Energy & Natural Resources Report
|
At a Glance
This article is part of Bain’s Energy and Natural Resources Report 2023 We are living through one of the most volatile and uncertain periods the world has seen for some time. War continues into a second year in Ukraine while nations continue to recover from the Covid pandemic. At the same time, the effects of climate change are materializing stronger and more often than before, as the world inches toward net-zero carbon emissions. The need for resilience has never been more urgent for boards and executive teams, and resilience is likely to be one of the most critical strategic differentiators of a company’s success. But traditional corporate approaches to resilience don’t rise to today’s challenges. They focus too much on near-term risks, without fully recognizing the potential impacts up and down the value chain, well beyond individual company boundaries. They usually make very limited use of advanced predictive tools, which could help identify some of those risks. And they fail to connect risks to the organization’s long-term strategic goals and economic model. These narrow approaches can leave blind spots and create a false sense of security. Bain recently asked executives about their confidence in navigating five types of threats, spanning from the physical effects of climate change through to technological vulnerabilities, input shortages, and bottlenecks (see Figure 1). Confidence across the board appears surprisingly high, especially as many of these threats continue to escalate.
Figure 1
These high numbers could reflect an overconfidence that’s not entirely justified by the limited investments most firms are making in resilience. People often fail to accurately assess the magnitude and likelihood of rare events, such as the physical effects of climate change, since most have not experienced them firsthand. Leading companies take a more comprehensive approach that includes strategic, operational, and supply chain resilience, in addition to managing the environmental risks to physical assets. Strategic resilienceAll strategy is formed amid some level of uncertainty, but the changes inherent in the energy transition multiply the difficulty. Uncertainty can handicap a firm in several ways. Overconfidence can lead to corporate myopia; under-confidence can leave firms in paralysis. Either scenario can stall action until it’s too late to prevent a bad outcome.
It’s rare that the losers in a transforming industry are really blindsided by change. More often, they fail to set a strategic direction that can adapt to shifting conditions. Leading firms start with a view of the future: What will customers need 30 years out? This approach can help companies set a long-term vision, free from the constraints of current practices and portfolios. Successful teams then plan for their long-term reference case, while continuously monitoring the environment and correcting course as necessary along the way. Even among companies that invest in long-term scenario planning, few consider the “corner scenarios”—events that are possible but much less likely, like unexpected policy shocks or losing access to capital markets. Planners often shelve these scenarios because they don’t want to invest time developing detailed plans for conditions that are unlikely to occur. But ignoring high-risk scenarios is, increasingly, a short-sighted strategy. The tumult of recent years makes it clear that the energy and natural resource transition is likely to become more disorderly, even chaotic. Stress testing a company’s capabilities has never been more essential, and it’s one of the ways that planners can locate the extreme corners, in order to understand the implications and potential opportunities of low-probability, high-risk scenarios. Operational resilienceReducing Scope 1 and 2 emissions helps ensure long-term commercial viability in several ways. First, it positions a company to be closer to compliance as regulations or carbon taxes increase. Closely related, it helps preserve an asset’s social license to operate, making it less susceptible to being targeted as a significant carbon emitter. It can also extend the working life span of the asset, given updates that renew operational capability. Reducing emissions signals all of these benefits to investors who are considering the long-term viability of businesses in a rapidly changing energy sector. In addition to ensuring resilience for operations, companies also have to ensure that their decarbonization programs are resilient and can adapt to changing conditions. In this context, resilience means the ability to persevere not only through extreme weather events but also economic downturns, changes in technology, and other unpredictable barriers. Some companies are moving quickly to gain front-runner status while others are taking a wait-and-see approach, aiming to take advantage of more efficient technologies and economies of scale.
Supply chain resilienceOnce the purview of the COO and purchasing functions, supply chain resilience has risen to the highest levels of the corporate agenda over the past few years. The pandemic, a semiconductor shortage, and war in Ukraine are among the crises that have exposed vulnerable supply chains. Quality and price are still table stakes, but increasingly supply chain executives are investing to improve flexibility and resilience (see Figure 2).
Figure 2
Supply chain resilience means different things across the sector, but in general it’s the ability to proactively minimize risk, absorb inevitable shocks, and quickly recover from setbacks to lessen the impact on operations. Taking a holistic view of the entire chain can help companies identify the most important risks to the business and then assess the likelihood of each. Comparing strengths to competitors’ can help companies find opportunities to differentiate while mitigating their impacts on energy markets and the environment. Physical resilienceMany companies are already experiencing the effects of climate change on their operations. For example, in 2022, Apple and Intel suffered a weeklong shutdown of some production facilities in Sichuan, China, where a drought stalled multiple hydropower plants. But many businesses underestimate the likelihood of physical climate risk events and their exposure to them, relying on a narrow set of risk-transfer tools (for example, insurance or financial hedges) rather than a broader set of strategic and operational levers for building resilience.
Power utility Southern California Edison, for example, has been working for more than a decade to manage the effects of climate change on its power grid and generation assets, which include more frequent wildfires and droughts that jeopardize the viability of hydroelectric power. To address these risks, SCE embarked on a detailed assessment of climate risks to its assets, operations, and services across its 50,000-square-mile service area. The results helped SCE reprioritize capital investments for new infrastructure that can withstand more intense flooding and storms, extreme temperatures, and more severe wildfires. SCE says it invests about $5 billion each year to maintain and improve its grid, and that by the end of 2021 it had reduced wildfire risk by about 70% compared with pre-2018 expectations. A more proactive approach to resilience starts with a systemic look across the entire value chain, using analytical tools to estimate risks today and in the future. Companies can then focus on practical actions to adapt to these risks and make decisions about which assets or facilities to protect and what strategic changes may be necessary to survive and thrive. The changes may include revising capital planning processes, restructuring or nearshoring the supply chain, or advocating for new policy solutions. More from the reportRead our Energy and Natural Resources Report 2023 |