Chapter Four: Cars and How Corporations Can Make Their Supply Chains Green
Overview of the Episode
Before doing Episode 4 of the podcast, I watched this Ted talk by Jens Burchardt about how the green premium for many products is smaller than we may think. Mr. Burchardt and his team at Boston Consulting Group have been calculating what it would cost to produce products that are CO2-neutral. For an average European mid-size sedan with a price of 30,000 euro, the green premium would only be 500 euros. The explanation is that the extra cost from the supply chain is low compared to the cost to the final consumer — only about 40% of all expenses come from suppliers. However, a large part of that goes to shipping and production. Ultimately, only 15% of the price of the car comes from the materials in it. That means that even if a company has to pay 50% more for the steel, it is only a fraction of the final sales price to the customer. The low extra cost is also something consumers could be willing to pay, but companies are held back because of price competition (Burchardt, 2021).
To evaluate the Ted talk, I reached out to Mr. Burchardt, who helped me contact Miranda Hadfield. We talked about the calculations that she and the team had been making and how companies will likely need pressure from legislators to shift more of their supply chains to come from sustainable sources. In the episode, I also talked with Thomas Hörnfeldt, who works at Hybrit, a company making CO2-neutral steel (Hybrit, 2021). For corporations to shift their sourcing, there need to be alternatives that can supply them with sustainable materials.
The Political Environment is Driving Supply Chain Developments
The policies in most countries are evolving to limit emissions from industries. In California, new laws will force a “40% reduction in the carbon intensity of cement” by 2035 (compared to 2019). It creates an incentive for companies to innovate and can guide other large cement-consuming countries such as China and India with new laws (Lobet, 2021). Likewise, most of the world’s countries have pledged to be carbon neutral by 2050 (Wallach, 2021). To do that, legislators will have to be busy making new laws similar to the ones made in California but across industries.
One of the goods that will be affected is steel, a core material in cars. Globally, the steel industry is among the three biggest producers of carbon dioxide. At the same time, the difficulty in decarbonizing lies in the lack of innovation in the sector (Hoffman, 2020). In the EU, the European Commission has plans to create and reshape markets in steel, using approaches similar to the success of renewable energy in the block. Specifically, market interventionalists policies will be used, leading to cost reductions and innovation, which would align with the Union’s plan to only make carbon-neutral steel by 2050. However, such policies can be disadvantageous for regions without large amounts of renewable electricity, primarily since steel production uses vast amounts of electricity (Vogl et al., 2021).
A core in the policies to reduce emissions in the EU emissions trading system (EU ETS), which pursues a cap-and-trade system. Different industries have different “caps” on the number of emission allowances, and the cap is set to be reduced over the years, leading to lower emissions. Within each cap, companies can receive or buy allowances. Every year, heavy penalties are imposed on those that do not relinquish their allowances to cover their emissions (Hoffman, 2020). The prices for emitting carbon dioxide will increase until 2050 in the EU but are also legislated by each EU country. For example, the average cost of carbon dioxide was 55 euros in 2019, and Germany has announced prices for 2026 in the range of 55–65 euros per ton. By 2050, the price will be 100–150 euros (The EU, 2021).
The EU ETS certainly incentivizes businesses to invest in sustainable initiatives and does so at a large scale. Currently, it includes more than 11,000 power plants and factories — equivalent to 41% of the EU’s total greenhouse gas emissions (Appunn, 2021). It uses a linear reduction factor, with the target to cut emissions by 4.2% per year. However, such a trading system would be more efficient with links to other regions’ ETSs to have a global carbon market with uniform emissions control. The benefits include access to various emission markets to use the most efficient market agent. Due to more significant market liquidity, the price volatility is also reduced, and the market power of individual participants is diminished because of decentralization (Ahlberg, 2013). In general, ETCs exist in various regions; some US states, China, and South Korea — among others. As long as some areas stand without such a scheme, it incentivizes coal-generating industries to do business there. While it may benefit the local economy in the short-term, future externalities because of climate change may be costly for us all.
However, equally important as carbon tax and frameworks such as EU ETS is a provision of start-up capital and subsidies for initial investments, compensating for capital expenditures required to develop technological shifts (Hoffman, 2020). For example, the Hybrit project, owned by three state-owned companies, has received massive funding from the Swedish state. It exemplifies a collaborative effort between governments, regulators, and industry stakeholders to facilitate access to capital.
Hybrit and the Difficulty for Politicians to Choose Optimal Investments
One of the main questions I had to Thomas Hörnfeldt was his view on the critics on Hybrit by Professor Magnus Henreksen. Prof. Henreksen calls Hybrit “environmental nationalism,” as they decrease Swedish carbon dioxide emissions but increase emissions on a global level (Törnwall, 2021). The argument is that the enormous amounts of electricity required to produce “green steel” would be more helpful to export to Germany and Poland to outcompete “dirty coal power.” Instead, Prof. Henreksen and his affiliates argue that legislating higher costs on carbon emissions would incentivize companies to recycle steel instead of producing new. According to Prof. Henreksen, the additional problem is that the state has decided to invest so heavily in Hybrit, and he sees similarities with significant investments in ethanol cars during the 2000s.
The analogy with ethanol cars comes from the rapid increase in ethanol demand in the mid-200s, which “chewed up so much corn so fast that it was hoisted on its own petard” (Runge, 2016). Back then, ethanol was seen as a solution to the rapidly increasing crude oil prices, which led to rising inflation that hit consumers hard (Boger & Hanke, 2018). Policy-makers worldwide believed that ethanol would decrease costs and mitigate climate change. Today, research has shown that cellulosic and corn-based ethanol was the worst of nine fuel types concerning: air pollution, climate, land use, and chemical waste (Jacobson, 2009).
It is essential to invest in technologies proven to work with recent history in mind, although it is more difficult given political pressure and rapid climate change. The circumstances force us to act quickly. Hybrit’s Thomas Hörnfeldt said in the podcast that we need both innovations such as “green steel” and investments in green electricity. Technology is crucial in lowering the environmental impact of consumption and production, but green growth may overstate its role (Probst & Taherzadeh, 2019).
Dealing with the Complexity of Supply Chains to Reduce Emissions
Not only do states and governments need to choose policies that favor specific technology, so do companies. In the conversation with Miranda Hadfield, it became clear that corporations can change how they make their products. Although the consumer price may be slightly higher, emissions go down, making them comply with increasingly challenging policies.
According to Hadfield and her team, there are specific initiatives that managers can take to decarbonize their supply chain, as BCG previously has presented (Figure 1). They interviewed multiple global companies about reducing emissions and found nine key actions. For example, companies can share the risk through co-investments by working with suppliers to address their emissions. Or, companies can scale up “buying groups” to amplify demand-side commitments, which can create sector-level action (World Economic Forum, 2021).
What’s more important than these nine steps is to act now. It is hard and takes time to decarbonize upstream supply chains. Companies will have to change how they design their products, engage with suppliers, and govern their organizations. While many organizations have already started doing this, it is time for others to start doing so, too.
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