Climate Strategy: Facing uncertainty and economic recession

September 10, 2009
This guest contribution is by Drs. Ans Kolk and Jonatan Pinkse, professors at the University of Amsterdam Business School, The Netherlands. Earlier this year, their book International Business and Global Climate Change was published by Routledge. Dr. Ans Kolk has focused on business strategy and climate strategy for a number of years, and we have collaborated on a major project on the oil industry (see Back to Petroleum?).

The Uncertain Policy Environment

With negotiations currently under way for a successor to the Kyoto Protocol, progress is slow and business faces considerable uncertainty. Although the US under the new Obama administration has shown commitment to reaching an agreement at Copenhagen in December 2009, there are many unresolved issues on the table. These include the level of the emission reduction targets for the US and other industrialized countries; the introduction of emission reduction targets for emerging economies such as Brazil, China and India; the future shape of emission trading schemes and the relationship between them; and the transfer of money and technology to less-developed countries. The credit crisis and current economic recession have also affected the current setting for business and climate change in various ways, shifting the terms of the debate and highlighting tensions at the business-climate change interface.

The economic recession

The economic recession has reduced economic activity, especially industrial production, leading to lower greenhouse gas emissions and making it easier for companies and governments to reach their GHG targets. The Netherlands, for example, recently reported that it expected to be able to meet its Kyoto target in 2011. At the same time, this has reduced prices for carbon permits and other tradable emissions rights, lowering incentives for longer term investments in low-carbon technologies. Still, prices have been recovering recently within the European Trading Scheme (ETS) and trading activity for carbon permits has increased by more than 50% in the first quarter of 2009 (compared to the last one of 2008). Overall, however, the emissions market is not yet mature and the outcomes of the negotiations for the post-2012 regime will decide its future shape and viability. Current carbon prices are rather volatile and too low to provide sufficient incentives to change behavior in a more climate-friendly direction.

The economic slowdown has put downward pressure on oil prices, making the search for alternatives less attractive. One silver lining is that it has lowered investments in tar sands, which are energy-intense in extraction and processing. More problematic has been the loss of incentives to develop renewables, which has been reinforced by the credit crisis and the difficulty in raising venture capital. In the US, for example, clean tech venture capital investment fell from $1 billion in the last three months of 2008 to $154 million in the first quarter of 2009. Companies in Europe report similar problems; the Dutch company Econcern, for example, has gone bankrupt and the Danish wind company Vestas announced a lay off of 10% of its workforce.

There has also been a sharp decline in interest in biofuels. Corn-based ethanol had been growing rapidly in the US, supported by heavy subsidies, while sugar-based ethanol in Brazil had also been booming prior to the recession. The US ethanol industry has now gone from boom to bust and even the strong Brazilian producers have been severely hurt, leading to bankruptcies and a wave of consolidation.

The high oil price was one of the drivers of sales of hybrid vehicles and smaller, more fuel-efficient cars in the US, as gasoline prices peaked above $4 per gallon. Car sales overall have dropped due to the economic recession, despite a temporary boost in the US (and other countries, particularly Germany) from the ‘cash for clunkers’ program, although hybrids have suffered surprisingly little compared with the overall market. Hybrid sales are being stimulated by preferential tax measures. In the Netherlands, for example, hybrids receive favourable tax treatment, especially for leased vehicles, which influences corporate purchases. In the first eight months of 2008, sales via leasing of Toyota Prius cars in the Netherlands increased by 550% compared to the same period in 2007 (for the Honda Civic hybrid, the figure was slightly over 300%). In 2009, the Honda Civic hybrid became the country’s most leased car.

Green Bailouts

The fiscal measures adopted by governments in the face of the 2008 financial collapse were painted various shades of green. Table 1 gives an overview of the ‘green’ share in the bail-outs by ten countries and the European Union as estimated by HSBC in early August 2009.

Kolk table bailout green

The table shows that South Korea stands out for the high percentage of its green bail-out, followed by the EU and China, whereas Italy and Spain have the lowest share. The green label needs to be treated cautiously, however, as definitions are vague. Moreover, these are only promises of funds; in the US, some targeted recipients, such as the wind energy sector, have seen no money so far.

Innovating for climate change

In view of the importance of transport, fuels and energy use for the economy, key sectors for reducing emissions are automobiles, oil, and electric power. These are prime targets of policy measures and also provide good illustrations of the trade-offs we face in moving towards a low-carbon economy. A key strategic issue facing managers is whether their businesses should focus on exploiting existing know-how and technologies or on developing new products and markets that represent a departure from the current energy infrastructure.

In most cases, there is not just one best ‘solution’. For example, if companies want to invest in renewables they still have various options, ranging from more mature to much less well-developed technologies. Most mature are hydropower, biomass co-firing, wind, solar thermal and geothermal technologies, which in the best circumstances are approaching cost-competitiveness with conventional sources. Offshore wind and solar PV are emerging technologies that are not yet cost-competitive. And there are renewable technologies that are still in the R&D phase – e.g. specific forms of solar power, ocean energy and advanced biofuels – which completely lack market penetration and largely depend on public subsidies for further development.

The specific balance of risks and returns differs by company but also depends on the sector and its level of technological dynamism. This can be illustrated by pointing at the difference in R&D patterns between power generation and the automotive industry. R&D intensity in power generation has been notoriously low, due the fact that innovation involves massive capital investments combined with limited opportunities for product differentiation. Car companies, on the other hand, operate in a much more dynamic technological environment and therefore face greater pressure to develop alternative drive-train technologies, such as hybrids, electric and fuel cell vehicles.

In addition to technology, new market development needs to be considered. Companies can develop niche markets that allow companies more opportunity to experiment, or undertake incremental changes and transitional technologies. The auto industry illustrates both approaches. The fuel cell vehicle has long been viewed as the ultimate winner because it followed the route of niche development. Since the 1960s, fuel cells have been used for power in several market niches, such as space travel and the US army and navy. However, they have demonstrated the typical problems of niche development as well: it has been difficult to move beyond the niche into mainstream markets due to cost and scaling issues, and the resources needed to move across niche markets. Transition technologies, on the other hand, may become dominant themselves and then become barriers to further change. A case in point is the success of hybrid cars such as the Toyota Prius, which might have serious consequences for the further development of pure electric or fuel cell vehicles.

An example of a technology that allows companies to extend existing technologies and know how is carbon capture and storage (CCS), popular among oil, coal and electricity companies. CCS gives carbon-intensive companies the opportunity to show proactivity on climate change, while concurrently continuing their core business activities – this has also been a source of criticism. Transition technologies also play a role in the oil & gas industry, where gas can replace coal in power generation, and liquefied gas can substitute for gasoline in transportation.

Climate change is a problem demanding solutions that extend beyond the reach of any single company. How far are companies willing to go in collaborating with others? This is a tough question, especially when there are also competitive dimensions to the relationship. Various types of cooperation can be noted. One is by several competitors together with smaller niche players that own a specific technology, as has happened often in the car industry (e.g. Ford and Daimler with Ballard for fuel cells). A drawback of this structure is that companies share the technology with a close competitor. Cooperation with companies from other sectors avoids this problem: Dow Chemical and General Motor’s joint work on the development of fuel cells, each for a different purpose, is a good example.

In some cases more systemic, infrastructure-related collaborations are required. For example, to commercialise the fuel cell vehicle, the auto industry needs the chemical and oil industries to supply the hydrogen and distribution system necessary to attract prospective customers. This necessitates major breakthroughs which could actually threaten the fossil-fuel suppliers. As the car industry cannot supply the hydrogen itself, it faces a major chicken-and-egg problem: oil companies will not scale up their hydrogen activities until car companies come with more affordable fuel cell vehicles, while car companies will only launch such models if there is a hydrogen infrastructure. A somewhat comparable problem exists regarding plug-in hybrids or electric cars, which need electricity networks capable of meeting peak power demand. Two partnerships – between Toyota and EDF and between Daimler and RWE – were announced last year, both with the aim to develop a recharging infrastructure in selected locations. For more widespread use, there must also be a sufficient number of charging points and places to exchange batteries, requiring cooperation with local authorities and electricity grid operators. In the Netherlands, such a partnership was recently formed with the goal of ten thousand charging points in public spaces in the coming years.

These systemic issues require determined policy efforts to break the deadlock and escape the current “carbon lock-in”. These policy initiatives needs to take into account not just the technological options but also competitive, strategic, and market considerations. The key challenge for the coming year is to develop a comprehensive approach that simultaneously addresses the economic slowdown and the climate crisis.

Sources and Further Reading

Dyerson, R. & Pilkington, A. (2005). Gales of creative destruction and the opportunistic incumbent: The case of electric vehicles in California. Technology Analysis & Strategic Management, 17(4), 391-408.

Harvey, F. (2009). Healthy rebound for clean energy. Financial Times, 18 August.

Hekkert, M. & Van den Hoed, R. (2004). Competing technologies and the struggle towards a new dominant design. The emergence of the hybrid vehicle at the expense of the fuel cell vehicle? Greener Management International, 47(Autumn), 29-43.

Kolk, A. & Pinkse, J. (2008). A perspective on multinational enterprises and climate change. Learning from an ‘inconvenient truth’?. Journal of International Business Studies, 39(8), 1359-1378.

Neuhoff, K. (2005). Large-scale deployment of renewables for electricity generation. Oxford Review of Economic Policy, 21(1), 88-110.

Raven, R. (2007). Niche accumulation and hybridisation strategies in transition processes towards a sustainable energy system: an assessment of differences and pitfalls. Energy Policy, 35, 2390-2400.

Romm, J. (2006). The car and fuel of the future. Energy Policy, 34, 2609-2614.

Sandén, B.A. & Azar, C. (2005). Near-term technology policies for long-term climate targets – economy wide versus technology specific approaches. Energy Policy, 33, 1557-1576.

Unruh, G.C. (2000). Understanding carbon lock-in. Energy Policy, 28, 817-830.

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