The True Cost of Carbon Emissions

Scientists have proven that we currently are at a global warming of 1.1°C and well underway to a global warming of 3°C, assumed current emission targets and pledges are met. As the window of opportunity for staying below 1.5°C is narrowing, it is vital that manufacturers take matter in their own hands to reduce their emissions swiftly at the very least to abate upcoming costs. This article reveals which economic consequences climate change has on businesses, and which costs it increases, and will increase.

What is often left out of the public discourse, is how anthropogenic CO2 emissions (and by CO2 we mean all important greenhouse gases) affect the economy. According to the Swiss Re Institute, climate change is a far greater threat to the global economy than the Covid-19 pandemic, and as highlighted by EUROCORDEX's 2018 climate projections, Europe should warm more than the global average (2°C of warming relative to pre-industrial levels, even if current emission targets are achieved), which does not improve the situation.

Management's view

The intensification of climate change is why it is crucial that climate change be taken seriously by managers around the world, particularly as all actors globally could be affected, wether their supply chains are international or local. A 2021 study by Deloitte showed that more than a third (38%) of interviewed CFOs declare that taking action on climate change is motivated by the opportunity to save costs, a number that should grow and an argument that should gain in importance as tremendous climate change-related costs are already falling on businesses, states and individuals worldwide.

How does (and will) climate change concretely increase costs for businesses?

Production shocks

Climate change affects supply chains by disrupting the provision of raw materials and slowing down or stopping production activities (through i.e. damages at production plants, lack of workforce), causing shortages, pressures on supply and demand. Thus, the material prices will increase. Morevover, climate change-led local and international conflicts around resources such as water and forests can add to this issue.

Raw Materials

Taking the example of the 2022 Pakistan floods where heavy rainfall has submerged large parts of the country and affected roughly 33 million people, the cotton industry was heavily impacted. Pakistan is a producer of cotton, which is used in the country's textile industry and for export purposes. The floods destroyed agriculture crops among which cotton crops, resulting in an increase in cotton prices and cotton-derived products.

Infrastructure

Infrastructure is the bedrock of economic activity, and global warming is already affecting it. For example, 2015 research in the UK highlighted many risks with confidence such as:

• Increased delays and safety risks due to track buckling during heat waves.
• Increased frequency of road flooding due to rising sea level and heavy rainfall.
• Reduced power line capacity.
• Increased Information and Communications Technology faults due to lightning strikes, wind and hail damage.
• Low rainfall can lead to restrictions and may cause the failure of public water supply.
• Wind damage to power plants.
• Bridge closures due to high winds, as they are problematic for tall vehicles such as trucks.

Additionnally to the costs related to production disruption, price increases and damages, the shifts in infrastructure lead to a raise in taxes for public funding of infrastructure repair and rebuild.

Labor

Additional labor costs should also incur via a loss in productivity. According to a 2021 article by Reuters, a global warming temperature of 3°C (a likely scenario given the current measures and pledges) could cost as much as $1.6 trillion each year in lost labour productivity. Health hazards such as flood-facilited diseases and heat-related illnesses contribute to productivity loss. The 2022 Pakistand floods, directly linked to climate change, caused food shortages and water-borne and vector-borne diseases to spread. Aside from the considerable deterioration of the humanitarian crises, this also has consequences for companies, since they suffer productivity losses (sick leave, missing workers) and their health expenses skyrocket, impacting material prices. Heating, cooling and renovation of damaged facilities to improve working conditions also become a cost factor.

Findings in a 2018 study on the effects of weather shocks on economic activity by Acevedo et al. for the International Monetary Fund show that rising temperatures lower per capita output in countries with relatively high annual average temperature, such as most low-income countries, affecting international supply chains. Additionnally, the study highlights that in these economies, the adverse effect is long-lasting, operating through several channels, namely lower agricultural output, decreasing labor productivity, reduced capital accumulation, and poorer human health.

The German government has just established the total cost of climate disasters on its economy, which has suffered over 80 billion euros in damage and lost earnings sofar. The report published by the Ministries of Climate and Environment takes into account the damage against infrastructure, but also the loss of earnings caused by climate problems for the economy and the decrease in productivity.

Ironically, CO2 generated in economic activities boosting the GDP on the short-term end up impacting it negatively in the middle and long-term, possibly making the world lose around 10% of total economic value by 2050. But another source of expenditures very much discussed at the moment is the price set on carbon. There are two basic models for pricing carbon emissions: the CO2 price via emissions trading and the CO2 tax.

CO2 tax

The CO2 tax on certain products is set at the beginning of its commercialization and is increased regularly (e.g. on fuels, which thus increases the price of refueling meaning higher costs for companies that use road transport in their supply chain). Sofar, this tax exists, among others, in Great Britain, Estonia, Spain, France, Sweden, Switzerland, Poland, Mexico, Japan and India.

CO2 price

Through CO2 pricing in the emissions trading system (ETS), the damage costs caused by global warming are no longer borne by the people and communities, but directly by the polluters. In the process, CO2 pricing will make all climate-damaging products and components more expensive, while low-emission products and components become cheaper. The CO2 price results from supply and demand and is currently at around €101 per ton of CO2 (as of 22.02.2023) in the EU-ETS system.

Over time, the "emission cap"- the amount of free allowances- should be reduced and fewer allowances issued, until eventually all free emission allowances are eliminated. This is intended to put pressure on companies to reduce their emissions more quickly.

There are certainly inexpensive measures that can be implemented today to limit costs related to CO2 emissions. The price of these investments are already lower than the damage from climate change they would avert. And as manufacturing's contribution to global warming is tremendous, we believe much progress can be done by manufacturers to limit the impacts of climate change and their upcoming costs, particularly as numerous tools, frameworks, policies, knowledge and innovations are materializing to support them. We therefore recommend them to:

1. Look at their supply chains at evaluate climate-related risks.
2. Set up a sustainability strategy with science-based targets, dealing with decarbonization and circularity.
3. Measure their products' emissions to detect emissions hotpots, with the support of accurate and up-to-date CO2 data, essential for practical CO2 management.
4. Identify and plan CO2-optimization levers.
5. Be transparent by reporting on the current state of affairs, targets and (non-)achievements.
6. Transition to renewable energy sources for the entire company.
7. Choose suppliers and partners displaying a climate strategy and a willingness to abate their emissions.
8. Implement circular economy measures such as material efficiency.
9. Design products "for the environment".

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