Decarbonization credit risks: All you need to know

Decarbonisation credit risks in the chemical industry
Published on January 19, 2024

As the global commitment to decarbonisation intensifies, businesses face a pivotal choice: adapt or face escalating risks. With climate positivity on the rise, decarbonisation has become a crucial imperative for businesses. However, the transition towards net zero involves decarbonizing the chemical industry, and it comes with significant credit risks for an organisation. It can have a domino effect, impacting credit ratings, access to financing, and ultimately, the financial stability of businesses.

Decarbonizing the chemical industry

As of 2023, it is estimated that the chemical industry consumes about 10% of the total fossil fuels and emits 3 billion metric tonnes of CO2. The chemical industry consumes the largest amount of coal, gas, and oil out of all the other sectors. Fossil fuels are utilized as inputs or feedstock in addition to being burned to provide the heat and pressure required for chemical reactions. Emissions originate from direct chemical reactions as well as energy used in production processes.

On the bright side, more than 70% of the world’s top chemical producers have committed to net zero by 2050 [1]. Chemical giants BASF, Dow, and LyondellBasell are ramping up their climate efforts, with ambitious CO2 reduction targets across the industry. BASF pledges a 25% cut by 2025 [2], Dow targets 15% by 2030 [3], and LyondellBasell aims for a whopping 42% reduction by 2030 [4], compared to their respective baselines.

The chemical industry is taking a greener turn, with a surge in companies setting science-based emissions targets. The average goal for Scopes 1 and 2 reductions by 2030 or 2035 is a significant 40%–45% reduction, marking a dramatic shift from prior years [5]. Even the sector-wide International Council of Chemicals Associations (ICCA) aims for a staggering 70% reduction in greenhouse gases by 2050 [6].

Challenges of decarbonisation

Technology takes centre stage when it comes to decarbonising the chemical industry. The choice of technology utilised throughout the production process plays an important role in determining an organisation’s path towards net zero. Decarbonization necessitates the application of a broad range of technologies, relying on both existing and novel kinds. Businesses tend to implement solutions based on the particular products, industrial processes, and localities that they engage with. Regarding the amount of emissions that each of the decarbonization options will address, there isn’t any definitive agreement as of now.

While upfront costs may be high, prioritizing innovative and low-risk technologies can deliver the long-term benefits of increased efficiency and scaling into new markets. However, even in this scenario, the pace and cost of successful implementation will largely depend on how the regulatory landscape evolves. Inconsistencies in chemical regulations could disadvantage competitiveness and trigger operational disruptions across the industry, which can lead to credit risks.

What are credit risks?

Credit risks are the potential financial losses that companies might face if the credit borrower fails to repay a loan or meet contractual obligations. This can cause an interruption in the cash flow and could increase the costs of collection. The level of credit risk that organisations might face is tied to the choice of decarbonisation solutions that they adopt. 

Credit risks in decarbonisation

Credit risks in decarbonisation

Decarbonization-related credit risks are financial losses that businesses are prone to during the implementation of their decarbonisation solutions. A study report by S&P Global [5] mentions five decarbonization-related credit risks in the chemical industry:

Lack of a unified solution

There is no one-size-fits-all decarbonization solution, which could cause businesses to choose sub-optimal decarbonisation solutions. This could potentially slow down their progress towards net zero and raise their decarbonisation costs. As businesses are still evaluating the effectiveness of various technological possibilities, they are yet to arrive at a unified solution for decarbonisation.

Manufacturing disruptions

Prioritizing net zero necessitates businesses making plant-specific modifications to their chemical manufacturing in the next 20–30 years. One of the challenges is switching out carbon-based feedstock with low-carbon alternatives without sacrificing the characteristics of the final product. Chemical plants optimised to run at maximum utilisation could face disruptions under such circumstances.

Capital expenditures

Implementing alternative practices and methods for decarbonising can bring about additional operating costs. Through 2050, capital estimates range significantly but might reach hundreds of billions of dollars, if not over $1 trillion. It is uncertain whether producers can keep their profit margins by passing on these costs to consumers without hurting demand.

Demand-side decarbonization

As industry tries to go carbon-free, customers could avoid high-emitting chemicals, which could reduce demand. With a vast and varied customer base, the sector often finds its hands tied when it comes to influencing how its products are ultimately used.

Technological obstacles

Not all of the technology required to achieve complete net zero is currently available. The industry’s decarbonization journey could hit a roadblock with current technology. Bridging it demands advancements still in R&D pipelines and wider access to existing, but commercially underdeveloped, solutions.

Short, medium, and long-term risks

The chemical industry’s path to net zero hinges on its choice of solutions, and this sets the time frame for these credit risks to manifest. Being caught up in the transform or be transformed era, the industry’s efforts could also impact their credit quality. To mitigate credit risks within their net-zero goals, it is essential to map out potential manifestations as short-term, mid-term, and long-term credit risks.

Short-term credit risks

The chemical industry’s net-zero journey with an optimal route is currently shrouded in uncertainty. This volatility translates to short-term credit risks for companies relying solely on untested solutions. To navigate this terrain, businesses must embrace a flexible approach, leveraging existing technologies while keeping a watchful eye on promising R&D advancements. Only by adapting and future-proofing their decarbonization strategies can they mitigate these risks.

Medium-term credit risks

While manufacturing disruptions, operational costs, technological challenges, and resource constraints appear as medium-term credit risks, neglecting them can trigger a domino effect, escalating them into long-term threats. Decarbonization strategies that ignore these issues risk compromising operating efficiency, profit margins, infrastructure, and ultimately, the very feasibility of decarbonisation.

Long-term credit risks

Ignoring medium-term credit risks can snowball into a major long-term risk: massive capital outlays. Decarbonization comes with unprecedented investments, but the precise amount remains unclear. Chemical companies are yet to decide on strategies, and technology costs and availability remain unclear. However, careful, phased investments over the next three decades can make even this hefty outlay manageable.

Credit risks and decarbonisation solutions

Decarbonization choices are a double-edged sword for companies: while they unlock long-term sustainability, they also shape immediate credit risks. Opting for seemingly low-cost solutions might offer short-term relief but could harbor hidden long-term risks, potentially jeopardizing financial stability down the line. Therefore, a thorough analysis of the credit risks associated with each decarbonization strategy is crucial for navigating this delicate balance. Assessing the contribution of such solutions towards decarbonisation allows businesses to identify the optimal level of credit risk and implement targeted mitigation measures.

External factors like the changing regulatory landscape and supply and demand also play an important role in shaping the credit risks associated with decarbonisation. Organizations need to find the optimum pace of decarbonization in order to align with the regulatory environment. Striking the right balance between adhering to tightening regulations and avoiding the risks of untested technology is crucial for companies to succeed in their decarbonization journey. Failure to adapt to customer choices in the environment may lead to demand-side decarbonization, where chemical companies with high greenhouse gas footprints lose their footing in the market.

References

  1. https://environment-analyst.com/global/109848/expert-opinion-chemicals-sector-faces-uncertain-path-to-net-zero
  2. https://www.basf.com/global/en/media/news-releases/2022/03/p-22-191.html
  3. https://corporate.dow.com/en-us/science-and-sustainability/commits-to-reduce-emissions-and-waste.html#:~:text=By 2030%2C Dow will reduce,%2B3 plus product benefits).
  4. https://www.lyondellbasell.com/en/sustainability/addressing-climate-change/
  5. https://www.spglobal.com/esg/insights/featured/special-editorial/decarbonizing-chemicals-part-one-sectorwide-challenges-will-intensify-beyond-2030
  6. https://icca-chem.org/wp-content/uploads/2020/05/ICCA-Building-Technology-Roadmap-Executive-Summary.pdf
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