signposts are markers based on a company’s strategy that indicate when it should consider investing or divesting from a market, segment, or product. Signposts can also indicate the right time to scale up investments or when strategic positioning moves can be turned into shaping moves. For example, investment in gasification to produce biofuels could depend on the development of scalable gasification technology, government incentives or mandates for advanced biofuel feedstocks, demand for advanced feedstock biofuel products, and low-cost supply of cellulosic feedstocks.

Trigger points define the conditions under which an organization is prepared to act and what market conditions would change the strategic direction of the company. In the gasification example, trigger points for investment could include a full-scale gasification plant coming online, a government mandate that a certain percentage of fuel must be derived from cellulosic feedstock, customers making public commitments to fuel 10 percent of their fleet via fuels from gasification, or competitors beginning to acquire cellulosic feedstock aggregators to secure their supply.

Fewer well-defined, high-quality signposts are generally a better aid to decision making than many ill-defined ones, as monitoring too many signposts creates a fog that obscures the most important changes in the landscape. For example, signposts related to energy-transition scenarios could include the percentage of electric vehicle sales or the share of alternative fuels used in aviation. By monitoring these indicators, companies can assess changes in oil demand that could help to define their next moves (Exhibit 3).

In an accelerated transition scenario, drivers could trigger an extra 29 million-barrels-per-day demand disruption.

In the face of uncertainty, a blanket “wait and see” approach can feel comforting but carries risks. Without decisive action, companies could lose entry to control points along the value chain (such as feedstocks, infrastructure, and access to customers) as competitors secure their positions. Companies could also miss a window of opportunity due to long lead times for project delivery. “Act and adjust” may be the more prudent mantra than “wait and see.”

Making large-scale portfolio changes takes time, especially for organizations with substantial legacy businesses that eclipse the small—if fast-growing—revenues from nascent sustainability investments. But time is of the essence. For energy and materials companies to create value in volatile times, it is important to make shaping moves now and to react quickly and intentionally if trigger points are met.

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