Please consider the environment: Why decarbonization belongs in capital allocation conversations

Introduction

As the planet grows warmer, extreme heat events that used to occur once every 50 years are now likely to happen nearly five times in the same period.¹ Recent—and unprecedented—wildfires in Maui and Canada would appear to underscore the point. Indeed, climate change—something that may have felt somewhat conceptual 20 years ago—now exhibits tangible impacts.

The upshot for CFOs and other leaders? The future may belong to resilient, sustainable businesses. But building resilience requires a long-term perspective, one that anticipates evolving legal and regulatory requirements and possible disruptions to business triggered by severe weather threats. Likewise, CFOs will need to accurately assess, among a lengthy list of items, what it will cost their companies to transition to low-carbon operating models.

Like climate change, this growing attention to business sustainability is not likely to abate any time soon. As climate change considerations draw increasing scrutiny from investors and regulators—and as consumers and employees seek more information about corporations’ climate impacts--a sustainability filter will likely need to be applied to business decisions. Factoring in the cost of climate risk will almost certainly challenge assumptions about ROI,  portfolio strategy, and resource allocation. Forecasting, capital expenditures, external investments—all will probably eventually require some sort of sustainability component. 

As stewards of shareholder capital, chief financial officers will likely be asked to include decarbonization in capital allocation models. In time, decarbonization and, more broadly, ESG assessments, may become a routine consideration when conducting FP&A. The not-so-subtle message for CFOs: Get ready for a new environment for assessing investments and strategy. 

In this edition of CFO Insights, we look at the role of the finance function in assessing climate change impacts on capital allocation. What investment decisions may benefit the most from sustainability analysis? Could a commitment to sustainability provide a competitive advantage that separates winners and losers in a number of industries?  And ultimately, how do CFOs square societal obligation with the pressure to produce quarterly earnings?

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