Given its reliance on fossil fuels to meet energy demand, the power generation sector is responsible for an outsized portion of global greenhouse gas emissions.

Massive investment, therefore, will be required to transition the power sector. According to a report co-authored by Boston Consulting Group (BCG) and the Global Financial Markets Association (GFMA), an estimated investment of over $50 trillion will be needed globally over the next three decades to increase renewables capacity and improve grid flexibility and reliability.

Europe Outpaces the U.S. in Renewables

In other words, it’s an opportunity for private capital to participate in the decarbonization of electricity grids. The shift is fueled by a push to reduce GHG emissions to meet increasingly stringent carbon reduction targets. In the U.S., for example, some states have legislated requirements for electric and gas utilities to reach a net-zero goal. Moreover, renewable portfolio standards, which are policies designed to increase the use of renewable energy sources for electricity generation, have now been adopted by over 60% of U.S. states. Yet, relative to Europe, the U.S. still has work to do; the EU’s new 2030 climate target plan will further accelerate the deployment of renewables.

Markets are also increasingly rewarding businesses that are decarbonized or are on a pathway to meeting net-zero targets through valuation premiums and reductions in the cost of capital. For example, RWE, one of Germany’s largest utilities, transformed itself into Europe’s third-largest renewables player following a 2019 asset swap with E.ON. RWE’s decision to increase its renewable power assets, made in tandem with its plan to eliminate coal, set the business on a net-zero path. Subsequently, RWE’s valuation metrics improved.

A successful transition relies on power and utility companies transforming their generation mix to significantly favor renewables or low-carbon energy production. In the U.S., Rift Alliance forecasts wind and solar power capacity additions of 463 GW by 2035; this would represent a 262% increase in capacity from 2019 levels. Some of these companies have the capital and skills to do it themselves, but many do not.

Utilities Need to Reduce Emissions Quickly

For a U.S. utility that generally operates under traditional rate base/rate of return regulation, the next questions that follow are: Will the regulator allow that utility to recover the cost of new generation investments from ratepayers? Will the regulator let the utility use ratepayer money to figure out how to decarbonize? Or would it reject that capital plan, fearing cost overruns?

The more attractive solution might be to have an experienced third-party company bear that risk. Not only does this leave taxpayers out of the equation, it comes with other clear advantages. These types of operators often already have deep relationships with original equipment manufacturers (OEMs)—companies like GE and Siemens that not only build equipment like generators and turbines, but then put them to work. These relationships can help smooth the process of coming to a commercial agreement and solving any problems along the way.

Of course, some power users will not want to wait. Those with large Scope 2 emissions will seek more distributed generation with dedicated renewables capacity. Meanwhile, providers that can offer solutions in multiple geographies will likely earn a premium.

To some extent, the opportunity set to transform businesses is simply where the emissions are. With that in mind, heavy industries, like steel, cement and long-haul trucking, are ripe for transition.

Opportunities to Decarbonize Heavy Industries

Steel

Steel is vital in modern economies. It’s used in the construction of buildings, bridges, cars, trucks and wind turbines. Global demand for steel has increased more than threefold over the past 50 years—and will continue to rise as economies grow, urbanize and enhance their infrastructure.

According to the International Energy Association (IEA), the iron and steel sector is responsible for about 8% of final global energy demand and 7% of energy sector CO2 emissions (including process emissions).¹⁷ Among heavy industries, the iron and steel sector consumes more energy than any other sector besides chemicals (see Figure 6a). But the issue—and opportunity—is around its use of coal. This is because the steel sector is the largest industrial consumer of coal; in fact, coal provides almost 75% of the steel sector’s energy demand.

Coal is used to generate heat and to make coke—and coke is the fuel instrumental in the chemical reactions needed to produce steel from iron ore in blast furnaces. However, the unavoidable byproduct of these reactions is carbon dioxide.

Surveying the landscape of heavy industries, when it comes to CO2 emissions, the iron and steel sector comes in first, generating 2.6 gigatons of carbon dioxide (Gt CO2) emissions annually.

Decarbonizing Steel Requires More Electric Steelmaking—and More Renewables

Cement

Cement is essential, but it’s also highly carbon intensive. The industrial process that yields cement accounts for 8% of global greenhouse-gas emissions. In fact, if cement were a country, it would be the world’s third-largest emitter, behind China and the U.S. But what if the cement-making process evolved over the next decade such that the carbon emitted precipitously dropped?

The implementation of carbon capture and storage (CCS) is one possible solution. CCS is the process of capturing CO2 formed during power generation and industrial processes—and storing it so that it’s not emitted into the atmosphere. While carbon capture technologies are already used in various industrial processes, they could also apply to cement. HeidelbergCement, for example, is building an industrial-scale CCS plant in Brevik, Norway. When the facility is finished in 2024, the end result will be a 50% cut in emissions from the cement produced at that plant.

Transportation

Emissions in the transportation sector—which accounts for 16% of the energy sector’s GHG emissions—come from the use of internal combustion vehicles powered by fossil fuels. But the decarbonization pathway differs depending on the type of vehicle. For short-haul vehicles, the solution is to replace the fleet with electric vehicles. For long-haul transportation, like trucking and aviation, it will require the use of green hydrogen or biofuels.

For short-haul vehicles, the trends are already moving in the right direction. Governments are implementing climate-friendly policies to drive business transformation. The U.K.’s pledge to phase out all sales of cars using only petrol or diesel by 2030 is a strong example. In February 2021, Ford declared that it will stop selling cars in the U.K. and Europe with any form of internal combustion engine by 2030.

Competitive realities, as well as broader consumer acceptance of electric vehicles, are also spurring progress. General Motors announced its plans to get out of the internal combustion game—and sell only zero-emission cars and trucks by 2035. Volvo has said it would be all-electric by 2030. Meanwhile, Volkswagen plans to sell 1 million electric or hybrid cars this year—a near-tenfold increase since 2019.

Green Hydrogen Is a Completely Clean Form of Energy

Oil & gas companies will need to transition their businesses to a lower-carbon future. According to the IEA, 15% of global energy-related GHG emissions come from the process of extracting oil and gas from the ground and transporting it to consumers. However, this figure doesn’t include Scope 3 emissions, which will thus lead to a step change in how oil & gas companies think about the transition.

Energy majors have been among the most innovative companies of the last century; as evidence, consider the recent shale gas revolution. They will have to use this expertise to reposition themselves to become the producers of carbon-free power generation that will support the next century. First, they need to decarbonize the production and transportation of fossil fuel energy as much as possible. And second, to maximize the returns on their existing assets, they’ll need to develop lower carbon solutions that include CCS and hydrogen.

Therefore, the opportunity here is to help these companies quickly invest in what might be non-core today but will be core in the future. BP, for example, plans on cutting its fossil fuels production by 40% by 2030, and will simultaneously increase spending on low-carbon technologies. The net effect of these efforts could be a 30% reduction in BP’s greenhouse gas emissions.

Yet, for carbon-emitting companies that cannot adapt, the net effect of carbon prices will be declining margins, thus pressuring cash flow and impacting the value of their businesses.

Capital markets, of course, have already taken notice. Over the past decade, the market capitalizations of some oil & gas supermajors have drifted lower.

To be clear, oil is not going away any time soon. Therefore, finding ways to reduce the amount of carbon the oil & gas industry emits into the atmosphere is part of the solution. Companies are beginning to understand that decarbonizing their businesses is part of their value proposition to investors. But many of these businesses need a partner with experience to help them put a net-zero plan in place—so they can start their decarbonization journey.

It is likely these oil & gas companies will be incentivized to participate with a solutions provider, and share in the economics, because they want to protect, or enhance, the long-term value of their existing franchise.

But importantly, once oil & gas companies see a way to deliver their products in a decarbonized manner, in scale, they will see the benefit in investing in technologies that might be slightly uneconomic today—like CCS or green hydrogen—because it gives them a viable path to realizing value from their existing assets over a longer period of time.

Rift Alliance, in its base case, forecasts that energy, together with chemicals and power, addresses a $225 billion market globally for CCS in 2050. Among global CCS capacity, Rift Alliance notes that approximately 50% is in the U.S. Much of this is synergistic with existing businesses—captured through natural gas processing and sequestered in enhanced oil recovery.

Furthermore, as oil & gas companies look to “green up” their business for the energy transition, their midstream assets could be converted into critical infrastructure of new technologies. However, the commercialization of a technology like carbon capture and storage will require both significant capital and a drop in cost.

In the shorter term, the transition will be weighted toward renewables. But as other technologies prove themselves out and grind their way down the cost curve, the business transformation theme will move beyond renewables to these other technologies. Forward-thinking policies like carbon taxes will help accelerate that process.

In 2021, according to the IEA, global energy-related CO2 emissions are on course for their second-largest annual increase ever—reversing most of last year’s decline caused by the Covid-19 pandemic. Clearly, the time for all of us to act is now.

Effective, credible public policy provides the foundation for addressing climate change. It can incentivize companies to take more aggressive action to reduce their carbon footprint. But while the will to transition their business might be there, the way is often unclear. Private capital and operational expertise can assist in many ways—in transitioning power generation portfolios to green capacity, in electrifying the operating processes of heavy industries, and in developing and supporting new technology and related infrastructure. Putting it all together, it’s an opportunity to create real value.