Why carbon risk assessments are important to businesses?

What is carbon risk?

There are three phases for enterprises to achieve sustainable development. The first phase involves carbon inventory and the calculation of carbon footprints. Many companies in Taiwan are currently in this phase and have shown relatively slow progress. This is because policies like the Carbon Border Adjustment Mechanism (CBAM) and Taiwan’s upcoming carbon fee system have only emerged in the past year or two, leaving many small and medium-sized enterprises (SMEs) in Taiwan’s regulated industries to begin preparing for this trend only recently. For such companies, data collection and verification should be the priority. Companies in the second phase have already completed their carbon inventory and are planning carbon reduction actions, such as purchasing renewable energy certificates (RECs), installing rooftop solar panels, or replacing raw materials. Companies during this phase tend to have questions like "Which one should we start with?" or "Which one provides the most cost-effective benefits if done first?" due to the diversity of carbon reduction initiatives. Companies entering the third phase are mostly brand owners, which have usually been engaged in carbon reduction for some time and have achieved certain results. Therefore, their prime objective is how to take the final step towards carbon neutrality through methods like carbon credits or negative carbon technology. However, while businesses are focusing on reducing emissions, they may overlook an important factor — carbon costs.

Carbon inventory and carbon reduction costs

Table 1 below provides common carbon reduction initiatives and their costs. As consultancy are not necessarily required to conduct carbon inventory, this cost can be saved if companies have in-house expertise. However, there will be additional training expenses if the goal is to cultivate internal talent for conducting carbon inventory. The cost of third-party verification is an essential expenditure. It is generally required that all data undergo third-party verification, whether it is for export declaration or for reporting in accordance with domestic regulations. There are a few exceptions, such as when a company does not need to declare and the purpose of carbon inventory is to provide an internal understanding of its emissions, in which case the need for verification is less urgent.

Another common method, such as using renewable energy, is also one challenge faced by many companies seeking to reduce their emissions. While aiming to achieve 100% renewable energy use (RE100), companies will weigh the costs before making investments. However, it should be noted the RE100 criteria include market boundaries for sourcing green electricity. If a company has operations in many countries, the company is only allowed to source renewable electricity generated within the same market where it will be consumed. On the other hand, carbon capture technology and purchasing carbon credits are less adopted carbon reduction methods. Apart from technical difficulties, these two methods are often controversial in terms of methodology, thus deterring enterprises from adopting them. However, with the substantial investment of capital, technology, R&D manpower, and continuous modification in methodology, it is believed that these two methods may become more widespread in the future and become crucial drivers for businesses to achieve net zero. The aforementioned approaches are all possible carbon reduction options for businesses. Regardless of their current phase of implementation, it is imperative to factor in their costs during planning to prevent overestimating viability or underestimating risks in the future.

Table 1. Carbon reduction initiatives and costs

*The above costs are all approximate values.
*The data here is based on company cases, McKinsey, and InfoLink estimates.
 

Carbon costs will affect gross margins

There are costs incurred from carbon reduction, but it does not mean that businesses can avoid these costs by doing nothing. In a scenario analysis for a nut manufacturer (referred as Company A), we assisted Company A in estimating the carbon cost generated by its nut products. Based on the carbon footprint of Company A's products and annual exports to Europe, the cost of CBAM certificates for just one nut product series could result in a 3% reduction in gross margin by 2030 (see Figure 1 below). When combined with other products such as screws, the gross margin could potentially drop to below 10%, posing operational challenges for the company. Therefore, regardless of whether a company will invest in carbon reduction, carbon-related costs will inevitably be a part of the company's annual expenses in the future.

Figure 1. Estimated decline in Company A’s gross margins, 2026-2030
 

Benefits of carbon risk assessment

The significance of understanding one's own carbon risks allows businesses to conduct stress testing accordingly. By incorporating estimated carbon costs into the overall cost assessment of each future project, companies can better estimate the impacts of climate change and carry out risk management effectively. In addition, companies can use their good carbon reduction performance as a feature to promote their low-carbon products and become a preferred partner in the supply chain. Carbon risk assessment not only enables businesses to recognize the exact impacts of carbon reduction initiatives to avoid profit loss, but also provides a direction for future planning to maintain their competitiveness.