Morningstar Sustainalytics’ Low Carbon Transition Rating (LCTR) assesses how companies were doing on identifying and managing their climate risk and their progress toward addressing the Paris Agreement’s goal of limiting global warming to 1.5°C. We take a closer look at the leading industries and their best practices.
Best Practice One: Set reduction targets for GHG emissions
A focal point of the LCTR for assessing a company’s low carbon transition centres on whether a company sets a target to reduce its greenhouse gas (GHG) emissions and how robust these targets are. Just over a fifth of the companies we have assessed have set some kind of GHG emissions reduction target. Containers and packaging (46%), paper and forestry (41%), household products (39%), telecommunication services (35%), automobiles (32%), and textiles and apparel (32%) are among the top six industries in disclosing their GHG reduction targets (Fig 1).
Leading companies have high rates of setting absolute emissions reductions targets. A large proportion of these companies also have targets to reduce the GHG intensity of their emissions. There are a few companies in these industries which have only intensity-based targets, but they remain exceptions.
In most cases, leading companies and industries have GHG reduction targets aligned with either a deep decarbonisation or a moderate decarbonisation pathway; i.e., aligned to a 1.5-degree or 2-degree trajectory, respectively (see Fig 2). More companies are aligning their targets with deep decarbonisation pathways and getting their targets verified through the Science Based Targets initiative (SBTi).
In leading industries, we see a higher proportion of companies with verified science-based targets, particularly aligned to deep decarbonisation and a move away from moderate decarbonisation. Industries such as containers and packaging (46%), household products (33%), telecommunication services (28%), textiles and apparel (24%), and automobiles (32%) also have the highest proportion of companies with verified science-based targets.
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One area where leading companies stand out is in setting and disclosing specific scope 3 emission reduction targets. Implementing scope 3 targets requires significant engagement with suppliers, as well as work towards reducing downstream product emissions — often through changing the products sold or substantially redesigning them. While only 15% of the companies assessed in the LCTR universe have specific scope 3 reduction targets, leading industries have about 30% of their companies setting scope 3 targets.
Best Practice Two: Link board and executive pay to GHG reduction targets
Across the entire LCTR universe, only about 8% of companies have some disclosure on the link between performance on GHG reductions against targets and senior decision-maker incentives. Oil and gas companies are under increasing pressure to decarbonise their products and operations, transition away from fossil fuels and become providers of clean energy. In this context, it is unsurprising that they lead (25%) on linking decision-makers’ incentives with progress against the company’s GHG reduction targets. We also see other top performing industries such as aerospace and defence (18%) and containers and packaging (17%) leading on this indicator.
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Most commonly, we see that a firm’s top decision-makers such as the board and/or the CEO are the ones whose incentives are linked with achieving emissions reductions. But it is still uncommon to see these targets percolate down from the board to individual business units.
Beyond setting targets, decision-makers also need to have adequate understanding and resourcing to draft actionable transition plans. Over a quarter of the companies in the LCTR universe have a dedicated senior person with the responsibility to oversee emissions reduction efforts. A third of the companies have also appointed a board member who has some experience with business transformation or climate-related matters. However, only 3% of companies have provided the board with some form of training on the climate transition. While over 10% of boards claim to consult with internal and external stakeholders on matters related to climate and the transition that may affect the company or its stakeholders, the nature and details of these consultations remain vague.
Best Practice Three: Integrate carbon pricing
Another crucial element in ensuring that companies are adequately preparing for the low carbon transition is whether they use carbon pricing to make business decisions — especially ones that will have a longer-term implication for their business. It is important for businesses to anticipate future regulations such as a carbon tax or cap and trade market mechanism. Using internal/shadow/modelled carbon prices allows businesses to account for future cash outflows based on their emissions.
When it comes to instituting and reporting on integrated carbon pricing, high-emitting and harder-to-abate industries tend to dominate. Oil and gas producers (28%), automobiles (23%), construction materials (20%) and utilities (20%) lead in stating that companies use an internal carbon price in decision-making. There are not many commercially viable or scalable solutions available, but companies in these industries are doing well to incorporate carbon pricing into their decision-making in anticipation of global price regimes for their products.
Best Practice Four: Set out a long-term sustainable finance strategy
Among the companies assessed, over 10% have issued green bonds or loans to aid the investments required for greening their processes, infrastructure and products. Green bonds seem to be a more popular way to raise green capital among utilities (41%), real estate (31%), automobiles (29%), insurance (22%) and steel companies (21%).
Green bonds are a means for utilities to set up renewable energy capacities and real estate to help develop green and energy-efficient buildings. Automobile companies seem to be largely utilising green bonds to set up energy-efficient manufacturing lines for zero- and low-emission vehicles. Steel companies typically use green bonds to set up electric arc furnaces and, in some cases, pilot plants that reduce iron ore using hydrogen. The insurance sector is an outlier in this regard, as its focus is on issuing green bonds mainly to support the diversification of its investment portfolios.
Despite the popularity of green bond issuances, which typically mature after seven to eight years, there is fairly low disclosure on medium- and long-term climate transition plans and forecasts, even among leaders. The only exceptions are with utilities, steel and automobiles. This seems to be driven by the fact that these industries are mostly directing their sustainable investments/green bond proceeds towards their own longer-term manufacturing (i.e., automobiles and steel) or economic infrastructure (i.e., utilities).
Best Practice Five: Adopt green technology
Across the LCTR universe of companies, we see that waste heat recovery and utilisation (10%) and smart technology for energy savings (13%) are the most popular low carbon innovations being adopted. This is due in part to the scientific processes and technologies for these innovations being quite mature. The next most popular innovations are focused on the production of green hydrogen and setting up carbon capture, utilisation and storage (CCUS) technologies. CCUS and green hydrogen are particularly popular among the oil and gas production as well as refiners and pipelines industries.
While green hydrogen is a top contender as a fuel to replace oil and gas, CCUS will help oil and gas companies to continue selling the same product while reducing the level of carbon being released into the atmosphere. Green hydrogen is also an innovation being targeted by nearly 10% of utilities, as it helps with energy needs such as heating and storing intermittent renewable energy.
Best Practice Six: Focus on supply chain emissions
An important aspect of the LCTR is its focus on companies’ supply chain decarbonisation plans. As with their own operations, this is centred around setting targets to reduce emissions from scope 3 emissions. For upstream emissions, the LCTR looks at targets set by companies to reduce their supply chain emissions. Industries such as construction materials (32%), textiles and apparel (25%), and household products (24%) continue their leadership in this area. However, not all companies setting supply chain emissions reduction targets align them with the 1.5-degree goal. We see this even with the SBTi, where there are many companies which have scope 1 and 2 verified targets, but have not had their scope 3 targets verified.
Beyond setting targets, we see that only 8% of companies engage their suppliers to set GHG reduction targets and report their GHG emissions directly to the companies. Also, only 2% of companies require their suppliers to engage with their own suppliers on emissions reductions. Industry leaders all have large and complex supply chains, making having a supplier engagement programme a necessity. Such programmes typically cover more than just emissions reductions and include social and governance aspects as well. There are many companies (not scored for this indicator) which have supplier engagement programmes, but do not specifically address GHG reductions.
The need to catch up now
The companies that consistently employ most of the best practices covered above form less than 10% of the universe of 8,000 assessed companies in the LCTR. They are largely concentrated in only a handful of industries. Many of these leading industries are not amongst the highest emitting industries. It is therefore imperative that all companies, particularly those in the highest emitting industries, reflect on these best practices and take action to manage the most crucial parts of their exposure to climate risks.
Pustav Joshi is associate director of Climate Solutions
