Environmental, social, and governance (ESG) scoring and disclosures have widespread support as the means to achieve zero greenhouse gas (GHG) emissions—the Global Net Zero Economy transformation. However, sustained economic and societal progress have always been driven primarily by innovation, not by keeping score. The recent SEC proposal for detailed and mandatory environmental reporting may have an unintended consequence of creating a blind eye for the kind of innovations that would actually deliver significant emission reductions.
Cost-effective technologies evolve over time through the interplay of R&D advancements, competition, and increased adoption, which leads to declining costs. Heliogen has developed a closed-loop electrolysis system that utilizes sunlight to generate green hydrogen. Small modular (nuclear) reactors, being commercialized by NuScale Power and others, could also produce green hydrogen through the electrolysis of water and are well suited to replace coal and natural gas turbine fired electricity plants. As new technologies evolve, so too will competition for electric battery vehicles. For example, the longer the trip and the heavier the vehicle, the more competitive hydrogen-powered vehicles (including trucks and trains) become.
Currently, thirty countries have announced hydrogen transition strategies. The scale of the hydrogen economy that emerges in the future is heavily dependent upon firms’ success with innovation, including not only out-of-the-box-thinking startups, but also from established firms with proven capabilities, substantial financial resources, and a strategic leadership capacity to seize innovation opportunities to lead the Net Zero transformation.
ESG scores can easily miss how top management has evolved their firms’ business models to seize opportunities to reduce their customers’ emissions while creating value for their own firms. Net Zero innovations depend on smart managements who may well lead firms not necessarily higher-ranked for their ESG scores from rating organizations who don’t really understand the real value drivers in the firms’ business models.
For example, typical of large oil and gas companies, which invariably have low ESG scores, Occidental Petroleum has a problem and an opportunity. Stock prices imply expectations of returns on future investments to be less than the cost of capital, with the flip side an opportunity to gain substantial market value by giving investors reasons to forecast returns at least equal to the cost of capital on future capital expenditures. The key here is to make new investments that can meet the cost-of-capital criterion at scale—new, big market opportunities. These opportunities exist in hydrogen, small modular nuclear reactors, carbon capture/storage, zero emission steel and cement plus other hard-to-decarbonize sectors, and new ways to utilize carbon dioxide and avoid releasing GHG emissions in the atmosphere. Occidental Petroleum is investing in many of these areas and utilizing its core competency in carbon dioxide management. Occidental Petroleum has partnered with a Canadian company, Carbon Engineering, to construct the world’s biggest Direct Air Capture plant that will capture and permanently sequester carbon dioxide from the atmosphere.
As another example, Honeywell recently received an “F” score as to its GHG disclosures, targets, and reductions from the well-known, pro-ESG advocacy organization As You Sow. Given Honeywell’s deep knowledge of customer needs coupled to the firm’s innovation capacity, you might expect that top management’s decision, with board capital allocation approval, to commit 60% of its R&D budget to help customers innovate and reduce emissions would have yielded results. You would be right. The use of Honeywell’s Solstice line of low global warming refrigerants, propellants, and solvents results in emission reductions equivalent to removing millions of cars from the road. The firm has developed sustainable aviation fuel that would replace hydrocarbon jet fuel. Honeywell’s green diesel fuel reduces GHG emissions by 80%. The firm’s unique flow battery technology is on a trajectory to enable large-scale renewable energy storage. But none of these innovations favorably impact its ESG scores as currently measured and reported by third party entities.
Management and boards of directors have a fiduciary duty to develop and communicate credible (and even legally defensible) transition plans—not just targets—to achieve their Net Zero goals while still earning at least their cost of capital, even under multi-decade scenarios that include a price (tax) on carbon. Comprehensive Net Zero transition plans would illuminate not only investment in energy efficiency processes and internal GHG emission reduction programs but also new investments that may generate breakthrough innovations that significantly facilitate their customers’ ability to achieve Net Zero.
