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One-Third Of German Companies Are Behind On New 2045 Net-Zero Deadline

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Capital Markets View - January 2022

One-Third Of German Companies Are Behind On New 2045 Net-Zero Deadline

This report does not constitute a rating action.

The target year for Germany to become climate neutral has shifted to 2045, five years earlier than the EU's deadline of 2050. This follows a revision to the country's Climate Change Act, which focuses on national emissions: direct (scope 1), indirect from energy use (scope 2), and those outside a company's control (scope 3) if they occur within Germany. Scope 3 emissions could complicate matters for corporates like real estate, utility networks, car, and chemical producers that rely on third-party activities and suppliers; while many banks are targeting 2050 for their portfolios to be emission free. Germany is also aiming to reduce national emissions 65% by 2030 versus the 1990 levels. These new targets are more ambitious than in the Fit for 55 package under the European Green Deal, which requires a 55% reduction by 2030, or the 45% recently agreed at COP26.

This raises questions about how far along German corporations are on the path to net zero, and which entities need to catch up. S&P Global Ratings believes that, with various countries introducing guidelines for achieving net zero, it is becoming more difficult for international companies to find the right strategy, since they have production facilities across the globe where regulations may differ. Therefore, it is difficult to gauge the full extent of challenges companies will face in the coming years; as the transformation moves ahead, the situation will become clearer. German corporations might have some additional leeway beyond 2045 to become climate neutral, given more relaxed emissions rules elsewhere.

So far, we see that about 65% of the country's leading corporates have already established a faster schedule to achieve climate neutrality (see chart 1). Yet not all have unveiled a concrete plan to achieve this, and four companies have not yet disclosed an official net zero target year. Companies' definition of what net zero is differs, but most are focusing on scope 1 and 2 emissions, which are under their control. However, we recognize that companies are working actively to reduce their scope 3 footprint as well. We believe it is becoming critical for companies to turn their emission-reduction aspirations into viable plans that can be tracked and monitored externally. Many market participants are focusing on the cost and business implications of the accelerated timeline, but we believe the way corporations manage their emission-abatement efforts could also create long-term opportunities.

Chart 1


Germany's Climate Change Act Amendment Sharpens Legislation In Three Areas

The German government first introduced the Climate Change Act (Klimaschutzgesetz) in 2019 to provide clear guidance and rules regarding the reduction of greenhouse gases (GHGs) to achieve its obligations under the Paris Agreement. The law was intended to build a framework that allows the relevant government ministries to more closely manage the progression of that transition. Once a year, ministries allocated to industry sectors were to review the target outlined in the Act (see table 1) and implement legislation specifically for those sectors.

Table 1

German Sectors--Required Emissions Reduction According To Klimaschutzgesetz
(In million tons of CO2 equivalent)
Sectors 1990 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Total reduction required (%) Reduction already achieved (%) Gap analysis (%)
Utilities 466.2 280.0 -- 257.0 -- -- -- -- -- -- -- 108.0 (76.8) (39.9) (36.9)
% change -- (8.2) -- -- -- -- -- -- -- --
Industrial 283.6 186.0 182.0 177.0 172.0 165.0 157.0 149.0 140.0 132.0 125.0 118.0 (58.4) (34.4) (24.0)
% change (2.2) (2.7) (2.8) (4.1) (4.8) (5.1) (6.0) (5.7) (5.3) (5.6)
Buildings 209.7 118.0 113.0 108.0 102.0 97.0 92.0 87.0 82.0 77.0 72.0 67.0 (68.0) (43.7) (24.3)
% change (4.2) (4.4) (5.6) (4.9) (5.2) (5.4) (5.7) (6.1) (6.5) (6.9)
Transport 163.8 150.0 145.0 139.0 134.0 128.0 123.0 117.0 112.0 105.0 96.0 85.0 (48.1) (8.4) (39.7)
% change (3.3) (4.1) (3.6) (4.5) (3.9) (4.9) (4.3) (6.3) (8.6) (11.5)
Agriculture 87.0 70.0 68.0 67.0 66.0 65.0 63.0 62.0 61.0 59.0 57.0 56.0 (35.6) (19.5) (16.1)
% change (2.9) (1.5) (1.5) (1.5) (3.1) (1.6) (1.6) (3.3) (3.4) (1.8)
Waste and other 38.2 9.0 9.0 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 (89.5) (76.4) (13.1)
% change 0.0 (11.1) 0.0 (12.5) 0.0 (14.3) 0.0 (16.7) 0.0 (20.0)
Reduce 65% by 2030
Reduce 88% by 2040
Source: Umweltbundesamt, March 2021

However, the first version of the law was short-lived, since Germany's Constitutional Court warned the government of several shortcomings. The main criticism was that the law in its initial form provided clarity only until 2030. The government reacted swiftly, leading to the current revised version being passed into law on Aug. 31, 2021:

  • The most important change is an increased rate of emissions reduction until 2030, in particular for utilities and industrials.
  • Second, the revised Act establishes a plan for reducing GHG emissions in 2031-2040 (see table 2), which envisages a 65% reduction of carbon-dioxide (CO2) emissions from the 1990 level by 2030, and 88% by 2040.
  • The third key element is the introduction of a CO2 price, which will only be charged to transport and buildings, since industrials and utilities are already covered by the EU's Emissions Trading System (see "A Heightened Focus on CO2 Emissions Stokes Interest In The Carbon Markets," published Sept. 21, 2021). This CO2 price will be added to fossil fuel costs and result in additional costs for end consumers, which is intended to prompt a change in behavior and a switch to alternative energy sources. For buildings, we understand the discussion is still ongoing, but it is most likely that the cost of the CO2 tax will be equally split between the end user and the landlord.

Table 2

Germany's Emissions--Yearly Reductions Required For 2031-2040
2031 2032 2033 2034 2035 2036 2037 2038 2039 2040
Yearly reduction measured against 1990 (%) 67 70 72 74 77 79 81 83 86 88
Source: Umweltbundesamt, March 2021

Several Corporates Are Likely To Update Their Emissions Targets

Eight German corporations still have 2050 targets, including the world's largest chemicals company BASF, as well as Volkswagen and Lufthansa. That said, we acknowledge that emission-abatement ability varies substantially from one industry to another, given differences in the availability of technology and alternative products. What's more, about half of the companies we examined already link the remuneration of top management to the achievement of tangible environmental, social, and governance (ESG) goals, which we view as positive and should be instrumental in managing the transformation. This should create the necessary traction for technological advances and repositioning of some business activities.

Four financial sector entities, among them Deutsche Bank and Allianz, have already achieved their emission-reduction targets for scopes 1 and 2. They benefit from relatively moderate emissions as part of their own business activity and took offsetting measures to achieve their reported emission-free status. However, many financial institutions that are members of the U.N.'s net-zero asset owner alliance are also targeting an end to scope 3 emissions on their investment or loan portfolios by 2050, which is a more difficult task.

Overall, the depth of company reporting on sustainability and ESG is still not homogenous, and base years vary; therefore comparison remains difficult.

Carbon-Intensive Industries Face Increased Scrutiny

Carbon-intensive industries will remain under pressure in the coming years to present viable plans for transforming their current carbon footprint in line with a net zero economy. In our view, a detailed plan with regular progress updates is likely to be important for carbon-intensive sectors to remain attractive to investors, which are increasingly favoring carbon-light industries.

At this stage, Germany's revised Climate Change Act focuses on national emissions covering scopes 1 to 3, so goods that are exported or imported from suppliers abroad would not count. As such, for scope 3 emissions, which are in any case difficult to measure, only a portion is relevant. Many corporates are therefore focusing on scope 1 and 2 emissions in defining their emissions-reduction targets, since these are largely under their control. Scope 1 are direct emissions from company-owned and controlled resources as part of their production processes. Scope 2 refers to indirect GHG emissions from electricity, steam, heat, or cooling services.

Based on this, five of the 35 companies we examined account for 80% of scope 1 and 2 emissions, and the remaining 30 companies only 20%. The focus on GHG emissions remains concentrated in sectors like utilities, cement, steel, transport, and to a lesser extent, chemicals. The utilities and transport sectors still have the largest GHG deliverables, since emissions need to drop by about 40% from today's levels to be in line with the 2030 requirements (see chart 2).

Chart 2


Utilities are aiming to beat Germany's new net zero deadline.   Power generation companies are among the top emitters of CO2 measured by scope 1 and 2. RWE has set a very ambitious target for its production to become carbon neutral by that measure as of 2040 (RWE), and for EnBw and Uniper's European generation operations, the target year is 2035, 10 years earlier than the German Climate Change Act requires. To achieve this, RWE and Uniper will exit their current coal power production (hard coal and lignite), already mandated by 2038 in Germany (see "The Path To Germany's Coal Exit Has Diverging Credit Implications For Utilities," published Nov. 16, 2020), with the new ruling coalition potentially targeting an earlier date in 2030. Uniper has announced that it will reduce its German coal generation by about 70% by 2025 to about 1.1 gigawatts (GW), and RWE plans to reduce its German coal capacity by about 70% to about 4 GW by 2030. In contrast, utilities with a large network--like E.ON--have a much lower scope 1 and 2 CO2 emission footprint and E.ON has set a goal of achieving net zero scope 1 and 2 emissions by 2040.

The cement industry, another high CO2 emitter, will find it tough to achieve the new net zero deadline.  European cement companies have managed to bring down emissions substantially in the past few years, as a result of significant investments to improve plants' thermal efficiency and increase the use of alternative fuels, such as biomass. HeidelbergCement, the largest cement producer we rate in Germany, and among the largest in the world, has cut carbon emissions per ton of cement by 23% since 1990. Its emissions stood at 576 kilograms per ton (kg/ton) of cement in 2020. Energy efficiency remains the most relevant factor fueling emissions reduction until 2030, when most large European groups intend their emissions to be below 500 kg/ton. HeidelbergCement aims to reduce its scope 1 net CO2 emissions to 525 kg/ton of cement by 2025, and less than 500 kg/ton by 2030. It has also committed to offering carbon-neutral concrete across its product portfolio by 2050 at the latest. In our view, beyond 2030, a significant drop of emissions can only be achieved by wider use of technologies that are still under development, such as carbon capture and storage, and by much greater use of recycled materials. At the same time, the EU's "Fit for 55" plan will likely lead to a reduction of free allocations in the EU, which will test cement companies' ability to pass much higher carbon costs on to end users.

Lufthansa, like other airlines, supports the aviation sector's climate-protection goals and aims to achieve carbon neutrality by 2050, not 2030.   The main way that Germany's national carrier intends to achieve this is through continuous fleet modernization, increasing the use of alternative fuels, emissions-reduction initiatives, and offsetting activities. The difficulty in decarbonizing is shown by the sector's modest 8% emissions reduction since 1990, while a further decrease of 40% is needed by 2030. Hence carbon-offset regulations will likely need to play a bigger role, or the rising carbon cost attached to airline tickets may dampen passenger demand growth, unless there is a technological breakthrough in terms of new engines. The prospect of airplanes running on hydrogen, for example, is only likely well beyond 2030, however. In the meantime, airlines are seeking to modernize their fleets and opt for fuel- and CO2-efficient aircraft. The average age of Lufthansa's fleet is 12 years, somewhat above the global industry average. These measures entail larger capital expenditure and potentially higher operating costs, which may result in an increase in leverage.

In the chemicals sector, BASF has committed to achieving net zero emissions by 2050 and reducing its absolute CO2 emissions by 25% by 2030 compared with 2018 (or by 60% compared with 1990).   This is despite BASF's significant growth ambitions, including the construction of another Verbund site in South China to be completed by 2030. While renewable energy will be key to achieving these targets, the company is also developing and implementing new, low-emission processes. In line with the company's projections, we factor in limited capital expenditure (less than €1 billion) related to this transformation in the first half of this decade, with only a slight rise (€2 billion-€3 billion) in the second half. In the longer term, BASF is planning much larger investments (€10 billion or higher) beyond 2030 to ramp up the use of renewable energy and build world-scale production plants based on new technologies.

Some automakers have yet to fully adapt to the new targets, but we think further tightening of processes is likely over time.   Consistent with current legislation, Daimler has set a target of offering only CO2-neutral new vehicles by 2039, whereas Volkswagen (VW) and BMW are so far focused on their target of becoming climate neutral by 2050. That said, all three have reduced scope 1 and 2 emissions meaningfully over the past few years, and both BMW and Daimler are expected to report CO2 neutrality in their own production by the end of 2021 and 2022, respectively. This could be thanks to a strong focus on shifting to green energy, optimizing production processes, entering offsetting projects, and purchasing certificates. BMW and Volkswagen have set interim targets on the path to achieving their 2050 net-zero ambitions, which include scope 3. By 2030, BMW aims to cut CO2 emissions per car in the supply chain by 20% versus 2019, and by 50% versus 2019 in the use phase. VW targets a reduction in total lifecycle GHG emissions from light vehicles of almost 30% to 31.6 tons of CO2 per vehicle by 2025 from 43.8 tons of CO2 per vehicle in 2015.

The Impact Of Emissions On Credit Ratings Will Likely Keep Increasing

The financial impact on German corporates of accelerated emission-reduction timelines depends on several factors, including how public policy, regulation, and consumer behavior evolve, as well as the competitiveness of alternative products and the extent to which higher costs can be passed through to the end consumer.

In view of the evolving regulation, both at the national and EU levels, we expect to see a change in German companies' profit and business models as part of the transformation to a net zero economy. This is also likely to influence their creditworthiness depending on companies' success in adapting their business models to new regulation and the influence of any offsetting measures that rated entities could take (such as revising dividend policies), should their profitability change.

We note, however, that German industries generally enjoy strong access to capital markets, which should help them proactively modify their energy mix and products. They should therefore be able to finance the sizeable capital expenditure associated with investing in new technologies or emission-abatement projects as long as a sound strategic plan is in place.

In our "General Criteria: Environmental, Social, And Governance Principles In Credit Ratings," published Oct. 10, 2021, we explain how we factor ESG into our credit analysis. However, strong creditworthiness does not necessarily correlate with strong ESG characteristics and vice versa. We already reflect climate-transition risks as an environmental factor in our credit ratings to the extent that they are material enough to affect an entity's creditworthiness. Another point we carefully analyze is how corporates are preparing and setting strategy for action in the coming years. As such, our ratings remain dynamic and could change as climate-transition risks evolve.

Chart 3


Scope 3 Highlights A Large Reporting Gap

Companies have a fair amount of control over scope 1 and 2 emissions. Attempting to reduce scope 3 emissions--which include those from the use of products, and considering the full value chain from suppliers to the end consumers--is a more difficult prospect. It also adds enormous complexity to measuring emissions.

However, in many cases, scope 3 accounts for the majority of overall emissions for industrial companies (see chart 4). In particular, they add to the costs of German utility networks, automakers, chemicals, oil and gas, and real estate companies. Since those companies tend not to own or control activities generating scope 3 emissions, and in some cases there are few alternatives, devising a credible plan to reduce such emissions is a challenge. About 30% of the companies we examined do not yet report information on scope 3 emissions. Nevertheless, we see that the number of corporates would have to report substantially higher emissions taking scope 3 into account.

Chart 4


Related Research

Primary Credit Analyst:Tobias Mock, CFA, Frankfurt + 49 693 399 9126;
Secondary Contacts:Karl Nietvelt, Paris + 33 14 420 6751;
Timucin Engin, Dubai + 971 4 372 7152;

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