Decarbonization as a Path to Value Creation in Private Equity

“A goal without a plan is just a wish.” – Antoine de Saint-Exupéry.

Corporate America is saturated with net-zero pledges and carbon-neutral commitments, but carbon reductions aren’t achieved through hopeful declarations. In the private equity sector especially, decreasing emissions requires a results-driven strategy centered first on operational value creation.

In 2015, the United Nations Framework Convention on Climate Change (UNFCC) 21st Conference of the Parties (COP 21) became known as the landmark Paris Agreement, which ultimately kick-started the net-zero era. The objective of the Paris Agreement was to initiate international climate action by formulating a strategy to limit global temperature rise to well below two degrees Celsius above pre-industrial levels. In response to the Paris Agreement, countries around the world began unveiling regulations to limit the negative impacts from increasing GHG emissions.

Public entities also responded by announcing their own unique carbon reduction goals; however, a 2023 study by the Germany-based NewClimate Institute found that less than 5% of the 929 publicly listed corporations with net-zero targets have a credible plan in place to achieve this commitment. Or, borrowing Antoine de Saint-Exupéry’s words, approximately 883 publicly listed companies have made net-zero wishes. Not to mention, the Paris Agreement is now 10 years old, and many companies are walking back their commitments. Unilever is a prime example of this with its CEO recently stating, “When the initial targets were set we may have underestimated the scale and complexity of what it takes to make [hitting sustainability targets] happen.”

The impact of the Paris Agreement extends beyond public markets as well. Private equity is also experiencing “net-zero” pressure from limited partners to consider the impact of GHG emissions, develop decarbonization targets, and/or set targets through the Science Based Targets Initiative (SBTi). So how should private equity respond to this challenge? First let’s begin with an illustrative analogy.

Imagine with me.

Fast forward about 14 years and my 4-year-old daughter is about to graduate high school.

She’s been driving for a few years and is about to leave for college. During dinner one evening, she asks:

“Mom, Dad, could you help me buy a new electric vehicle?”

Her mother responds, gently but firmly:

“The car we gave you is reliable. It gets close to 30 miles per gallon, and safely gets you from point A to point B.”

Naturally, my daughter has a counterargument ready:

“The fuel economy isn’t even that good anymore, gas prices are getting out of control, plus I’ve got one of the oldest cars in the entire school!”

Before the conversation heats up, I ask her to join me in the driveway. Knowing she’s a visual learner, I say:

“Do me a favor and pop the hood.”

She does, and I pull out an engine air filter that’s clogged with leaves and debris. After buttoning everything back up, I ask:

“What’s the date and mileage on the service reminder sticker from your last oil change?”

Her silence is evidence that she’s long overdue. I follow up:

“Have you been asking the mechanic for conventional or synthetic oil?”

This time, she just gives me a puzzled look.

Then I have her start the car. A flurry of alerts lights up the dashboard. She quickly exclaims:

“The car’s been running fine! I would’ve said something if anything seemed wrong.”

As we head back inside, I pause to lend some wisdom:

“Buying an electric vehicle right now isn’t practical, especially when you’re not taking proper care of the one you already own.”

I continue:

“By doing routine, cheap or even free maintenance, you could be saving money at the gas pump, avoiding breakdowns and expensive repairs, and extending the life of your vehicle. That way, when the time is right, you’ll be in a much better position to buy a new one.”

The example above isn’t just a personal reminder to myself that it is my responsibility to teach my children how to properly maintain a vehicle, but it also serves as an illustration of the present state of how many manufacturers and large business enterprises interact with their energy intensive equipment. These organizations become so focused on generating revenue, manufacturing product, and putting out fires, that they fail to see energy as a controllable line item of spend—some of which can be recovered through improved operations and by performing routine maintenance.

Following the Paris Agreement, the market demonstrated its focus on PR through carbon-friendly, headline-grabbing, public announcements of commitments that take more time to mature than a government bond likely without specific, planned and measurable climate action. Meanwhile, companies continue to overlook a proactive and cost-effective starting point for an early sustainability win by neglecting critical mechanical systems, which is costing them a premium in perpetuity. Uninsulated boilers, leaking compressed air systems, fouled filters, and plant floor equipment left running over non-productive weekends are just a few examples of how these systems become neglected over time. As a result, these companies are overpaying their utility companies, which directly correlates to elevated GHG emissions—despite commitments to the contrary.

Emerging decarbonization strategies involve high implementation costs, complexity, and approaches that are not accretive to the business (or a combination of all three). Common are slick sales pitches, cutting edge technology, creative financing to pay for cutting edge technology, and shared savings models that make it deceptively easy to commit capital. Pouring money into capex heavy decarbonization strategies like these are predestined to fall short of delivering optimal cost savings and hitting GHG reduction targets if a company lacks leadership and culture in the efficient operation and maintenance of key mechanical and energy consuming systems. Furthermore, capital-intensive and theoretically more efficient equipment can compound inefficiencies by introducing new operational challenges for inexperienced, unfamiliar, and/or undertrained personnel.

Previously, we posed the question: How should private equity respond to this decarbonization challenge? By first envisioning a tactical strategy that is rooted in value creation that prioritizes building operations and maintenance expertise and human behavior to improve energy and emissions performance. This approach may not be as glamorous or headline-worthy as electrifying production equipment, procuring renewable energy, or protecting ecosystems with carbon offsets, but it also doesn’t require 25-years to attain tangible results. Efficiently managing energy use through a more focused operations and maintenance program is feasible in year zero including immediate results.

Given that a recent report found the median investment hold period for private equity is currently 5.8 years, expecting general partners to develop a 25-year forward-looking decarbonization strategy conflicts with the short-term nature of traditional private equity investment models. A more rational solution to this paradox is for general partners to align limited partners’ decarbonization goals by implementing an energy management program focused on rapid returns on investment along with verifiable emissions reductions as an added benefit. This is accomplished by implementing programmatic, yet routine, low-cost or no-cost operations and maintenance practices across entire facility portfolios. Following implementation of O&M measures, broader carbon reduction opportunities and next steps such as equipment upgrades (which are still accretive to the business) can be identified and packaged to potential buyers during the sell-side/exit process.

Based on Bridge House’s experience, organizations can achieve 15-20% reduction in energy costs at the portfolio level by improving operations and maintenance fundamentals. These sound business practices provide a strong foundation for evolving a broader decarbonization strategy over time. Before racing to develop a 25-year net-zero strategy, tap the brakes and address the energy-profit leaks first. A specific and focused operations and maintenance program is your fastest route to value creation that will enable your company to achieve its growth strategy and jumpstart your GHG emissions reduction.

“The road to GHG emissions reduction is, at first, paved with core business improvements.” – Anonymous

I’d buy it for you if it had better fuel economy.