As the world embarks on the net-zero transition, businesses face new costs and risks associated with making the switch to a low-carbon or net zero economy. These costs could include anything from investing in new green technologies to re-tooling entire factories to comply with emissions standards. Meanwhile, companies also face reputation risks if they are seen as lagging behind in the transition or if they are accused of greenwashing.
In this article, we will explore a small facet of this transition risks, and attempt to provide an overview of what this means for companies, with a focus on Small and Medium Enterprises (SMEs), since these form the bulk of jobs and economy of countries.
So, what is ‘Transition Risk’? It is defined as risks stemming from the shift to a low-carbon economy. Although broad, the Taskforce on Climate Financial Disclosure (TCFD) groups transition risks into four categories:
1. Policy and Legal Risk
This type of risk includes anything from national policy (e.g. carbon pricing, emissions reporting obligations, and mandates on and regulation of existing products and services) to the potential for litigation if a company is seen as not doing enough to mitigate its climate impact.
In Singapore, the government updated carbon tax levels.
- S$5/tCO2e (’til 2023),
- S$25/tCO2e (2024 and 2025),
- S$45/tCO2e (2026 and 2027),
- Reaching S$50-80/tCO2e by 2030.
For now, the tax is applied to facilities that directly emit at least 25,000 tCO2e of greenhouse gas (GHG) emissions annually. This includes six GHGs that Singapore is reports to the United Nations Framework Convention on Climate Change (UNFCCC), namely carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulphur hexafluoride (SF6). Singapore will also start reporting a seventh GHG, nitrogen trifluoride (NF3) by 2024, and a similar tax would apply.
The carbon tax directly covers 80 percent of our total GHG emissions from about 50 facilities from the manufacturing, power, waste, and water sectors. Facilities in other sectors indirectly face a carbon price on the electricity they consume as power generation companies pass on some degree of their own tax burden through increased electricity tariffs. When we account for fuel excise duties that incentivize the reduction of transport emissions, the overall coverage rises to about 90 percent of Singapore’s GHG emissions.
2. Technology risk
This risk includes the potential for a company to invest in new green technologies that turn out to be unsuccessful or switching products and services to greener alternatives that are quickly superseded by better options.
The net zero transition means that companies will need to invest in new, clean and green technologies to achieve net zero. This could mean technologies to supplement current business processes (e.g. in situ carbon capture and storage) to developing more energy-efficient products and processes.
All of these technologies come with risks: most are more expensive than BAU, while some may not be as reliable or efficient, and some may take longer to implement than expected, or even simply not meet local legal/ regulatory requirements. Businesses need to carefully assess the risks and benefits of each technology before deciding whether or not to invest.
They also need to be prepared for the possibility that new technology will become obsolete very quickly. For example, if a company invests in solar panels, but within a few years there is a new technology that is much more efficient and cheaper than solar panels, the company may lose out on the investment.
3. Market risk
This includes uncertainty about how consumers will react to net zero transition and what signals businesses will receive from the market about the viability of low-carbon options. For example, customers may prefer products from companies that are seen as being more environmentally friendly, those companies that have not made the switch to net zero may see a decline in sales.
Additionally, businesses may face higher costs for raw materials if the net zero transition results in an increased demand for renewable energy sources and goods produced sustainably. In alternative energy disadvantaged Singapore, the government has already been ahead of the curve by powering our island with natural gas. However, it is still a fossil fuel, and as the recent Ukraine crisis showed, this over-reliance on gas caused large price spikes in electricity prices.
4. Reputation risk
This type of risk includes the potential for a company to receive negative feedback from stakeholders or to be stigmatized for not doing enough to address climate change. For example, being in sectoral-based green networks (like carbon-neutral coalitions for tourism, green ICT sectors, green building council, carbon capture alliances) helps boost the green reputation of companies. This is also driven in part by individual consumer choices, especially when consumers start considering the climate impact of their purchases.
Locally, the perception would be if large incumbent oil companies can pivot to be green(er), smaller companies would be even easier to do so. Although these risks can be difficult to quantify, they can have a significant impact on a company’s bottom line by changing consumer behaviors.
What does this mean for businesses?
While all businesses face some level of risk when it comes to net zero transition, SMEs are particularly vulnerable. They often do not have the resources to invest in new technologies or to change their business models, and they may be more reliant on raw materials that become more expensive in a net zero world. Additionally, SMEs may not have the same name recognition as larger companies, making them more likely to suffer from negative publicity.
There is a lot of information out there on the risks and costs to businesses of net zero transition, and while we cannot cover it all here, we would like to provide some insights into the impacts faced by SMEs.
Policy and legal risks. Many businesses are already struggling to keep up with the current business regulations, and the net zero transition will only add to the burden. Companies will need to devote time and resources to understanding the new regulations, and may even need to hire specialists in climate change law and policy. Failure to comply can result in fines or other penalties, so it is important for companies to be aware of what is required of them.
As Singapore’s policy framework towards carbon is nascent (started in 2019), companies can expect government regulations to tighten. Moving towards net zero means tighter controls on domestic GHG emissions (impacting production capacities, less carbon equals less production), a rising carbon tax (impacting cost of goods), and combatting carbon leakage with border adjustment mechanisms (limiting outsourcing capabilities and capacities). Even with international carbon credits, Singapore only allows up to 5% of taxable emissions to be offset. These additional tax burdens will limit growth, drive production costs of goods and services up, and erode companies’ bottom line if companies continue as BAU.
Although Singapore has not met with climate litigation cases yet, there has been growing rhetoric from climate activists (e.g. students for a fossil free university) and even members of parliament to take bolder action. Given that Singapore is a refining and petrochemicals hub, chances are once such legal actions are taken against the larger, incumbent companies, SMEs and other companies may be in the firing line in the future.
Companies must be prepared for a rapidly changing international rules-based outlook, tightening domestic political and legal landscape, and explore how to green and decarbonise supply chains in anticipation of 2024.
Technology Risk. Taking stock of your current business processes and supply chain allows you to identify and plug emission gaps. Although carbon capture technologies are somewhat nascent, one can look at swapping out fossil fuel-run machinery for energy-efficient or low-carbon ones to reduce emissions. Starting this now rather than later gives rise to better understanding where the decarbonization opportunities are, and the runway to try out such technologies before it gets mandated.
Also, as technology improves, diversifying energy sources to more renewable ones as part of the net zero transition is key. Furthermore, this allows companies to have a similar ask on standards across the supply chain.
Market Risk. Changing consumer preferences fuel the race to achieve net zero. This drives up demand for low-carbon, carbon-neutral and carbon-negative products and services to support the transition. However, the supply of these goods and services currently falls far short of the demand, which is likely to result in higher prices for companies.
Furthermore, consumer preference changes across generations. The younger population are already on board and advocating for net zero products, whereas the more senior still prefer cheaper alternatives and lower cost of living. Mixed signals from the market will eat into profitability and send wrong price signals to companies.
This is further cascaded by surge in abrupt and unexpected shifts in energy costs. Net zero means cutting fossil fuels not gradually, but sharply. This sudden shift on an international scale forces companies to diversify into less carbon intensive energy sources, but also forces the costs of production up, eating into the bottom line.
Reputation Risk. Simply put, companies that are seen to be lagging behind in their efforts to reduce emissions will suffer reputational damage, which can lead to lost customers (stigmatization of industry/ company) and revenue (deceased demand for goods/ services). As more investors incorporate environmental, social and governance (ESG) considerations into their decision-making, those companies that fall short on climate action will find it increasingly difficult to access capital.
To conclude, there are costs and risks associated with businesses making a net zero transition. It is crucial that businesses begin planning now, so that they can understand and manage these risks. By understanding the trade-offs, SMEs can make good decisions about how to proceed and ensure that they are not caught off guard by this rapidly changing landscape. Those who are prepared for this shift will be in a better position to weather the challenges and take advantage of the opportunities that come with it.
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Zijian Khor is Senior Assistant Director at the Ministry of Sustainability and the Environment, Singapore.
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