Smart financial solutions can help companies achieve ambitious greenhouse gas targets
This article was coauthored by Jan-Willem Bode, partner at Guidehouse, and Bruce Schlein, Director of Impact Investing at Citi.
For years, companies have been using marginal abatement cost curves (MACCs) to prioritize decarbonization investments. By capturing complex financial and abatement information in one relatively simple chart, MACCs help corporate decision makers navigate investment options.
However, companies often do not unlock the full potential of MACCs. Rather than looking at the MACC holistically, companies tend to prioritize measures that have negative abatement costs or abatement costs below a regulated or internal carbon price. Further, companies focus on individual measures, which offer the greatest ROI, meaning they start with the lowest hanging fruit before hitting a wall as the average payback period starts increasing.
By focusing on individual measures, companies ignore the substantial greenhouse gas (GHG) reductions available from measures deemed too costly that could be unlocked by taking a more holistic approach to the investment. We suggest using the following three approaches to unlock the full potentialof MACCs.
Figure 1. Illustrative MACC with Behavioral and Operational Measures (Blue), High CAPEX Measures (Green), and Measures with No ROI (Gray)
Cross-Subsidizing Expensive Measures with Cheaper Measures
Blending the paybacks of measures is a key strategy to achieving goals by leveraging low hanging fruit. Measures with a negative ROI can be financed using the savings made with other measures. For example, companies can invest in green energy by using power purchase agreements and achieved financial savings to offset CAPEX or increased operational costs. By doing so, companies can benefit from scale when investing in GHG abatement. This strategy can also be applied to sites, where location-specific paybacks are a factor of weather conditions and utility rates.
Figure 2. Cross-Subsidizing Measures
Off-Balance Sheet Financing Makes Larger Programs and Longer Payback Measures More Interesting
For large programmatic rollouts that include measures with high upfront investments and a payback period of 5-15 years, companies can minimize liabilities by using off-balance sheet financing. Energy services agreements or efficiency as a service solutions utilize third-party ownership structures where companies do not have to provide upfront capital. In this model, the company contracts with a third party to build, operate, and maintain the asset (e.g., LED retrofits, electrification), and the company only pays the third party a service payment for realized units of energy saved. Companies can also use leasing platforms to rent equipment since rental payments can be treated as an OPEX and are tax deductible. For companies low on cash, another option is to sell an asset and repurchase it as a service, thus turning CAPEX into OPEX. An example would be selling a combined heat and power plant and using heat and power as a service.
On-Balance Sheet Financing for Smaller, Shorter Payback Behavioral and Operational Measures
Behavioural and operational measures such as increased equipment efficiency require relatively limited investments and can generate high returns and a positive impact on OPEX. To finance these measures, centrally orchestrated departments within companies, including asset management or finance, can set up a ringfenced fund. More innovative ways of financing include a zero-cost fund or green bonds, where avoided energy costs can be used to finance debt repayments.
Figure 3. Zero-Cost Fund
In short, financial solutions offer attractive unit economics for decarbonization. The total CAPEX required to hit a GHG abatement target can be significantly reduced and replaced with immediate savings through smart financial solutions. If companies want to reach their climate targets, they can no longer afford to ignore the right side of MACCs.