The Growing Climate Stakes for the Defense Industry

Related Expertise: Aerospace and Defense, Industrial Goods, Defense and Security

The Growing Climate Stakes for the Defense Industry

By Diana DimitrovaMike LyonsPelayo LosadaMike MesterTina Zuzek-ArdenMarine Baudin-Sarlet, and Matthieu Schmitt

The world’s defense contractors have generally been late to the battle to mitigate climate change. But mounting pressure from investors and military customers is making environmental sustainability a higher priority. Although most contractors have begun reducing emissions from their own operations and energy use, they’ve barely begun to curtail the 90% to 95% related to their supply chains and usage of the products they sell. Without more aggressive action, the global defense industry’s contribution to worldwide CO2 emissions could soar from 2% today to 25% by 2050.

Aside from good citizenship, defense contractors have four compelling business reasons to set their sights on net zero:

  • Maintaining equity values and low capital costs as more investors make environmental sustainability an integral factor in their portfolios
  • Capturing opportunities to maintain and grow their order books by supplying new products and services that will help defense ministries achieve their emission-reduction targets
  • Getting a fair share of the growing public R&D funding related to climate change
  • Improving cost competitiveness as nations impose higher prices on carbon emissions

Read more about both climate change’s implications—and the opportunities for defense contractors that go green—here.

Compared with most other sectors, the global defense industry remains at an early stage of its journey to reduce greenhouse gas emissions. This isn’t entirely surprising: safety, reliability, and performance have been and will continue to be the paramount requirements of customers in the armed forces. Many defense systems and supporting infrastructure are also inherently more difficult to decarbonize than in most other sectors. As a result, it’s conceivable that the global defense industry’s contribution to worldwide CO2 emissions could soar from 2% today to 25% by 2050—unless contractors work more aggressively to reduce their carbon footprints.

Contractors that fail to act will face increased pressure from investors and customers, who are placing a higher priority on environmental sustainability in their portfolios. Such companies could incur higher capital costs; they could lose market share or opportunities to supply new products and services that will help defense ministries achieve their nations’ climate goals; and they could miss out on public R&D funds related to climate change. Over time, they could also become less cost competitive.

The defense and security industry is aware of this new challenge. Most leading defense companies we studied have begun efforts to cut what are known as Scope 1 and Scope 2 emissions—those related to their operations and energy usage, respectively. But these emissions currently account for only a small fraction of defense contractors’ total emissions. Contractors have barely begun to curtail the 90% to 95% of emissions that occur outside their direct control: those from the parts and materials they procure, which are referred to as Scope 3 upstream emissions, and from the usage of the products they sell, which are called Scope 3 downstream emissions. Contractors must therefore work with their suppliers, customers, and partners if they want to reach net zero.

Decarbonizing efficiently will require a holistic approach. Defense contractors need to get a clear picture of their current emissions to establish a baseline, define firm targets and strategic roadmaps for each business unit, and start implementing emission reduction initiatives. These initiatives will vary by company and busines unit, but they should include procuring greener inputs and assemblies from suppliers, accelerating R&D programs to develop new generations of carbon-efficient products, and coordinating with other players to create green solutions at scale. Companies that successfully transform into greener businesses will not only be contributing to the race to net zero—they will reinforce and expand their market position.

Financial Opportunities for Climate-Efficient Defense Contractors

There are many reasons defense contractors have generally been late to the battle to mitigate climate change. Until recently, environmental sustainability has ranked as a low priority among military customers compared to other imperatives, such as performance in the field and cost. Another reason is that half of the emissions from defense are tied to fossil fuels, for which cost-effective alternatives are nascent, expensive, and subscale. Furthermore, R&D and deployment cycles that can span decades mean that significant lead time is required before full decarbonization can realistically happen.

But as the gaps widen between the defense industry and other sectors that are making more rapid progress in reducing emissions, contractors won’t be able to avoid the spotlight much longer. Indeed, the mitigation of global warming is now rising on the agendas of many defense departments. In May, Lloyd Austin, the US Secretary of Defense, called climate change an existential crisis: “Today, no nation can find lasting security without addressing the climate crisis. We face all kinds of threats in our line of work, but few of them truly deserve to be called existential. The climate crisis does.” Lieutenant General Richard Nugee, leader of the UK Ministry of Defence’s climate change and sustainability program, expressed a similar sentiment in March: “The imperative could not be clearer: defense must and will act now.”

Beyond good citizenship, defense contractors have four compelling business reasons to set their sights on net zero:

  • Maintaining equity values and low capital costs
  • Capturing opportunities to maintain and grow their order books
  • Getting a fair share of public R&D funding
  • Improving cost competitiveness

Maintaining Equity Values and Low Capital Costs. Investors around the world are seeking to make their portfolios greener—a concern that can have a significant impact on defense contractors’ stock valuations and costs of capital. Climate change was cited as influencing investment strategies for 86% of fund managers surveyed by Robeco, a global asset manager, in its 2021 Global Climate Survey. Most asset management firms have launched environmental, social, and governance (ESG) funds to cater to environmentally conscious consumers. For instance, the 128 members of the Net Zero Asset Managers Initiative, collectively responsible for managing $43 trillion of assets as of August 2021, have committed to reaching net-zero emissions across their entire portfolios by 2050.

When major investors announce climate commitments, they push the companies in their portfolios to move in the same direction. In an interview with BCG, Blackrock CEO Larry Fink said that a “tectonic shift of capital” is underway. Within five years, he said, ESG will be “integrated into every asset class and everything we do.” Since a handful of investors own large stakes in key US and European defense companies, their climate moves are likely to help shape the industry’s trajectory.

The largest shareholders are not the only ones to watch. In the oil and gas sector, for example, small activist investors recently demonstrated that they can have a significant impact in pushing energy giants to adopt more ambitious climate initiatives. Three new directors with significant climate experience were elected to ExxonMobil’s board, for instance, after the company lost a proxy battle led by a sustainability-focused fund.

Reputational risk associated with supporting high-emission companies is only one reason investors are focusing more intensely on the carbon footprints of their holdings. Several studies have shown that ESG-compliant companies and funds tend to outperform their peers across industrial sectors on most metrics—including stronger financial performance, higher stock prices, and lower capital costs. (See Exhibit 1.) This is why many investors and CEOs now look at the total societal impact of companies.

Companies cannot become carbon-neutral overnight, of course. But investors do expect a commitment to reach net zero by 2050 at the latest, and they demand proof that companies are ready to “walk the talk.” Defense contractors that can present a credible roadmap for achieving climate targets—as well as strong financial performance—will have a significant advantage in attracting investors and lower-cost capital over those who don’t. This will help them fund projects, invest in their businesses and their people, and ultimately win in a more and more challenging market.

Maintaining and Growing the Order Book. The defense industry’s customers are increasingly embracing mitigation of climate change as a strategic priority. Safety, reliability, and performance will remain crucial for securing contracts, but “green procurement” principles that already are widely applied in other areas of government will permeate the defense world in the coming years and translate into new requirements for suppliers.

Some governments are already signaling they will exert their strong influence over contractors to enable them to meet their climate goals. The UK Ministry of Defence and US Department of Defense, for example, have pledged to help their nations achieve net-zero emissions by 2050. NATO committed to a Climate Change and Security Agenda in March.

Although 2050 may seem a long way down the road, departments of defense are moving fast. The UK Ministry of Defence has announced that it may start including environmental criteria in its tenders as early as this year. In the US, the Biden Administration has committed to a 50% national reduction of carbon emissions by 2030, leaving just over eight years for public and private organizations alike to achieve a step change in their climate efforts. To ensure this ambition is realized, the US has launched a task force to detail the implications for future defense contracts; in the coming months, this task force is expected to recommend changes to the Federal Acquisition Regulation.

These announcements indicate that the carbon efficiency of defense products will soon draw greater customer scrutiny and increasingly become a differentiator. It is safe to assume that contractors will be required to publicly disclose emissions and other climate-related risks when bidding for government contracts. Ministries of defense worldwide will increasingly ask their contractors to set emission-reduction targets and plans. Over the medium term, these targets and plans—and progress toward their realization—are expected to be incorporated into procurement criteria.

We expect contractors that demonstrate a lower climate impact than competitors and develop new generations of emission-efficient products to maintain and capture market share. Pure defense players might face strong competition from more diversified companies able to leverage the investments in green technologies they made in their civilian-focused business units. It is imperative, therefore, to turbocharge investments in green technologies.

Higher emphasis on sustainability will also create new business opportunities. In the short term, demand for retrofitting services to replace parts with more ecofriendly ones in existing air, ground, and maritime fleets will soar. In the longer term, new generations of emission-efficient products, such as hydrogen-powered aircraft or electric vehicles, will overtake the market. Demand will also grow for solutions and services that better address climate concerns, such as advanced weather-pattern detection, climate-threat scanning capabilities, simulators, and synthetic training environments. In addition to new goods and services, armed forces will seek strategic partners to help them define and deploy climate strategies and optimize the carbon footprints of their services, workforces, and assets.

Getting a Fair Share of Public R&D Funding. Many governments are increasing their R&D spending to achieve their climate ambitions and applying “positive regulation” principles to support companies and institutions engaged in this effort. The UK, for example, has pledged to more than triple R&D funding by 2024, to more than $30 billion, to “build a future which is greener, safer, and healthier.” The US federal government also devotes a considerable portion of its $140 billion in annual R&D spending to sustainable technologies. In August, the US Senate approved a $1 trillion infrastructure package that includes significant funding for clean energy and climate-transition programs.  

Although governments have sizeable budgets dedicated to helping companies engaged in climate programs, the civilian sector captures an increasingly high share of this spending. In the US, in fact, defense is the only sector in which R&D funding has decreased in absolute terms over the past 15 years—at a time when total R&D spending increased by 10%.

As defense companies accelerate their climate efforts, they should aim to capture their fair share of the public R&D spending dedicated to environmental topics. Doing so will help fund costly research programs on the new technologies required to decarbonize their product portfolios.

Improving Cost Competitiveness. Manufacturing carbon-intensive products is likely to cost more in the coming years. The European Union is preparing to make it increasingly expensive to emit greenhouse gasses by adding a carbon border adjustment mechanism—commonly known as a “carbon border tax”—to its existing cap-and-trade system. The levy, aimed at leveling the playing field between domestic industries and imports from foreign producers with higher carbon footprints, would reflect the amount of carbon emissions attributed to imported goods. The UK is expected to introduce a similar tax. As the cost of carbon continues to rise, companies with lower emissions will benefit from an increasingly competitive cost base, while high polluters will pay the price.

Such mechanisms encourage companies to implement emission-reduction measures. As long as the cost of these measures is lower than the cost of carbon, they will have a positive return on investment. Many such investments have already reached the break-even point with the current price of carbon. In Europe, that price generally oscillates between €40 to €50 per metric ton of CO2; it has recently surpassed €60, reflecting increased regulatory pressure from the European Commission’s “Fit for 55” climate package of proposals, which calls for reducing emissions by 55% by 2030.

Going greener can even drive down costs in the US, where establishment of a carbon price at an economy-wide level is not yet planned. Some companies have managed to accomplish this by becoming more energy efficient, shifting their energy mix towards renewables, streamlining their supplier bases, or reducing waste and rework in their manufacturing processes.

How Contractors are Starting to Address Climate Stakes

Most defense companies have started to tackle the climate challenge in response to pressure from regulators, customers, investors, and the public. These efforts primarily focus on the 5% to 10% of defense-industry emissions identified as Scope 1, which are emitted from their own operations and manufacturing, and Scope 2, which are generated through energy usage. However, the industry is in the very early stages of addressing its Scope 3 emissions—those generated indirectly through the upstream supply chain and downstream usage of products by customers. While amounts vary across suppliers and business units, Scope 3 accounts for more than 90% of defense emissions on average. (See Exhibit 2).

A comprehensive approach to address emissions across these scopes is based on four key steps:

  • Gaining emission transparency
  • Committing to emission-reduction targets
  • Launching internal initiatives and programs
  • Seeking cross-sector collaboration

Gaining Emission Transparency. To understand and measure their climate impact, companies first need a clear picture of their current emissions. In most nations, publicly listed companies are required to report Scope 1 and Scope 2 emissions. Measurement systems exist, and most large defense contractors have been reporting these emissions for more than five years.

Scope 1 and 2 emissions reported by contractors vary widely. Of the publicly listed defense contractors we studied, emissions in 2019 ranged from around 10 metric tons of CO2 per $1 million in revenue to more than 40 metric tons. (See Exhibit 3.)

Part of these gaps in Scope 1 and 2 emissions are likely explained by companies’ product portfolios: service-oriented companies inherently pollute less than product-focused companies. Because individual business units and divisions do not disclose emissions separately, normalized estimates that factor in such differences are not available.

Reporting on Scope 3 emissions is not yet reliable because most defense companies only disclose the small portion of emissions that they can directly influence. The complexity and fragmented nature of companies’ supply chains, the investments required for small suppliers to measure their emissions, and the difficulty of tracing emissions across the full value chain makes collecting Scope 3 data a challenge. This lack of transparency on Scope 3 also makes it difficult to compare companies on a like-for-like basis. Companies that do their own manufacturing, for example, inherently report higher Scope 1 and 2 emissions than those that outsource subassemblies—another factor that partly explains the emissions differences.

One way to more fully address the complexity of measuring emissions, particularly Scope 3, is to create heat maps. Areas of the organization responsible for the highest emissions should be analyzed in detail; other areas can be more broadly estimated. Defense companies should partner with their highest-emitting suppliers to help them develop detailed, item-level emissions reporting. For the remaining suppliers, emission estimates can be made through a volume- or spend-based methodology using digital solutions. These solutions help develop granular carbon-footprint estimates by leveraging a combination of leading emissions-factor databases while using the power of artificial intelligence and machine-learning algorithms to map companies’ emission sources to these databases. By using this approach, defense companies can build a solid understanding of their baseline in three to six months.

Committing to Emission-Reduction Targets. Most major defense contractors have committed to emission-reduction goals for Scope 1 and 2. But these commitments vary significantly in size—from reductions of 20% to 100%—and in time targets, from 2025 to 2050. As of August, only a few companies, including Babcock, BAE Systems, ITP Aero, Meggitt, and QinetiQ, have aligned to set science-based targets to meet the Paris Agreement goals for containing global warming.

To date, very few defense contractors have made commitments on Scope 3. Because that represents the vast majority of total defense emissions and because governments are requesting at least partial transparency, we expect more contractors to work with their suppliers and customers to set such targets. To do so, companies can again leverage digital tools to model climate scenarios and derive adequate emission pathways for their different business units and product lines.

Launching Internal Initiatives and Programs. Most companies have begun internal efforts to curb their emissions, albeit at different speeds. Three-quarters of the defense companies we studied have already decreased their Scope 1 and 2 carbon intensity over the past five years. Their methods include stricter energy management, moves toward greener energy sources, the replacement of carbon-intensive manufacturing processes, and better waste recycling and disposal. As the industry shifts its focus to Scope 3, companies will need to invest more in R&D and engineering to design carbon-efficient products and commence joint efforts with suppliers.

The most mature defense contractors have also begun integrating climate awareness into their operating models. Safran, for instance, uses an internal carbon pricing for transactions between its business units to ensure that the cost of carbon is considered in all strategic decisions.

As defense companies continue to develop their roadmaps, they can consider a wide range of strategies deployed in other industrial sectors for optimizing CO2 footprints. Leading automotive manufacturers, for example, are working closely with their suppliers to cut Scope 3 emissions. Schaeffler integrates nonfinancial KPIs into its contracts, reserving the right to shift work to other suppliers if benchmarks are not met. Ford has a dedicated team devoted to ensuring that each of its more than 40,000 outsourced parts are produced sustainably. In the electronics sector, companies have been working for years on recycling and greener ways to dispose of products. As a result, they have significantly reduced emissions and waste. HP, for example, collaborated with the Massachusetts Institute of Technology to develop CO2 footprints for 99% of its products.

Cross-Company and Ecosystem Initiatives. Truly moving the needle on emissions will require collaboration across ecosystems. Industry forums can encourage the sharing of best practices, enable the codevelopment of solutions that are too complex or costly for individual companies to take on by themselves, and create incentives for all players in a sector to move in the same direction.

One initiative along these lines is the Clean Skies for Tomorrow Coalition, led by the World Economic Forum. It encourages aerospace and oil and gas companies to develop carbon-neutral solutions together, with a focus on rapidly scaling up sustainable aviation fuels. Another such initiative is a private, quarterly symposium called the A&D CTO Forum, organized by eight leading aerospace and defense companies, in which chief technology officers discuss joint approaches to climate challenges and other issues.

In this dimension too, looking outside of the defense industry can provide valuable inspiration. Construction and steel companies, for example, have established several think tanks and lobbying groups to push for stricter climate standards, as have lime and cement producers. The freight industry, meanwhile, is investing heavily in joint R&D initiatives on electric vehicles and sustainable aviation fuels. These collaborations accelerate progress on crucial industry-wide climate stakes.

Domain-Specific Opportunities for Reducing Emissions

The opportunities for emission-reduction vary by the military domain—air, maritime, ground, or cyberspace.

In aerospace, the path to net zero will focus on alterations in engines and fuels. Competition among both defense and civilian companies is intense. Safran and General Electric, for example, are collaborating on an engine powered by sustainable aviation fuel that is 20% more fuel efficient than current aviation propulsion engines. Airbus is investing in hydrogen R&D to design a zero-emissions commercial aircraft by 2035—such as using hydrogen as fuel for engine combustion, as an energy source for onboard electrical fuel cells, or as a source for synthetic fuel. Boeing, GE, NASA, the US Air Force, and several universities are conducting research into liquid hydrogen fuel cells. In addition to engines and fuels, selected aircraft design can help reduce emissions. For its Demon and MAGMA unmanned aerial vehicle programs, for instance, BAE Systems is developing flap-free technologies that make aircraft lighter and more fuel efficient.

In the maritime domain, fuel and propulsion system alterations will also receive major attention. The US Navy’s Great Green Fleet program, inaugurated in 2012, has demonstrated the practical potential of naval vessels sustained by alternative fuels. Companies are working on other technologies. Leonardo has developed a range of electric and hybrid-electric propulsion systems, for instance, while Babcock is working on a fuel cell battery-powered ship developed with WMG. Design improvements can also make vessels more carbon efficient, such as through adoption of greener ship-building materials and use of renewable energy for powering heating, cooling, and lighting.

In the land domain, militaries are expected to follow the civilian sector by introducing more electric vehicles (EVs) or hybrids. While EVs may not be well suited to all combat situations, several defense ministries have indicated that they regard full reliance on fossil fuels as a risk. The UK Ministry of Defence is working with NP Aerospace, General Dynamics, Supacat, and Magtec to develop a hybrid version of the Foxhound and Jackal 2 armored vehicles. In April, the US Army enlisted six companies for its Power Transfer Cohort program, which explores the development of electric and hybrid technologies for its future fleet. QinetiQ has been awarded contracts for the first development phase of the US Office of Naval Research’s electric hub drive unit, while General Motors Defense presented a prototype of its all-electric Infantry Squad Vehicle to the US Army in May.

In cybersecurity and electronic solutions, Scope 3 emissions are more limited than in asset-heavy divisions. The greatest opportunities for improving carbon efficiency lie in the monitoring and management of multidomain battlefield networks. Sensors can be installed in equipment to measure emissions and identify optimal conditions for reducing them, for example, and emission management can be taken into consideration when preparing fleet deployments. In addition, defense contractors can adopt a “green IT” lens when developing their solutions, such as by streamlining application architectures and using emission-efficient, renewable-energy-powered data centers.

What the Path Toward Net Zero Could Look Like

Achieving net zero will require addressing all three scopes of emissions, with a strong collaboration across the defense industry value chain.

In the first couple of years, the easiest gains can be achieved by accelerating reductions of Scope 1 and Scope 2 emissions. To cut Scope 1 emissions, defense contractors should identify ways to make manufacturing processes more carbon efficient, such as by reducing waste and rework. Boeing has recently introduced several successful initiatives along these lines in military aircraft programs, including digital-first engineering testing and the recycling of high-emission carbon-fiber material used in aircraft assembly. To cut Scope 2 emissions from energy usage, contractors can shift to renewable sources or green onsite generation, deploy energy-efficient systems in buildings, and electrify heating.

In addition, companies should launch Scope 3 upstream abatement programs to decrease the carbon emissions of purchased goods. Such programs should be led jointly by procurement and engineering departments. Creating greener products that perform up to expectation is a longer-term project that engineering departments need to start now. But shorter-term actions can also have a big impact—such as switching to suppliers capable of manufacturing the same goods with better carbon efficiency or choosing suppliers closer to manufacturing bases to reduce emissions from long-distance shipping.

Finally, certain Scope 3 downstream initiatives can also be completed in this timeframe. Defense contractors can capture retrofitting opportunities to replace parts with carbon-efficient equivalents, thereby boosting aftermarket revenues through replacement. They can also upgrade their solutions and services to take carbon emissions into account. For instance, fleet-management solutions can help armed forces make smarter choices about which assets to deploy when and where to optimize their carbon footprints. Training programs and simulators can be adapted to include the new threats caused by climate change, and such programs can be delivered in an emission-efficient way, such as by using virtual or synthetic environments.

In the long term, new generations of products and technologies must be commercialized to help defense ministries achieve their net-zero ambitions. This will require significant investment in climate innovation and R&D. It is worth noting that emission efficiency will be one of several considerations informing the design of next-generation products, in addition to military performance, evolving customer needs, business and financial considerations, and technological breakthroughs.

Immediate Actions for Advancing Climate Agendas in Defense

A successful response to the climate challenge requires a multiyear commitment across an entire organization, including individual business units. Defense companies should devote the first three to six months to stand up a central team that can orchestrate action across the organization and set an overall direction, including the establishment of baselines and targets for each business unit. Over the next 12 to 24 months, companies should capture quick wins, especially regarding Scope 1, 2, and 3 upstream emissions, and lay out the foundations of the more complex initiatives needed to address downstream Scope 3 emissions. The long-term focus should be on executing plans to achieve net zero, including commercialization of R&D investments. (See Exhibit 4.)

We have identified the following five actions defense contractors in all domains should take—both internally and externally—to accelerate their journey to net zero:

  • Gain visibility into the full emissions baseline, including Scope 3. Defense companies should work with their suppliers to estimate upstream emissions for each product and input they procure and identify opportunities for switching to greener inputs. They also need to understand the downstream emissions of customers for each of their products and solutions, such as how frequently they are being used and how much longer these assets are likely to remain in operation. Advanced data analytics solutions can help conduct these activities in just a few months, identifying key areas of focus and suggesting abatement levers. This would significantly accelerate the journey from measurement to implementation.
  • Align on ambitions and set targets for business units. Defense contractors must set a date by which they are committed to reaching net zero for each emission scope and communicate these company-level targets publicly. Then, they should cascade these targets by business units and establish a set of milestones to get there. Companies also should set incentives for management and employees to reach these targets.
  • Design strategic roadmaps for each business unit. Each business unit should create a strategic roadmap for the next 10, 20, and 30 years that incorporates climate goals along with other strategic dimensions. It should decide whether its objective is to comply, compete, or lead: Are the climate opportunities valuable enough to lead the charge towards sustainability, or would it be more appropriate to focus on incremental improvements and be a “fast follower” that quickly adopts innovations pioneered by other business units? These decisions should strongly influence the R&D and portfolio strategies of each business unit.
  • Develop compelling narratives for customers, investors, and prospective employees. Climate commitments are unmatched opportunities for defense companies to redefine their purposes and market positioning. Green commitments should become an integral part of companies’ value proposition for customers, investors, and the talent they hope to recruit. Companies can also elect to tackle the whole ESG sphere at once, adding social, ethical, and governance commitments to their climate pledges.
  • Seek partnerships with defense ministries and the entire ecosystem to shape a climate roadmap. Defense departments worldwide will seek partnerships with their strategic suppliers to define national climate roadmaps and standards. Contractors can also contribute to transversal initiatives with their peers within and beyond the defense industry to accelerate the sector’s climate journey, such as by quickly developing solutions at scale and helping define standards. They can also forge a consensus on their expectations from suppliers regarding standards, disclosure, emission-reduction timelines, and cost sharing.

The global defense industry is fast approaching a critical transition. In addition to meeting traditional demands for high performance and cost control, contractors will be under intensifying public, investor, and customer pressure to join civilian industries in the fight against global warming. We are convinced that the climate imperative will create sizeable business opportunities and sources of long-term competitive advantage for defense contractors that commit to going green.

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