Keywords

2.1 Introduction

In 2015, a historic accord was reached in Paris, uniting 195 nations and the European Union in a collective commitment to climate action. The Paris Agreement set an ambitious target—limiting global warming to well below 2 °C compared to pre-industrial levels (Paris Agreement, see United Nations (UN), 2015). Despite the ensuing struggles with implementation and the limitations inherent in such a broad international pact, the Paris Agreement represents a monumental global breakthrough, embodying the goal of attaining net zero emissions and providing a roadmap for joint international environmental stewardship.

This book serves as an exploration of that roadmap and how businesses can contribute to it by charting the path known as the ‘Road to Net Zero’. Therefore, as the first thematic focus of this book, Chap. 2 sets out the broad context and objectives of this journey, outlining the background for sustainability transitions steered by businesses towards a climate-friendly future. While subsequent chapters examine the role of businesses in detail, this chapter first focuses on the interplay of climate science, policymakers, and corporations needed in setting the course for a decarbonised future.

The structure of the chapter is designed to guide readers through the multifaceted aspects of this complex topic. Section 2.2 lays the foundation with a brief overview of fundamental climate science. A basic understanding of these fundamentals is crucial to understanding the urgency and scope of the task at hand. Section 2.3 charts the evolution of global climate policy, taking readers along the path that led to the Paris Agreement. It elucidates why the pursuit of net zero emissions necessitates a profound shift away from current mainly fossil-fuel-based economies towards a sustainable, low-carbon future. Section 2.4 zooms in on the role of national and supranational policymakers. Their role in crafting regulations and incentivising changes is vital in propelling the world along the Road to Net Zero. Engaging with these basics, Sect. 2.5 features the expert conversation of Prof. Dr Veronika Grimm, FAU Chair of Economic Theory and Member of the German Council of Economic Experts, Prof. Oliver Zipse, CEO of BMW Group, and Dr Thomas Becker, VP Sustainability & Mobility at BMW. They shed light on the intricate balancing act between regulation, infrastructure support, and the strategic and technological imperatives of businesses. Finally, Sect. 2.6 delves into the science-based frameworks for setting, measuring, and reporting climate targets at the corporate level in line with the Paris Agreement before Sect. 2.7 concludes.

2.2 A Brief Review of Selected Climate Science Insights

A basic understanding of climate science fundamentals is helpful for grasping the complexities of climate change and the pressing need for mitigative action. The aim of this section is to encapsulate some of these rudiments, especially those relevant to the Road to Net Zero, as elaborated upon in this book. While the idea of ‘following the science’ is indeed crucial, it is important to acknowledge that science is an iterative field that progresses through a constant exchange of ideas and testing of theories. Science does not provide static answers; rather, it generates ever-evolving explanations that are refined over time based on new evidence and understanding. This concept of iterative refinement and learning applies equally to climate science.

The Intergovernmental Panel on Climate Change (IPCC) exemplifies this process of scientific collaboration and consensus building. Composed of three working groups, the IPCC does not engage in original research; instead, it synthesises the global body of climate research to provide policymakers and the general public with comprehensive assessments of the scientific consensus on climate change (IPCC, 2021b). Working Group I assesses the physical science basis of climate change; Working Group II addresses the vulnerability of socio-economic and natural systems to climate change, the negative and positive impacts of climate change, and options for adapting to it; and Working Group III assesses options for reducing greenhouse gas emissions and otherwise mitigating climate change (IPCC, 2021a).

Central to understanding climate change is recognising the role of carbon dioxide (CO2) and other greenhouse gases (GHGs) in heating our planet. CO2 and its equivalents trap heat in the Earth’s atmosphere, thus affecting global temperatures (Shakun et al., 2012). Prior to the first industrial revolution, the emissions and absorptions of greenhouse gases were in balance, resulting in relatively limited alternating CO2 concentrations and temperatures. However, increasing anthropogenic (i.e. human-made) actions, such as industrial and economic activities, have disrupted this delicate balance of the global carbon cycle. The burning of fossil fuels releases carbon from the ground into the atmosphere, while land use changes (such as deforestation and the conversion of wetlands into agricultural land) also emit carbon and reduce the Earth’s natural capacity to absorb carbon. As a result, the concentrations of CO2 in our atmosphere have been rising and, in turn, have been warming the planet (IPCC, 2023; Prentice et al., 2012).

Accurately measuring the historical and current levels of GHG emissions, including CO2, is a complex but crucial part of climate science. By 2022, atmospheric CO2 concentrations had reached around 421 parts per million (ppm), more than 50% higher than pre-industrial levels (National Oceanic and Atmospheric Administration, 2022). This increase in CO2 concentrations corresponds to a warmer planet, with the average surface temperature estimates from 2011 to 2020 indicating the Earth was already approximately 1.1 °C warmer than during the pre-industrial period (1880–1900) (IPCC, 2023, p. 4).

Climate science has harnessed such historical data to construct and validate advanced simulation models for predicting future temperature levels. In IPCC reports, these future simulations rely on varying emission scenarios, also known as shared socio-economic pathways. These scenarios contemplate different potential socio-economic and technological developments. For each scenario, simulation models can anticipate future GHG emissions and the corresponding shifts in global temperature (IPCC, 2021c).

Comprehending the spectrum of these temperature variations is vital for assessing the potential ramifications of climate change. These consequences are extensive, permeating almost all aspects of our lives. They encompass increased frequency and intensity of heatwaves, extended droughts, unpredictable precipitation, escalating biodiversity loss, intensified wildfires, invasive species, forest loss, rising sea levels, melting ice caps and glaciers, ocean acidification, vanishing coral reefs, heat-related illnesses and mortality, the spread of vector-borne diseases, and heightened food insecurity (IPCC, 2022).

Given these threats, a protracted discourse has emerged regarding the critical levels of global warming beyond which humanity would face severe and dangerous climate change. Within the IPCC, two such goals have gained specific attention: the 2 °C threshold and the more recent 1.5 °C target. The 2 °C target, first proposed in the 1970s by economist William Nordhaus, later garnered political recognition in the 1990s. By the time of the IPCC’s Fourth Assessment Report (AR4) in 2007, this target had become a commonly referenced goal in policy discussions. However, the AR4 did not explicitly endorse the 2 °C target but instead presented a range of possible outcomes based on different emission trajectories. It highlighted that a global temperature rise of 2 °C above pre-industrial levels would have serious impacts, including an increased risk of extreme weather events, significant biodiversity loss, and a higher likelihood of tipping points in the Earth system (IPCC, 2007). The IPCC’s Fifth Assessment Report (AR5), published in 2014, further reinforced these findings (IPCC, 2014). Consequently, the IPCC was tasked with preparing a special report on the impacts of global warming of 1.5 °C. This report, published in 2018, clarified that the impacts at 1.5 °C of warming are significantly less than at 2 °C and underscored the need for rapid, far-reaching, and unprecedented changes in all aspects of society to achieve this more ambitious target (IPCC, 2018).

In its most recent synthesis report, published in 2023, the IPCC underscored the significance of this shift towards the 1.5 °C goal because the latest stage of climate science suggests that dangerous forms of global warming are likely to occur at lower levels of global warming than previously anticipated ‘due to recent evidence of observed impacts, improved process understanding, and new knowledge on exposure and vulnerability of human and natural systems, including limits to adaptation’ (IPCC, 2023, p. 15). One specific concern is the potential for the climate system to reach tipping points and trigger self-enforcing feedback loops. Such tipping points, including the melting of Arctic sea ice or the thawing of permafrost (which releases methane), could contribute to further warming, even if anthropogenic emissions were fully eliminated.

The quest to prevent these catastrophic impacts led the IPCC to study the probable effects of limiting global warming to 2 and 1.5 °C above pre-industrial levels. Their analyses provide the scientific basis for these temperature goals, which are now central to global climate policy.

Emerging from this research is the concept of a ‘carbon budget’. This is the aggregate amount of CO2 emissions that can be discharged into the atmosphere while still maintaining a likely chance of limiting global warming to a specific temperature target. The size of the remaining carbon budget varies depending on whether the goal is to limit warming to 2 or 1.5 °C. In its latest synthesis report, the IPCC estimates the remaining carbon budgets from the beginning of 2020 to be 500 Gt CO2 (for a 50% likelihood of limiting global warming to 1.5 °C) and 1150 Gt CO2 (for a 67% likelihood of limiting warming to 2 °C) (IPCC, 2023, p. 21). At the 2019 emissions level, this budget would be almost fully utilised for the 1.5 °C goal and roughly a third would be utilised for the 2 °C goal by 2030.

Therefore, climate science illustrates that achieving both the 2 °C and the 1.5 °C goals is feasible only with a massive and rapid decarbonisation of the economy. Regardless of whether the target is to limit warming to 2 or 1.5 °C, global emissions must reach ‘net zero’ at the culmination of this process. This term implies that any emissions discharged into the atmosphere must be offset by equivalent removals, either through natural processes (i.e. by absorption by natural sinks, such as plants and the ocean) or human-made technologies, such as carbon capture and storage.

However, a crucial point to emphasise is that achieving net zero emissions by a specific year is not sufficient to stay within a specified carbon budget. What matters for climate stabilisation is the accumulated emissions over time, which means the actual reduction pathways on the way to net zero. This means that if emissions are reduced too slowly in the early years, then faster reductions will be needed later to stay within the carbon budget. Thus, while a net zero target sets the end goal, the pace at which emissions decrease on the Road to Net Zero is just as crucial (IPCC, 2021c).

In summary, understanding the basics of climate science is key to appreciating the challenges of climate change and the urgency of taking action to mitigate its worst impacts. As science evolves, so too must our responses to it. The Road to Net Zero, for example, is not just about reaching a destination; it is also about how swiftly we embark on that journey and how many iterations (cf. Chap. 1; Fig. 1.1) we will need to do so. The following section discusses the evolution of this journey in the global climate policy debate.

2.3 Global Climate Policy: The Road to Paris and Beyond

The origins of global climate policy can be traced back to the 1972 United Nations Conference on the Human Environment and the ensuing establishment of the United Nations Environment Programme (UNEP). The conference, hosted in Stockholm, provided the foundation for international environmental cooperation (Bodansky, 2001). Recognising the potential threat of climate change, UNEP, in collaboration with the World Meteorological Organization (WMO), formed the Intergovernmental Panel on Climate Change (IPCC) in 1988. This independent entity was tasked with assessing scientific literature and furnishing crucial scientific information to the climate change process.

The Earth Summit of 1992 in Rio de Janeiro heralded the establishment of the United Nations Framework Convention on Climate Change (UNFCCC)—a pivotal international treaty devoted to addressing climate change. The UNFCCC, grounded in scientific insights suggesting that human-made greenhouse gas (GHG) emissions could influence global temperatures, was adopted with the ultimate objective of preventing ‘dangerous anthropogenic interference with the climate system’ (UNFCCC, see UN, 1992, Article 2). While the UNFCCC aimed to stabilise atmospheric GHG concentrations to preclude dangerous warming, it did not specify the level at which this stabilisation should occur.

The UNFCCC came into effect on March 21, 1994, and today enjoys near-universal membership. The 198 nations that have ratified the Convention regularly convene for global climate conferences, referred to as the Conferences of the Parties (COPs). These ongoing conferences highlight how the history of global climate policy has been shaped by the dynamic interplay between emerging insights from climate science and political negotiations on a global scale. Climate policy is informed not only by findings from climate science but also by political evaluations and decisions that extend beyond the realm of science (e.g. when discussing what impacts count as dangerous or how burdens should be distributed).

Political negotiations concerning climate change have encompassed a broad array of topics. As the impacts of climate change become increasingly evident, more attention is devoted to questions of adaptation, protection of the most vulnerable, assisting developing countries with the transition and debates about financial compensations for countries most affected by global warming. While these topics are pertinent and relevant for international political negotiations, the following review is specifically focused on the policy discussion on limiting global warming, the emergence of global science-informed targets and, consequently, on selected milestones for setting the trajectory for the Road to Net Zero discussed in this book.

The Kyoto Protocol, adopted in 1997 at the third Conference of the Parties (COP 3) in Kyoto, Japan, marks the first significant milestone in global climate policy. For the first time, it introduced legally binding obligations for developed countries to reduce GHG emissions, thereby sparking international cooperation on climate change mitigation. These so-called Annex I countries (including the EU, Canada, Australia, New Zealand, and Russia) committed to substantial reductions in their greenhouse gas emissions—a 5% reduction compared to the 1990 level, with the target period set between 2008 and 2012. However, countries like China, India, Brazil, and Indonesia ratified the treaty without agreeing to binding targets. By establishing the principle that nations bear common but differentiated responsibilities concerning climate change, the Kyoto Protocol laid essential groundwork for subsequent climate agreements, including the Paris Agreement (Bodansky, 2001).

From a more technical perspective, the Kyoto Protocol is also noteworthy for its definition of the most relevant greenhouse gases (the seven Kyoto gases), encompassing not just CO2 but also methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulphur hexafluoride (SF6), and nitrogen trifluoride (NF3). These latter six gases have their warming potential translated into CO2 equivalents when determining emissions and emissions reductions. The Kyoto Protocol is also notable for its adoption of market mechanisms, such as emissions trading, the clean development mechanism (CDM), and joint implementation (JI). These innovative tools provided flexibility in how countries could fulfil their commitments (Barrett, 2005). Despite this, the Kyoto Protocol faced criticism for various limitations, including the absence of some major emitters (including the USA, which refused to ratify) and challenges in achieving its targets (Barrett, 2005).

While the Kyoto Protocol defined reduction targets for GHG emissions, it did not include a specific temperature or GHG concentration target to specify what ‘dangerous interference’ with the climate system implies. This began to change with the Copenhagen Accord, which was developed during the 15th Conference of the Parties (COP15) in Copenhagen in 2009. The Copenhagen Accord, reflecting advances in climate science and political assessments of climate impact, was the first instance of a global temperature target being explicitly mentioned in an international climate policy document. The Accord stated that ‘deep cuts in global emissions are required […] to hold the increase in global temperature below 2 degrees Celsius’ (Copenhagen Accord, see UNFCCC, 2009, p. 5). Nevertheless, a notable point is that the Copenhagen Accord did not formally establish the 2 °C target and lacked legal bindingness. The 2 °C target was officially adopted the following year, at COP16 in Cancun, which culminated in the Cancun Agreement.

Arguably, the most significant milestone in charting the Road to Net Zero thus far is the Paris Agreement, enacted at the subsequent COP17 in 2015. The Paris Agreement not only reaffirmed the 2 °C goal but pushed further, aiming to limit global warming to 1.5 °C if possible. While the Paris Agreement encompassed various important aspects, such as matters of adaptation, loss and damage, and climate finance—thereby emphasising the need for responses to climate change to extend beyond mitigation efforts alone (Klinsky et al., 2017)—the following features and implications of the Paris Agreement are particularly relevant for the Road to Net Zero, as they specify its purpose, destination, group of travellers, and travel model.

First, in terms of the purpose of the Road to Net Zero, the Paris Agreement (see UN, 2015, p. 3) established a global commitment to prevent dangerous climate change by keeping global warming ‘well below 2 °C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5 °C above pre-industrial levels’. The Paris Agreement thus represents a significant, though still insufficient, step forward in recognising the urgency of the climate crisis (Rogelj et al., 2016), with the inclusion of the 1.5 °C goal reflecting current climate science insights regarding the risks associated with warming above this threshold.

Second, in relation to the common destination of the journey to Net Zero, the Paris Agreement was the first global treaty to complement a temperature goal with a long-term goal of achieving net zero emissions by the latter half of the century. This goal of achieving net zero emissions had not been explicitly included in global climate agreements prior to the Paris Agreement. The Kyoto Protocol and other earlier agreements focused primarily on setting specific, near-term targets for reducing greenhouse gas emissions from developed countries, rather than stipulating a long-term global goal of achieving net zero emissions. However, while the concept of net zero emissions has become central to discussions on how to achieve the temperature goals of the Paris Agreement; notably, the phrase ‘net zero emissions’ does not appear verbatim in the text of the Agreement. Instead, the Agreement states that Parties aim to reach ‘a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases’ in the second half of the century (Paris Agreement, see UN, 2015, p. 4).

Third, regarding the group of travellers embarking on the journey to Net Zero, the Paris Agreement includes commitments from all countries to reduce their emissions. Unlike the Kyoto Protocol, which legally mandated emission reductions for developed countries only, the Paris Agreement brought together all countries, including major emitters like the United States and emerging economies such as China and India. The Agreement requires all nations, regardless of development status, to set, report on and revise their climate goals. This global responsibility reflects the rising emissions from developing countries and underscores a shared duty for climate action (Bodansky, 2016). It also explicitly states that the journey to Net Zero is a challenge of a global nature.

Fourth, in terms of the mode of travel, the Paris Agreement defines the journey to Net Zero as an iterative, continuous learning process. Contrasting with the Kyoto Protocol’s top-down approach, where international targets were imposed and enforced on nations, the Paris Agreement encouraged a bottom-up approach. In this arrangement, each country develops its own climate plan—the so-called Nationally Determined Contributions (NDCs)—detailing its emission reduction targets and adaptation strategies. Intended to foster flexibility and national ownership of climate commitments, the concept of the NDCs is to engage countries in a regular review process, in which each country’s NDCs are reviewed and updated every 5 years in what is known as the ‘Global Stocktake’ (Paris Agreement, see UN, 2015, pp. 18–19).

The regular review process of the Paris Framework is intended to ensure that efforts to address climate change are progressively scaled up. Despite this intention, critics argue that without a legally binding enforcement mechanism, the Global Stocktake relies excessively on international peer pressure and goodwill to drive increases in ambition, with a lack of legally binding mechanisms to enforce climate action (Bodansky, 2016). Irrespective of this criticism, an important point to note is that, despite its historic character, the Paris Agreement was not a breakthrough that resolved all issues. On the contrary, the Paris Agreement marked the beginning of continuous follow-up negotiations, with the operational details for the practical implementation of the Paris Agreement agreed upon at the UN Climate Change Conference (COP24) in Katowice, Poland, in December 2018—colloquially referred to as the Paris Rulebook—and finalised at COP26 in Glasgow, Scotland, in November 2021.

So, what are the key implications of the Paris Agreement for the Road to Net Zero as discussed in this book? It is difficult to overstate that Paris represents a fundamental departure from previous agreements by defining the long-term net zero-emission goal instead of short-term incremental reductions. The net zero goal is an absolute target that differs qualitatively from relative reductions. To achieve this distinct target, merely improving the efficiency of fossil-fuel-based technologies will not be enough. Instead, companies and the entire economy need a radical transition towards extensive decarbonisation. This necessitates a shift in energy sources, technologies, products, value chains, infrastructure, regulation, and much more.

Moreover, by affirming the global commitment to the 2° goal and the ambition to achieve the 1.5 °C goal, the Paris Agreement has anchored the concept of a remaining carbon budget in the global policy discourse. This implies that not only the long-term Net Zero goal matters but that ambitious reduction pathways are needed to align with Paris. This requires rapid and far-reaching emissions reductions.

The Paris Agreement’s commitment to a bottom-up approach invites individual countries to formulate and submit their NDCs. This indicates that paths to Net Zero may differ between countries. So far, however, these national pledges are far from sufficient. In fact, a report by the UNFCCC in 2022 warned that the combined climate pledges of all 193 parties to the Paris Agreement would result in about 2.5 °C of warming by the end of the century (UNFCCC, 2022). More ambition is therefore needed. Consequently, with countries needing to step up their efforts, the spotlight now falls on the climate policies that can be enacted at the national level, a topic the subsequent Sect. 2.4 delves into. Meanwhile, multinational corporations aiming to align their operations with the Road to Net Zero must effectively navigate this complex policy terrain. Science-based frameworks can assist these companies in developing long-term strategies that consider diverse national climate policies. This is particularly pertinent, as the Paris Agreement demonstrates the evolutionary nature of global climate policy, reflecting the ever-evolving insights provided by climate science. Therefore, taking an active role on the Road to Net Zero and preparing for prospective regulations are greatly aided by a science-based approach, a topic that we will examine further in Sect. 2.6.

2.4 The Role of National Policy Frameworks and Governance Mechanisms

As discussed above, the Paris Agreement employs a bottom-up approach, encouraging all nations to propose their NDCs. Internationally, this necessitates negotiations on how these national efforts collectively align with the vital emission reductions needed to adhere to the 2 or 1.5° goal (Rogelj et al., 2016). Conversely, on a national level (and supranational level, in the case of the EU), the challenge extends beyond setting ambitious emission reduction targets to formulating the domestic policies that will facilitate these reductions.

Accordingly, national governments and supranational entities like the European Union find themselves navigating a complex and challenging landscape. On the one hand, they must determine their fair share of the globally agreed climate goals, even in the absence of sanctions for non-compliance. They must also devise policy instruments that can effectively catalyse rapid and significant emission reductions. On the other hand, they must simultaneously consider the potential costs associated with these mitigation measures, their impacts on local populations and their implications for economic innovation and competitiveness.

In this situation, policy frameworks and governance mechanisms that promote sustainable innovations and offer significant economic value for domestic companies are highly desirable, even in the absence of clear implementation roadmaps and sanction mechanisms. Conversely, it becomes much more challenging to justify other climate measures that, while crucial to upholding a fair national contribution to the agreed-upon climate goals, impose substantial mitigation costs at the national level and do not provide dynamic benefits in terms of innovativeness and competitiveness for domestic companies. Therefore, domestic policymakers strive to enact climate policies that balance ecological effectiveness, economic efficiency, and legal and administrative feasibility while maintaining political acceptability.

The subsequent analysis will spotlight the actions taken by the EU and Germany as examples of concrete policy measures employed to balance these diverse objectives.

At the core of the EU’s climate policy plans lies the European Green Deal, which was proposed and introduced in 2019 (see European Commission, 2023a). It includes the goal of reducing net greenhouse gas emissions by at least 55% compared to 1990 levels by 2030 and provides a roadmap for transforming the EU into a carbon-neutral continent by 2050. The Green Deal encompasses a wide range of specific goals, such as the sustainable use of resources (known as the Circular Economy Action Plan; see European Commission, 2023c), as well as specific sustainability goals and emission targets for different sectors, including the mobility and the building sectors (see European Commission, 2023d). However, in addition to these emission reduction goals, the Green Deal explicitly aims to promote innovation and competitiveness among domestic firms and industries by fostering the development of products and markets for clean technologies. These goals have been enshrined in the European Climate Law, which came into force in July 2021 (European Commission, 2023f; European Climate Law, see European Parliament & European Council, 2021). Nonetheless, the ultimate responsibility for implementing most of these ambitious policy goals lies with the individual national governments within the EU.

Governments have a wide range of policy tools at their disposal to implement specific emission reduction targets. Here, we provide an overview of the most important and prominent instruments adopted in Germany. We categorise these instruments into three groups: (1) market-based instruments that assign a proper price to external costs; (2) direct support instruments designed to promote the development and adoption of sustainable technologies and products, including infrastructures; and (3) traditional regulatory approaches, also known as ‘command-and-control measures’, which involve the direct prohibition of specific polluting technologies or products.

2.4.1 Market-Based Instruments to Directly Internalise External Costs

The fundamental idea behind these policy tools is to impose a market price on activities that have a detrimental impact and cause damages borne by society as a whole, rather than directly affecting producers or consumers involved. External costs occur when the cost of these damages is not fully reflected in the market prices faced by the market participants directly involved. Market-based instruments are designed to correct this mismatch and impose prices that properly reflect the external costs caused (Pigou, 1920).

Two popular market-based mechanisms are available for reducing GHG emissions: carbon taxes and cap-and-trade systems (Baumol & Oates, 1988). A carbon tax imposes a fee per unit of emissions, encouraging businesses to reduce emissions to lower their tax burden. This mechanism sets a certain price on emissions, but the emissions reduction is uncertain. Conversely, cap-and-trade mechanisms set a firm limit on total emissions (the cap). Entities can then buy and sell emissions allowances (the trade), which provide certainty on emissions reduction but variability in cost. While a carbon tax eliminates carbon price volatility, cap-and-trade ensures meeting the target, but at the disadvantage of volatile carbon prices (Tietenberg, 2006).

An important policy instrument of this kind is the European Union Emissions Trading System (EU ETS). The system was launched in 2005 as a cap-and-trade mechanism with the aim of pricing GHG emissions and limiting total emissions (for detailed information on the functioning of the EU ETS, see, for example, European Commission, 2023e). Currently, the EU ETS covers emissions from electricity production, energy-intensive industries (such as iron, steel, cement, glass, etc.), and some parts of aviation and maritime transport. Overall, the EU ETS covers approximately 40% of the current GHG emissions in the EU (European Commission, 2023e). In December 2022, the EU Parliament and the EU Council agreed to strengthen the EU ETS.

Also in December 2022, the EU Parliament and the European Council agreed to extend the ETS to emissions occurring in the transport and building sectors that were so far not included in the EU ETS (European Parliament, 2022). Germany had already introduced a national CO2 price for these sectors. The corresponding law (Brennstoffemissionshandelsgesetz, see Deutscher Bundestag, 2022a) was introduced in 2019 and became effective in 2021. This system is phased in by a period of yearly increasing emission prices and then transitions into a cap-and-trade system. The prices for CO2 emissions increase in several steps from 25 €/ton CO2 in 2021 to 45 €/ton by 2025, which correspond to 0.07 and 0.11 €/l gasoline, respectively (see, for example, Umweltbundesamt (UBA), 2022). In this early phase, the system thus implements de facto a CO2 tax. From 2026 on, a switch to an emission trading system is planned, however within a price corridor between 55 and 65 €/ton CO2 (Brennstoffemissionshandelsgesetz, see Deutscher Bundestag, 2022a).

Market-based instruments that aim to internalise the external costs of emissions can be powerful tools to combat climate change (Stavins, 2003). When properly established, emission targets or carbon taxes can lead to an efficient achievement of climate goals within a closed economy (Baumol & Oates, 1988). However, the reality is that neither the EU nor its member states operate in isolation. Climate change is a global problem, but market-based mechanisms are typically implemented on a relatively small, national, or European scale within the framework of open economies. In response to this, the EU proposed the EU Carbon Border Adjustment Mechanism (CBAM), a policy that mandates importers of specific goods into the EU to pay for the carbon emissions embodied in those goods. The CBAM is designed to prevent carbon leakage, a phenomenon that occurs when companies relocate their production to nations with less stringent climate policies (European Commission, 2023b).

Part of the EU’s ‘Fit for 55’ package, the CBAM will apply to a range of products, including cement, iron and steel, aluminium, fertilisers, and electricity. Advocates of the CBAM anticipate that it could help diminish GHG emissions by encouraging other countries to adopt more rigorous climate policies. The mechanism also aims to shield EU industries from unfair competition arising from nations with laxer climate regulations. However, the CBAM has faced its share of criticism. Some critics argue that its implementation could be challenging and potentially spark trade disputes with other countries or—if the coverage is incomplete—may lead to the relocation of value chains outside the EU (Garnadt et al., 2020; Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, 2020). There are also concerns that the CBAM could disproportionately impact developing countries that depend on the export of carbon-intensive goods.

The CBAM is thought to address the challenges market mechanisms face when carbon prices vary across countries and sectors. In an ideal setup, there should be a global uniform carbon price for all market participants (Nordhaus, 2019). Through the thorough implementation of such mechanisms, we could in principle address climate emissions cost-effectively. The idea is that if emission targets are reliably announced, they could provide strong long-term incentives to trigger the necessary investments and spur innovation in technologies and infrastructure, such as green energy generation and hydrogen or electric mobility charging stations (Aldy et al., 2010).

However, global carbon prices are currently absent. Moreover, there can be additional market or government failures, which could arise from political uncertainty, imperfect financial markets, administrative and transaction costs, limited appropriability of innovative activities, or network effects. Failures may occur, for example, when governments unexpectedly adjust carbon prices for political reasons, when green start-ups struggle to secure venture capital, when network effects affect infrastructure, or when innovation rents cannot be fully appropriated.

Politicians, tasked primarily with the welfare of their domestic populations, navigate this complex terrain. While market-based instruments represent a powerful option to tackle climate change (Stern, 2007), integrating such mechanisms with other policy tools may be advantageous from both a national and a European perspective. This approach would help address the limitations of a single-policy method and potentially enhance the effectiveness and efficiency of climate change policies (Goulder & Parry, 2008).

2.4.2 Direct Support Instruments for Sustainable Technologies and Products

A second category of policy tools directly incentivises the adoption and development of technologies and solutions crucial for mitigating greenhouse gas emissions. Economically, this approach is especially sensible for nascent technologies. Early-stage technologies frequently confront challenges, such as high costs, infrastructure deficiency, and market uncertainty, that could impede their development (Jaffe et al., 2002). Government subsidies can help overcome these barriers, driving ‘directed technical change’ towards greener technologies that can not only correct market failures related to environmental externalities but also stimulate innovation and economic growth (Acemoglu et al., 2012). However, note that such subsidies must be carefully designed to ensure they are cost-effective and do not lead to unintended consequences.

A prime example of such an instrument is the German Renewable Energy Sources Act (Erneuerbare-Energien-Gesetz or EEG; see Bundesministerium für Wirtschaft und Klimaschutz, 2023). First introduced in 2000, the EEG has seen several revisions to adapt to changing market conditions and technological advancements. Its primary objective is to support the expansion of renewable energy generation and reduce the country’s dependency on fossil fuels. The EEG provides a stable and long-term framework for the development of renewable energy projects by guaranteeing minimum compensations for electricity generated from renewable sources. Those guaranteed compensations typically are granted for a period of 15–20 years, for most renewable projects they are determined in tender procedures. The EEG covers a wide range of renewable energy technologies, including wind power, solar power, biomass, hydropower, and geothermal energy. It establishes specific compensation guarantees for each technology, also considering factors such as the installation size, technology type, and regional resource potential.

Largely as a result of the Renewable Energy Sources Act (EEG), the proportion of gross electricity consumption in Germany derived from renewable energy sources has seen a significant increase in recent years. The share rose to 41% in 2021 and further escalated to 46% in 2022 (Umweltbundesamt (UBA), 2023b). However, it is critical to recognise that the reported electricity consumption of 549 TWh in 2022 (UBA, 2023c) constitutes merely a fraction of Germany’s total energy consumption, which approximates around 2500 TWh (UBA, 2023a). Currently, the largest portion of energy consumption is non-electric energy, which is predominantly utilised in the mobility and heating sectors. These sectors are expected to undergo major electrification in the coming years. While the electrification process is expected to considerably boost energy efficiency, and the current version of the EEG-2023 proposes highly ambitious expansion paths, especially for wind and solar power (Erneuerbare-Energien-Gesetz, see Deutscher Bundestag, 2023, §4), it still presents a formidable challenge to fully cover the drastically increased electricity needs with German domestic renewable energy sources.

Germany also makes serious efforts to promote sustainable products that are considered to contribute significantly to low-emission scenarios, particularly in the mobility sector. Since 2016, the German government has implemented a financial incentive programme called the ‘Umweltbonus’ to promote the purchase of battery electric vehicles (BEVs) and fuel cell electric vehicles (FCEVs). As of 2023, the programme provides subsidies of up to 4500 € for smaller cars and 3000 € for medium-sized cars. From 2024 onwards, these subsidies will be reduced, with only smaller cars eligible for purchase subsidies (Presse- und Informationsamt der Bundesregierung, 2022). Additionally, all newly registered BEVs and FCEVs are exempted from the vehicle tax until 2030 (equivalent to approximately 100–200 € per year; see Bundesministerium der Finanzen, 2023). Finally, since 2017, substantial support programmes have been introduced to incentivise the installation of private and publicly accessible charging points for BEVs throughout Germany with a total volume of 1100 Mio. €. Public support programmes for installing charging points for FCEV are also in place, focused on commercial vehicles and requiring the usage of 100% green hydrogen, currently resulting in significantly smaller support volumes as observed in the case of electric charging points (Bundesministerium für Digitales und Verkehr, 2021).

2.4.3 Traditional Regulatory Approaches: ‘Command-and-Control Measures’

Finally, a third category of governance mechanisms, known as command-and-control measures, imposes mandatory regulations and standards to regulate emissions and promote sustainable practices (Tietenberg & Lewis, 2018). From an economic perspective, these instruments are typically perceived as the least efficient. However, under certain specific circumstances, command-and-control tools can be relevant and may even provide a superior alternative to market-based instruments. Factors such as transaction costs, administrative costs, possibilities for strategic behaviour, or political costs can influence this preference (Newell & Stavins, 2003). Similarly, mandatory uniform standards in environmental regulation might be economically justified and offer ‘efficiency without optimality’, for example, when transaction costs make market-based mechanisms impractical (Baumol & Oates, 1988, p. 159).

A prominent example of command-and-control instruments are the regulations and laws to realise the German Coal Phase-Out. The goal is to eliminate Germany’s dependence on coal for energy production and transition to cleaner and more sustainable sources of power. The corresponding law has been effective since 2020 (Kohleverstromungsbeendigungsgesetz; see Deutscher Bundestag, 2022b). One essential feature of this law is the prohibition of constructing new coal-fired power plants in Germany. Additionally, it includes a precise timeline for phasing out existing coal-fired power plants with the aim of shutting down all coal-fired power plants by 2038 at the latest. This includes both hard coal (anthracite and bituminous coal) and lignite (brown coal) power plants. Owners of existing coal plants are compensated for exiting the market.

Command-and-control mechanisms also play a significant role in the regulation of emissions within the German and European mobility sectors. At the EU level, emission standards have been set to reduce the environmental impact of vehicles and improve air quality. These standards, known as EURO-Norms (currently EURO 6), limit the amount of pollutants, such as nitrogen oxides, particulate matter, and carbon monoxide, emitted by vehicles. Further regulations explicitly limit the average fleet emissions of the greenhouse gas CO2. Since 2020, this has been governed by Regulation (EU) 2019/631 (see European Parliament and European Council, 2019). The standards have been progressively tightened over the years, with each new iteration introducing stricter emission and measurement limits. Recently, as part of the EU’s ‘Fit for 55’ package, concrete plans are in place to enforce zero emissions for new passenger cars and vans from 2035 onwards. However, to date, the fleet emission targets pertain solely to tailpipe emissions and do not account for emissions related to manufacturing the vehicles. As the transition towards electric mobility shifts emissions from the use phase to the production phase, there is increasing momentum to consider all CO2 emissions throughout the entire life cycle of those vehicles (see European Parliament, 2023).

The aforementioned compilation of policy frameworks and governance mechanisms represents the most prominent initiatives driving Germany’s sustainable energy and mobility transition as described in this chapter. These policies and mechanisms play a central role in shaping the country’s renewable energy landscape and fostering the integration of sustainable transportation solutions. However, it is crucial to acknowledge that this overview does not provide a comprehensive survey of all relevant measures implemented in Germany. The measures supporting and guiding towards a successful energy and mobility transition indeed encompass a diverse range of additional strategies and initiatives that all contribute to the ongoing transformation. In sum, policy measures across the spectrum, from market-based mechanisms to supportive subsidies and command-and-control regulations, all have strengths and limitations in managing environmental issues in practice. The preferability of each approach depends on the specific context and requires careful economic and policy analysis to determine the most efficient and effective combination of measures.

2.5 Expert Conversation on Economic Climate Policy: Between Technological Openness and Regulation

What Are the Challenges and Opportunities of Sustainability as a Corporate Strategy?

  • Grimm: This is a great opportunity to talk about sustainability in companies and also climate goals in the world. What is the biggest challenge for you at BMW, when you look at the climate goals that have now been tightened even in Germany and the EU?

  • Zipse: Sustainability is at the core of our operation here at BMW. At the same time, political circumstances change, and climate change is on the run. Everyone knows that this is one of the major challenges in the world. Our customers’ behaviours are also changing. Therefore, it was about time to put sustainability right at the centre of our corporate strategy. That is for customer reasons, that is for political reasons and also for economic reasons.

  • Grimm: For decades, companies have regarded sustainability as a necessary and costly exercise. What has led to this shift in focus?

  • Zipse: If we neglected sustainability due to commercial reasons, our strategy would not be sustainable. Think about the increasing prices of resources. If we do not include the possibility of reusing materials through recycling into our corporate strategy, we could encounter difficulties producing cars as we do today in the near future. That is why we have created a new architecture for new cars, which is going to be launched in 2025 and puts the secondary use of materials at the core of the architecture. What we see today is that steel, copper, nickel, palladium, and rhodium are becoming increasingly more expensive. Hence, we must find ways to keep cars affordable for our customers.

Do Politics and Industry Approach Sustainability from Different Perspectives?

  • Grimm: In a way, one can get the impression that the industry is now taking the side of the people who protect the climate and have fought for a long time—also in the streets—against climate change much more ambitiously than the politicians are doing at the moment. At least, it seems that industry can be faster in some way. Politicians have to fight for goals, have to fight for the implementation of certain regulations. Are the regulatory frameworks already working? Do companies have the right incentives to advance towards sustainable business?

  • Zipse: I think it is good advice to have very close contact and a trusted relationship to politicians, because we actually share the same framework about our future path. Politicians are elected by members of society and our customers are part of that same society. So, actually, we share the same basis for our strategies. Where we need more intense discussion is about the speed of transformation. Sometimes, industry wants to move ahead. Sometimes politicians want to move faster. I think speed is everything and the right acceleration. Let me take you through one example. For the transport sector, electromobility is the dominant approach to bringing down CO2: The car’s emissions directly factor into fleet regulation for new cars. Yet, acceptance of new electric vehicles by new car buyers and thereby the impact on the emissions of the transport sector are directly linked to the charging infrastructure. Without this ramping up fast, the decision to go for 0 g/km in new cars by 2035 could lead to lower new car sales and, consequently, to further ageing of the EU car fleet—the opposite of what is needed. That is why we have strongly urged to discuss how quickly the charging infrastructure in 27 European states can increase realistically and how one can set a target on the emissions of cars while at the same time agreeing on the path of charging infrastructure growth in the European Union. Yet, today, we still see a strong fragmentation of the EU markets: where infrastructure availability is highest, so is the BEV share—and vice versa. Therefore, we need a very thorough evaluation of the relation between supply-side regulation and demand-side prerequisites when the decision to go for 0 g/km in 2035 will be re-evaluated in 2026.

How Does Charging Infrastructure for Electromobility Affect Target Setting?

  • Grimm: It seems to me that one of the challenges is that the charging infrastructure is not predictable for the future. As a consequence, people do not know whether they can drive a battery electric vehicle everywhere they want to go. That, of course, will affect their choice to buy it, and that will affect your choice as a car maker to produce them.

  • Zipse: Well, we are aware of the infrastructure challenges, which is why we offer our customers the power of choice between different drivetrains.

  • Grimm: Basically, the same situation occurs in the field of hydrogen mobility. Especially in heavy-duty mobility, there has to be an infrastructure to initiate investments in the production of cars and heavy-duty cars. This is a big problem. Do you think politics acts in the right way here? What kind of strategy could one have, maybe to scale infrastructure up in a foreseeable way and also to co-finance it. It does not have to be the case that the state provides all the funding, but maybe there are interested investors who can put their money into it, because it could be a good business model. As soon as heavy-duty mobility based on hydrogen accelerates, a lot of money could be invested.

  • Zipse: We are well-advised to make the first step, because politicians will rarely make a first step if they do not have the feeling that there is an industry that takes on the challenge. For instance, we introduced the first electric car at BMW in 2013—a long time ago. The decision to produce that car has already been made in 2009. We did that far before politicians even talked about it. Thereby, you provide the opportunity of being more progressive on the political side.

  • Grimm: Will you pursue a similar approach with hydrogen mobility?

  • Zipse: When it comes to hydrogen, we are now at the same point that we have been with electromobility 10 years ago. We show that it is possible to propel cars with a fuel cell. Then, of course, the infrastructure is being built. It is not always a chicken and egg problem. It is more like ping-pong, where everyone moves forward step by step, and we want to be part of that game. We want to prove that technologically, there is a lot more possible than the average person knows. It is our task to convince politicians to be sometimes more progressive and sometimes to look at the timeframe again to slow down a little bit.

How Does International Competition Shape the Market for Zero-Emission Mobility?

  • Grimm: There is also very fierce international competition, especially in the area of fuel cell cars. East Asia is already having them in serial production. That could be a challenge for Europe. At the same time, society often cannot imagine that there is a lot of scope for further technological development. If people cannot imagine how different things will be, it is difficult to make decisions in politics to set the stage, for example, as in the case of hydrogen mobility. There is a huge ongoing debate in Germany about it. However, I understand that you are not saying the market has settled on battery electric vehicles, but you state that there are plenty of opportunities for both—hydrogen vehicles and battery electric vehicles.

  • Becker: Let’s take the electric vehicle market as an example. If we look at the situation in the electric vehicle market today, this development was preceded by a political decision, the California Zero-Emission Vehicle Mandate, which included the obligation to put zero-emission cars on the road. This policy choice tied the automotive industry to a binding and increasing quota of zero-emission vehicles, be it fuel cell or battery electric. A similar approach could have been taken towards quotas of hydrogen—not at the vehicle side but at the infrastructure side. Hydrogen, for example, would then have had to be used in proportion to mineral oil production. We would have a different automotive industry today had such a choice been made. It is all about policy choices.

  • Grimm: So, on the one hand, it is the industry that innovates and, on the other, the regulatory dimension that triggers the strategic decision to bring a particular technology to the mass market.

  • Becker: As you rightly said, when you look at the demand side of fuel cells, it is an infrastructure choice that has to be made. It is about a concerted effort by industry and governments, by those who produce the energy, and by those who convert it into hydrogen. Therefore, our message is very clear in that respect. We feel very competent to supply the cars. We are developing different technologies to provide a space for politicians to make decisions, but ultimately it is their decision. In this regard, we have a very fragmented situation globally. If you look at Korea, they have a clear hydrogen agenda. If you look at California, there is no car that gets more credits than a fuel cell vehicle. The race is on. Sometimes, in Germany, we tend to overlook the fact that we are just one market and that people think differently in different places.

How Does Consumer Behaviour Influence Decision-Making Towards Sustainability?

  • Grimm: I think another big challenge is that it is very difficult for people to imagine how much will change in the future. It could be resources; as you mentioned: you need completely different resources and completely different supply chains, which will affect energy trade. Therefore, we have to move from importing fossil fuels to importing renewables, and these are big changes that have to become a reality quite rapidly. One of my questions would be: To what extent do you think that your customers already see what needs to change? At the same time, there is this continuing debate about the price of petrol, which is somewhat counterintuitive, because of course fossil fuels have to become more expensive if we want to become more sustainable. Something has to happen to make it more attractive to have a zero-emission car than a car that runs on fossil fuels. Hence, the other question is: How do we proceed in that direction in a situation where people, once they are affected, also react quite reluctantly?

  • Zipse: Well, the customer is the big unknown in this equation because a customer’s behaviour is different from his/her political behaviour. What the consumer decides to vote for in terms of a political party and what the consumer decides to buy can be very different. Hence, basing one’s product strategy on political elections is a very dangerous thing to do. People buy cars for many reasons, emotional reasons, cost reasons, and factual reasons, and I think you always have to observe and detect changes in customer behaviour. Customers do not change their behaviour overnight. Electromobility is a good example to support my point of view. It has taken more than 10–15 years, and there is still a lot of mistrust: Where are the charging points? How much will it cost me? Does the battery last long enough? Range anxiety; you have all that.

  • Grimm: So, what could be a solution to the uncertainties surrounding new technologies in the marketplace?

  • Zipse: A good piece of advice again is to look at the customer. We think there is room for a hydrogen market, namely for larger cars and especially in the premium sector. There are always first movers who want to have the latest technology. I think a premium brand like BMW suits progressive new technologies. It does not have to be scalable right away, but there is a new, growing market that could be very interesting for us.

Is the International Infrastructure Ready for New Sustainable Vehicles?

  • Grimm: We don’t just have to think about what we do in Germany. In Germany, we have to think about what the world does and how we can contribute to it. How do you see the infrastructure issue? As far as hydrogen supply is concerned, do you see the possibility of scaling it up for private cars using the heavy-duty vehicle infrastructure, or do you think a different infrastructure is needed? Are there synergy effects?

  • Becker: If you provide hydrogen at the petrol station, would you really tell people that they have to have three axles or four in order to qualify for the use of hydrogen? I mean, if you provide the infrastructure, you should let everybody use it whenever there is a demand.

  • Zipse: I think there is an important difference with electromobility. Electromobility is geared towards privately owned cars. Hydrogen, on the other hand, is more of a cross-sector phenomenon in the energy market at the moment. There is not going to be a hydrogen infrastructure built just for private cars. It will probably start with steel production and then be used in the chemical industry and, regarding transportation, particularly in the heavy-duty sector. Eventually, individual transport may be able to use this infrastructure in the future. That is why there is an opportunity to develop the industrial infrastructure and the transport infrastructure for trucks and personal vehicles at the same time. This development is in contrast to electromobility, which started with small cars.

  • Grimm: I share the opinion that it does make sense to have this dual use of infrastructure. Very often, the opponents of it argue that it is wasteful, basically because you have two energy infrastructures for mobility. On the other hand, you have this heavy-duty mobility, where you need something other than battery electric vehicles anyway. So, you can also take advantage of this situation.

  • Zipse: It is possible that the structures will not be built in parallel. In the transport sector, hydrogen infrastructure will be built specifically for those cases where, for some reason, you cannot have electric mobility.

    What I found compelling about hydrogen is the fact that we are already developing infrastructure for this kind of cases: we are currently using hydrogen mainly inside our buildings and factories, for example in the Leipzig plant, but also in the United States, where we use hydrogen for the internal logistics system.

  • Grimm: Why is that?

  • Zipse: If you want to become emission-free, the easiest way to do it is within closed systems, so we already have some experience in that area and it works really well for us. We are not just at the beginning of this technology. Hydrogen is one of the few elements that can be used with or without methane as an energy storage medium, so it can substitute or be combined with natural gas—which you cannot easily do with electromobility. This is the point at which individual mobility may choose the fuel cell as a drive system, particularly where you do not have access to a charging point or where hydrogen is set as a substitute for methane and where it will be more efficient to use it directly than generating electricity from hydrogen. That will be the case in many places, such as Japan. They will not have the same extensive charging infrastructure that we can build up here in Germany.

What Is the Status of Hydrogen Infrastructure Development?

  • Zipse: Electromobility is currently on the political agenda. There is an awareness that an infrastructure for electric mobility is necessary. Every country, be it France, Germany or even the European Union, is going to invest a lot of money in charging infrastructure. It is much more difficult to predict political behaviour on the hydrogen side. How much is the hydrogen infrastructure lagging behind the development of the electromobility infrastructure?

  • Grimm: I think it depends very much on the political decisions that are taken now. In the case of battery electric vehicles, there are the first vehicles, and now there is pressure to expand the infrastructure. With hydrogen development, it is more simultaneous. Regarding hydrogen, we are talking about cars and vehicles, and at the same time, there is a debate about infrastructure.

    For heavy-duty mobility, there is still a debate about whether you can do it with battery electric vehicles, which I doubt. There are many problems involved if you want to realise long-distance transport. It is very effective to scale up hydrogen mobility by implementing or scaling up the logistics first. I see that there is an ongoing debate on prioritising and first using hydrogen in heavy industry, where it is needed in the chemical industry. And I think there’s a big group of people who argue very much that battery electric vehicles will do it in mobility, which I doubt.

  • Zipse: Right. Do you think, due to the multi-use of hydrogen, we will ever be able to scale it up quickly enough? The chemical industry, steel industry, truck industry, car industry—everyone wants green hydrogen and it all must be green and not blue, not grey, and not brown, you know?

  • Grimm: In Germany, everything must be green immediately. In other countries, for example, in East Asia, they are much more pragmatic. They are scaling up the technology by being pragmatic about the ‘colour’ of hydrogen. I think, also in Europe, many countries are working with the so-called red hydrogen from nuclear power or with hydrogen produced from the country’s energy mix and are trying to scale up the technology. I think, in Germany, we should be a little bit more pragmatic in this transition period until green hydrogen is available on a larger scale. At the same time, this would allow us to have a lot more hydrogen available during this transition period. Then, of course, we can hope that green hydrogen will become competitive in the long term, comparable to blue hydrogen, and then it would not be in short supply. But that is still to be decided, of course.

  • Becker: One factor that I think is closely related to the points you made is the organisation of a competitive market for decarbonisation. We strongly believe that emissions trading is a key element of sustainability. Today, when I charge my car, I use electricity that has been produced under the conditions of emissions trading with a cap. If I use diesel, that is not the case. If we make that car or the aluminium for that car in Landshut, it is part of the emissions trading system. So, wouldn’t it make sense to extend this approach to transport? No matter what the energy source, be it hydrogen, liquid fuels, or electricity, it should all be priced according to CO2 content. Then, you would see the performance in the price.

  • Grimm: You have said something very important. If you charge a battery electric vehicle, then it is—to a certain extent—carbon-free because there is a cap on the emissions in the trading system. So, it does not matter how carbon-intensive the energy mix is, but if you think about mobility in terms of the emission trading system, carbon intensity plays an important role. I think it would be wise to extend it.

  • Becker: What do you think would be a regulatory solution that would allow for technological openness?

  • Grimm: It is a very hard political battle that has to be fought, of course, at the level of the European Union. First of all, to include all the sectors and then also to include all the countries, because different countries have very different conditions. Some rely heavily on carbon-intensive energy production, others on nuclear power, which is also problematic from a German perspective. I think it is worth moving in this direction. Setting a carbon price is not the only tool. I think a carbon price is very predictable in the sense that if you know that emissions are capped and the cap decreases year by year. You can live with that to a certain extent. It is predictable and therefore a typical business risk that we are used to. Moreover, fossil fuel prices are fluctuating as well and you have to deal with the consequences for the economy. So, above all, it is very difficult to predict what particular regulation different governments will implement in the future.

How Can Carbon-Pricing Mechanisms Be Developed on a European Level?

  • Zipse: Designing market mechanisms that correlate sustainability goals with the actual behaviour of all participants would be a first step towards a Green Deal for Europe. That is not happening at the moment. Currently, each industry is assigned different sustainability targets. It would be the perfect time to introduce a price on CO2, which, of course, would give you a big lever on achieving the targets. Why is this not happening?

  • Grimm: Economists have been proposing this concept for years. It is interesting that it is now being discussed so much in politics. The negotiation process at the European level makes the setting of targets difficult because some countries would be more affected than others. Therefore, you would have to compensate at the European Union level. In addition, this measure is unpopular—as you can see from the debate on petrol prices—because it visibly increases prices. A socially acceptable way must be found to reduce the burden on the customers. In other respects, this debate is not loud enough because it would be easy, for example, to increase CO2 prices and at the same time reduce the price of electricity, which is currently dominated by taxes and levies. Therefore, you could very easily reduce it by a third, which would cost a typical household 400 euros less per year. There are possibilities, but it is very difficult to discuss these matters. Of course, there are different groups in society with different interests.

  • Becker: Looking at fuels, it shows that a trading system could provide a visible incentive for producers to decarbonise their products. For example, blending hydrogen-based synfuels into petrol could keep products affordable for customers. This example could then support a political debate—but that seems to be very controversial at the moment.

How Can Private Investments Support a European Green Deal?

  • Grimm: I think it is relatively easy to agree on targets, for example, climate neutrality by 2050 or 2045. However, it is very difficult to agree on the path, the mechanisms, and the regulation that will get us there. There are different perspectives on this issue. One part of the discussion focuses on the CO2 price and market-oriented measures. Another part of the discussion emphasises that the state has to play a much more important role, that public spending has to be increased a lot in order to achieve climate neutrality. This is a misconception because investments in the private sector are just as necessary. Private investments account for 85% of total investments in Germany. So, in total, there is only 15% public investment compared to 85% private investment. However, increasing public investment will be difficult to steer in the right direction because of the fierce debate going on about what is the right way forward. Which sectors should be decarbonised first?

  • Zipse: And what is your opinion on that?

  • Grimm: There is a lot of dispute and no agreement on how to proceed. I would think that we need to agree on measures that will enable companies to invest. That means, on the one hand, the price of CO2, of course, and the expansion of infrastructure in a predictable way. On the other hand, we also need more venture capital, and we need more capital in order to scale up innovation and to really establish the production of new climate technologies and applications in Europe. At the moment, we have much more venture capital opportunities in the US and even in East Asia. I would like to hear your thoughts on how to increase venture capital opportunities in Europe?

  • Zipse: I think, as you said before, we need to increase private investment in infrastructure in Europe. We need to consider a joint venture between policy makers, the banking sector, and the private sector to form consortia. This is the only way to really share the risks involved in infrastructure investments. Maybe that is the European route. I think Europeans are willing to take risks if the burden is shared. However, we have to take more risks in the future. That is for sure.

2.6 Science-Based Targets: Opportunities and Challenges of Setting Emissions Targets at the Company Level

The preceding expert conversation underscored the interconnectedness of national policies, market regulation, and corporate actions in navigating the Road to Net Zero. Achieving alignment with the evolving climate science and policy necessitates that corporations not only comprehend what is expected of them, but that they also dispose of robust methodologies to evaluate—and where needed, enhance—their mitigation strategies. With this in mind, this section turns its attention towards the concept of Science-Based Targets (SBTs) for ambitious GHG emission reductions. This is even more relevant, as the EU will require companies from 2024 onwards to report on their strategy for achieving compatibility with the 1.5° target using ‘science-based’ methods.

As underscored in Sect. 2.3, global climate policy has fostered a collective commitment to the Net Zero goal and the aim to limit global warming to well below 2 °C. This commitment requires ambitious emissions reduction trajectories that align with the 1.5 or 2 °C goal, respectively. SBTs provide a framework to translate these broad reduction pathways into tangible, corporate-level action plans. Leveraging insights from climate science, corporations can discern the specific degree of decarbonisation necessary for their unique context.

The objective of the SBTs is to offer clear directives for corporate climate action and enhance transparency regarding the alignment of emission reductions with the Paris Agreement. However, the methodology for establishing SBTs is multifaceted and continuously evolving. The goal of this review is not to delve deeply into these complexities, but rather to furnish an overview of the overall rationale and highlight pertinent considerations for its application, critical assessment, and future development.

2.6.1 The Science-Based Target Initiative: Origin and Mission

Around the time when the Paris Agreement was adopted, the CDP (Carbon Disclosure Project), the United Nations Global Compact, the World Resources Institute, and the World Wildlife Fund formed the Science-Based Target Initiative (SBTi) to develop a standard to derive GHG reduction targets that are aligned with the 2 °C or, respectively, with the well below 2 °C temperature goal of Paris at the company level (Bjørn et al., 2022). More recently, the SBTi increased its ambition level to focus on the 1.5 °C target.

Subsequently, the fundamental premise of SBTs at the individual (corporate) level has evolved into a pragmatic, data-informed, target-setting method and validation under the SBTi enabling businesses to align their strategies with the Paris Agreement’s objectives. In 2021, more than 2000 companies from 70 countries, accounting for 35% of global market capitalisation according to the SBTi Progress Report, have either committed to setting SBTs or have already had their SBTs approved (SBTi, 2022). This number continues to grow, with more than 4000 companies setting targets by the end of 2022 (SBTi, 2023a).

The mission of the SBTi is to drive ‘ambitious climate action in the private sector by enabling organizations to set science-based emissions reduction targets’ (SBTi, 2023a). The SBTi seeks to accomplish this mission by providing a framework and guidelines for businesses to set and validate their GHG reduction targets. Facilitating a process to independently assess and validate companies’ targets, the SBTi provides an external assessment of corporate emission reduction targets and promotes transparency by publicly recognising companies that have set science-based targets. What the SBTi does not do (and does not intend to do) is to verify the reported data and actual business performance.

As a multi-stakeholder initiative, SBTi’s funding relies on target validation fees and contributions from various corporate and charitable entities. Given its standing as a private non-profit organisation with substantial global influence, there has been a discussion regarding the absence of a public entity or policy to carry out the functions of the initiative (see Bjørn et al., 2022; Lister, 2018; Marland et al., 2015; Trexler & Schendler, 2015). Despite facing initial criticism (cf. Trexler & Schendler, 2015), the SBTi has nevertheless evolved as the globally most acknowledged framework for setting emission reduction targets.

2.6.2 The Science Base of the SBTs

The SBTi aims to mobilise ‘the private sector to take the lead on urgent climate action’ by ‘enabling organizations to set science-based emissions reduction targets’ (SBTi, 2023a). But what exactly constitutes the ʻscienceʼ in Science-Based Targets?

The labelling of targets in the political and business arena as ʻScience-Basedʼ might initially seem contradictory, as ‘operational targets are socio-political choices’ (Andersen et al., 2021, p. 2). While climate science can delineate the phenomena, causes, and repercussions of global warming, the decision to halt or control climate change involves normative judgements that go beyond the scope of science. Accordingly, the IPCC’s 4th assessment report (IPCC, 2007, p. 64) stressed that defining what constitutes a ‘dangerous anthropogenic interference with the climate system’ is only partially rooted in science ‘as it inherently involves normative judgements’.

Against this background, the Paris goals of limiting global warming are ʻscience-basedʼ in the context of being scientifically informed but politically determined. Climate science asserts that the hazards of global warming rise sharply beyond 1.5 and 2 °C. However, the aspiration to avert these risks, as codified in the Paris Agreement, is a value-based choice informed by scientific findings, but ultimately decided politically.

In crafting science-based targets for corporations, the SBTi takes the political commitment to the Paris Agreement’s goals as its starting point. Under this framework, corporate emission reduction objectives are deemed ʻscience-basedʼ if they align with ‘what the latest climate science says is necessary to meet the goals of the Paris Agreement’ (SBTi, 2023c, p. 5). The ʻscienceʼ in these targets maps the path required to achieve the globally accepted Paris objectives. This necessitates that the SBTs be quantifiable, measurable (Andersen et al., 2021) and guided by a methodology anchored in the emission reductions that climate science prescribes to fulfil the Paris goals. Importantly, as these targets are linked to the ‘latest climate science’, advances in climate science, such as revised estimates of the remaining carbon budget, could necessitate updates to SBTs and amplify the level of ambition required for climate action.

2.6.3 Which Emissions Count? Clarifying the Scope and Base Year for SBTs

Before explaining the different types of SBTs and how to calculate them, it is important to clarify the scope of emissions that companies need to consider according to the SBTi. Here, the SBTi leans on the carbon accounting methodology defined in the GHG protocol (see World Resources Institute [WRI] and World Business Council for Sustainable Development [WBCSD], 2004). This protocol categorises Scope 1 emissions as direct GHG emissions ‘from sources that are owned or controlled by the company’ (GHG Protocol, see WRI and WBCSD, 2004, p. 25), such as from combustion, production, or chemical processes. Scope 2 refers to indirect GHG emissions caused by energy consumption (including electricity, steam, heating and cooling energy), and Scope 3 refers to GHG emissions caused by activities neither controlled nor owned by the company. Scope 3 thus includes emissions that occur in a company’s value chain, both upstream and downstream (GHG Protocol, see WRI and WBCSD, 2004, p. 25). In the case of automotive original equipment manufacturers (OEMs), this can include emissions from battery production (upstream) or vehicle emissions from customer cars (downstream).

In setting SBTs as per the latest guidelines, companies are required to cover a minimum of 95% of their Scope 1 and Scope 2 emissions (SBTi, 2023b). The situation with Scope 3 emissions is more intricate, as their obligatory inclusion relies on various other factors, which will be elaborated subsequently.

2.6.4 Different Types of Science-Based Targets

As the Road to Net Zero is a marathon and not a sprint, companies need targets that allow them to plan for both the immediate next steps and the long-term journey. Accordingly, the SBTi provides different types of SBTs.

Near-term targets focus on rapid and deep emission reductions that cover a minimum of 5 years and a maximum of 10 years from the date the target is submitted for validation. Near-term targets must be aligned with a 1.5 °C scenario. For most companies, this implies halving emissions by 2030. In addition to Scope 1 and 2 emissions, near-term emissions must cover at least 67% of all Scope 3 emissions if these indirect emissions account for more than 40% of a company’s life cycle GHG inventory. For many companies, this is the case. To illustrate, after significant reductions of its Scope 1 and 2 emissions, BMW’s Scope 3 emissions account for much more than 90% of its total emissions. Companies that have less than 40% Scope 3 emissions are encouraged to include them voluntarily.

Long-term targets indicate the degree of emission reductions that companies need to achieve by 2050 or sooner. Long-term targets must cover a minimum of 30 years from the date the target is submitted for validation and must be aligned with a 1.5 °C scenario, which means that most sectors must achieve at least a 90% reduction in absolute emissions by 2050 (or 2040 for the power sector) compared to a base year. For long-term targets, companies must cover at least 95% of their Scope 1 and 2 emissions and at least 90% of their Scope 3 emissions (irrespective of their relative share).

The net zero standard is a newer benchmark established by the SBTi and provides guidance to substantiate the path for a company to reach a science-based ‘net zero’ status. Apart from committing to long-term and short-term reductions (90%), companies are obligated to neutralise any remaining emissions. This entails utilising permanent carbon removals and storage methods (including nature-based solutions, such as restoring forests, soils, and wetlands, or technical solutions, such as direct-air capture) to counterbalance the final <10% of residual emissions that cannot be eliminated. Note that offsetting emissions through compensation measures that merely avoid emissions elsewhere (e.g. more efficient cook-stoves) are deemed insufficient (SBTi, 2023d).

2.6.5 Different Methods and Sector Approaches for Determining Necessary Reduction Levels

The crux of the SBTi, albeit intricate and somewhat complex, lies in the methodologies used to determine the exact emission reductions required to attain a specific ambition level. Previously, the SBTi offered calculation tools based on accepted target-setting methods from various sources, including public organisations, companies, and academia, resulting in a total of seven methods (Bjørn et al., 2021). More recently, however, the SBTi has refined its recommendations for Scope 1 and 2 emissions targets to two methods, focusing on either absolute reductions (company-wide) or relative reductions (emission intensities, such as per ton of product or per dollar of revenue) (Bjørn et al., 2022, p. 55).

Regardless of the method, the underlying approach considers the extent of emission reductions needed by all companies to achieve a particular temperature goal. In the SBTi’s early framework versions, companies could align their ambition level with a 2 °C or well below 2 °C trajectory. However, given the recent warnings from climate science (cf. IPCC, 2018), the SBTi has raised its framework’s ambition to aim for the 1.5 °C goal. Consequently, whereas the 2 °C or well below 2 °C pathway-aligned SBTs were previously approved, since mid-2022, the SBTi only approves SBTs consistent with the 1.5 °C pathway (SBTi, 2023b, p. 4).

With the new ambition level of 1.5 °C in mind, let us come back to the absolute and relative reduction approach. The former approach focuses on an absolute decrease in emissions, irrespective of a company’s size, production output, or revenue. Known formerly as the ʻabsolute contraction approachʼ (ACA), this method applies broadly across sectors (with exceptions like agriculture) and demands that absolute emissions decrease by an amount at least consistent with the cross-sector pathway. For the 1.5 °C goals, this equates to most sectors reducing their Scope 1 and 2 emissions by a minimum of 4.2% annually (SBTi, 2023b, p. 3).

Contrarily, relative or ‘intensity’ approaches set emission reduction targets relative to a specific business metric, such as per unit of production (physical intensity) or per revenue unit (economic intensity). This approach enables companies to decrease greenhouse gas emission intensity while accommodating business growth. The SBTi employs corresponding pathways to model the necessary emission intensity reductions to align with the 1.5 °C goal, generally applicable for Scope 3 emissions.

Nevertheless, emission intensity and the scope for its improvement vary by sector, as do absolute emissions and their potential for reduction. Decarbonising power generation through a shift from coal to gas or solar, for instance, is simpler than decarbonising aviation, which relies on kerosene. Acknowledging the diverse mitigation opportunities and challenges that various sectors face, SBTi methodologies incorporate the Sectoral Decarbonisation Approach (SDA), using sector-specific emission scenarios from the International Energy Agency (IEA). Applied to the absolute reduction approach, the sector-specific reduction approach prescribes absolute reduction targets for specific sectors like agriculture or iron and steel. Similarly, the sector-specific intensity convergence approach applies relative reduction logic to sector-specific pathways. For the food, land use and agriculture sector (FLAG), there are even commodity-specific reduction pathways that model the necessary emission intensity reductions for commodities like beef, rice, leather, or dairy to align with the 1.5 °C goal (SBTi, 2023b, p. 6). The EU’s CSRD reporting requirements foresee targets to be set in absolute terms. So, from 2024 onwards, the choice for European companies is effectively limited.

This overview underscores the multitude of methods for setting an SBT, creating significant complexity. In response, the SBTi provides small and medium-sized firms (SMEs) with a simplified procedure that offers flexibility. Even large corporations have some leeway in choosing their base year, target format (near-term or long-term), scope (optional for Scope 3 emissions) and, most importantly, the methods to define their target. Some academics see this diversity of methods as a strength, contending that ‘there is not a single SBT method that is best in all sectors and company situations’ (Aden, 2018, p. 1095). However, others criticise the potential for lack of comparability and for companies to choose less challenging targets (Bjørn et al., 2021; Freiberg et al., 2021). Against this backdrop, the SBTi continuously refines its methodology and provides more sector-specific guidance, yet questions persist about potential future refinements to the methodology.

2.6.6 Benefits and Challenges of Science-Based Targets

So far, setting SBTs has been voluntary. While the SBTi predicts widespread adoption, citing innovation theory that rapid diffusion occurs when a critical mass of early adopters is reached (SBTi, 2022), it remains to be seen whether the majority of companies will set SBTs without legislative pressure.

Independent of the further development and dissemination of the SBTi framework, research indicates two areas of potential positive impact from setting SBTs: corporate climate action and regulatory alignment, as well as public policy.

Regarding corporate climate action on the Road to Net Zero, the SBTi offers direction to companies, and through its validation, potentially encourages more ambitious corporate climate action regarding GHG reduction. For strategic direction, companies need operational targets for their planning because what gets measured gets done (cf. Chap. 1). This is particularly important when considering long-term strategic investments. For instance, in the automotive industry, the development and implementation of a new car platform with a projected lifetime of more than 20 years can be considered. To prepare adequately for the future, companies find it valuable to anchor their strategies in precise assumptions (cf. Chap. 3).

When it comes to potential incentives for more ambitious climate action and actual emission reductions by companies, the existing research is not conclusive. Initial studies, such as those by Freiberg et al. (2021) and Bolton and Kacperczyk (2023), have explored the impact of the SBTi on emissions reductions, but the results are largely inconclusive for making generalisable claims due to various influencing factors affecting targets and a company’s climate ambition (Bjørn et al., 2022, p. 61). Nonetheless, companies that report SBTs for emission reduction appear to invest more than do companies that merely set internal targets (cf. Bjørn et al., 2022; Freiberg et al., 2021).

In terms of potential business benefits, science-based targets equip companies to better align with not only the present but also future regulatory environments. As discussed in Sect. 2.4, policymakers are currently implementing various policy instruments at the national level, creating a fragmented regulatory landscape for companies operating across borders. While it remains uncertain whether and how these diverse regulatory approaches will converge, it is evident that the Paris Agreement and its reduction targets will persist as a global benchmark guiding future implementation. By aligning their operations with this global goal, science-based targets can provide a universally relevant framework amid a disjointed regulatory landscape, thus reducing regulatory risk and uncertainty.

Regarding the evolution of public climate policy, both research and recent policy developments indicate a potentially positive impact of SBTs on public policy. Whereas early critics, such as Trexler and Schendler (2015, p. 933), argue that SBTs ‘will only further delay policy’, Marland et al. (2015) disagree with the claim that SBTs are just another distraction from solving the real problem and point to the importance of bottom-up initiatives in a democracy as a means of developing regulations from the dialogue that emerges. Especially in the absence of public policy, Banda (2018, p. 387) argues that ‘private climate governance could help embed rules of public international law in the domestic sphere and drive up State ambition over time’. Similarly, recent policy developments in corporate sustainability reporting, such as the CSRD, illustrate how the voluntary GRI reporting framework and other voluntary standards have evolved over two decades into a new policy (cf. Chap. 4).

Therefore, while it is clear that private sector initiatives can stimulate public policy development, these frameworks alone cannot meet the challenge of achieving the 1.5 °C target without corresponding regulations and instruments, as discussed in Sect. 2.4. Furthermore, critics contend that the SBTi requires financial contributions from companies for registration and consultation, questioning the monetary independence of the initiative. Despite these criticisms, no other current framework that translates global climate goals to the corporate level has gained equal recognition or refinement.

The ongoing critiques of the SBTi underscore the fact that the SBT framework is still maturing and would benefit from further evolution and refinement. A key aspect of the SBTi’s future progress involves enhancing the target-setting methodology. As of 2023, sector-specific guidance remains absent for several sectors, including iron and steel, chemicals, and oil & gas. Even with the guidance available for other sectors, the multitude of methods can result in potential misuse and a lack of transparency. Moreover, while SBTs differentiate between near-term (2030) and long-term (2050) targets, discussion is ongoing regarding the establishment of medium-term targets, especially concerning the necessary emissions reductions between 2030 and 2050. Ultimately, future enhancements are required to strengthen the comparability, guidance, and transparency of SBTs.

Finally, any methodology that sets reduction targets for carbon emissions will depend on the quality of the underlying GHG data and accounting. Currently, the SBTi leans on the carbon accounting methodology defined in the GHG protocol. Although widely used as the de facto global standard for carbon accounting, this methodology has several weaknesses. In particular, Scope 3 emissions pose significant challenges. Their measurement, due to the complexity of global supply chains, can be fraught with errors and potential bias.

The Protocol’s allowance for using secondary or averaged data instead of specific emissions data (GHG Protocol, see WRI and WBCSD, 2004) often opens the door for the evasion or manipulation of Scope 3 measurements. Consequently, companies may strategically choose what to report. For instance, if a company has a supplier whose actual emissions greatly exceed the industry average, the company can reduce its reported emissions by using that averaged data. On the other hand, if a company invests in improving supplier performance, thereby lowering the industry average, competitors can exploit these industry averages to report emission reductions without making substantial changes to their own processes. This level of flexibility not only weakens the integrity of Scope 3 measurements but also does little to spur sincere decarbonisation efforts (Kaplan & Ramanna, 2021).

Consequently, the effectiveness of SBTs may be curtailed by these inherent limitations in carbon accounting as long as they continue to align with the GHG Protocol. Therefore, future improvements to the SBT framework should not solely focus on refining target-setting methods, but should also explore innovative approaches in carbon accounting. This could potentially involve adopting systems such as the proposed E-liability accounting system, which advocates for the use of inventory and cost accounting practices to accurately measure GHG emissions across corporate supply chains (Kaplan & Ramanna, 2022).

2.7 Conclusion

The Road to Net Zero symbolises a collective expedition requiring diverse entities to contribute their unique inputs, with a shared destination in sight. This chapter’s objective was to lay the groundwork for this journey, detailing the climate science and policy contexts underpinning the Road to Net Zero, ahead of subsequent chapters that delve into the specific roles of and actions taken by corporations.

Climate science provides the essential scientific underpinnings (Sect. 2.2), while global climate policy, as exemplified by the Paris Agreement, fosters a collective commitment to limit global warming to well below 2 °C and target net zero emissions (Sect. 2.3). National policymakers have various tools at their disposal to establish and execute national emission reduction goals (Sects. 2.4 and 2.5), and for corporations, Science-Based Targets (SBTs) offer a framework to synchronise their climate initiatives with global policy objectives (Sect. 2.6).

Reflecting upon this foundational chapter, we highlight five significant takeaways that encourage further discourse:

  1. 1.

    To cap global warming at 2 °C, or ideally at 1.5 °C, thereby averting perilous climate change, swift and considerable emissions reductions are imperative. This indicates that unless swift decarbonisation transpires, the remaining carbon budget will soon be depleted.

  2. 2.

    The Paris Agreement’s legal commitment to a precise temperature target and the objective of achieving net zero emissions fundamentally necessitates a comprehensive economic transformation. Unlike Kyoto’s incremental reductions, the Net Zero target demands a profound transition from our current fossil fuel-based economy to extensive decarbonisation.

  3. 3.

    National climate policies are instrumental in facilitating emission reductions through bolstering market-based solutions, augmented by supportive schemes and standards setting where needed. This policy mix needs to negotiate a balance between ecological efficacy, fair contribution to global reductions, economic efficiency, political and administrative feasibility, and impacts on competitiveness and innovation.

  4. 4.

    For long-term decarbonisation, public policies need to offer certainty and unambiguous guidance on targets. Promoting technological openness in achieving these targets can stimulate innovation, enhance resilience, and boost efficiency. Moreover, infrastructure is key to decarbonising the transport sector. Policy plays a crucial role in collaboration with corporate players to ramp up the availability of charging for battery electric vehicles, as well as for hydrogen-powered fuel cell electric trucks and cars.

  5. 5.

    SBTs furnish a framework enabling businesses to align their strategies with cutting-edge climate science and global public policy commitments. Despite their limitations, SBTs serve as crucial tools for augmenting the efficacy and credibility of business-driven decarbonisation. To better capitalise on this potential, future developments of SBTs will profit from further methodological refinement, improved carbon accounting, and enhanced legitimacy of the underlying standard-setting process.

The Road to Net Zero thus embodies a collective endeavour wherein companies play an indispensable role but it also necessitates an enabling environment fortified by public policies and robust science. The subsequent chapters of this book will explore the transformative changes that companies can engender in their business strategy, reporting, products, value chains, production, and technology. Starting this exploration, Chap. 3 ‘Creating Corporate Sustainability Strategy. From Integrated Thinking to Integrated Management’ will discuss these ideas in greater detail. A novel and more integrated perspective is required to navigate the challenges of the Road to Net Zero and other sustainability issues.