By Gideon Malherbe, Founding Partner, VCI
Climate change threatens the prosperity and security of us all. Every CEO has a critical role to lead the transition to a net zero emissions economy. But this is no easy task, especially in the resources and energy sector. Here ,CEOs like many others, initially kicked in their heels, and under the auspices of a universal growing demand for minerals and fuel, thought they’d be okay.
On January 27, 2021, the Biden administration took a series of coordinated actions that, considered together, may well mark the beginning of the end of the fossil-fuel era. This hard setting of parameters is in line with the Paris Accord and similar in tone and intent with most other countries.
Many leading corporations released their ESG strategies and goals during this same period. However, their strategies are insufficient in addressing the fundamental structural shift happening in the global economy. This is harming the future of the industry around the world as well as the interests of investors and their beneficiaries.
Climate change and related regulations will impact all companies. Be prepared for a near future where your investors will demand an annual vote on a transition to net zero emissions action plan. ESG virtue signaling as well as ridiculously long-term targets to reach net zero are not cutting it.
Structurally, this is not as simple as some make it out to be. The reason is that the entire industry structure is getting repositioned – not just the gas plant that gets augmented with a hydrogen plant; or in the case of mining, the coal-based electricity supply source that is replaced by on-site photo voltaic generation.
These Scope 1 and 2 moves are necessary, but not sufficient. When you get to Scope 3 strategies, Humpty Dumpty falls off the wall. Twenty-Year Scenarios overwhelmingly indicate structural changes in all industry sectors:
1. Technology cost curves
· Every new technology in your strategy will rapidly reduce in its cost and price. In a few years, a brand new electric car will cost you less than $5,000 and probably be built by Dyson
2. Convergence of technologies causes exponential growth due to NOVEL reconfiguring of component parts
· Cloud computing and smart phones allowed UBER to become larger than all taxi and limo companies in the US combined
3. Adoption curves are accelerating at an unprecedented pace
· Starting with TV adoption that took more than 20 years to the tablet adoption in less than 2 years
4. Business model innovation redefines how money is made
· From owning an asset like a hotel to renting rooms in houses. Someone else is making the money while you are kicking a dead horse
5. Industry structures are collapsing and reforming
· Caterpillar is morphing into a software platform company
· Halliburton calls itself a leading software provider
If you unpack these drivers, it soon becomes clear that any strategy that assumes everything around your company will remain near-constant while you are transforming the company to your ESG goals is simply not good strategy-making. Let’s look at a few examples. Electricity consumption will increase in line with population growth. So, the long-term supply demand assumption holds. Or, our existing vendors will be electrifying their equipment, so we need not worry about them.
There are at least three levels of interrelated systemic work that must form part of your Scenario Planning process.
1st – The value maximization of your asset base in line with ESG guidelines
2nd – The commercial design of a business that is value accretive in a clean energy environment
3rd – The design of a future ecosystem in which the company will operate and consequently the new business model
This last point means that your future income streams must look different than your traditional ones.
Let’s describe it like this. Commodity producers – fossil fuels, minerals, and even heavy industry manufacturers are getting commoditized. That is, they are expected to run at near zero marginal cost. Thanks to automation, digitization, and machine learning, this is now possible. Thus, the holders of these assets will not be able to generate the free cashflow their investors require through simply releasing product to market. They will be absorbed by the trading houses and moments later by the software houses (platform companies). Or, to extend the scenario logic, the full value stream will be integrated by a platform company that also happens to be the largest DeFi financial institution at a valuation scale many times over the total capitalization of any of the mentioned industry sectors.
The alternative to the above ecosystem’s evolution is that the commodity asset holder aggressively migrates upstream and takes economic control of its own operations platform, commercial platform and logistics platform and then selects the next integration depending on the maneuvers of the other actors in this competitive space. This is a must-do, as the fundamental economic fact is that margin is being sucked out of the asset owner class into the digital platform class. Just how many telco and software platforms and services can an industrial executive buy in before there is absolutely no margin left. Doing nothing is sadly not an option as the economics of a platform-based business is far superior that that of an analog business.
As we do more and more scenario planning, we are dismayed at the number of CEOs that miss this cardinal insight: if you believe the industry is fundamentally undergoing a transformation, you must accept the fact that the ecosystem in which you operate will equally undergo a fundamental restructure. Where you operate from, who supplies you and finances you, who works for you, and who buys from you. All of it.
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