Russia’s signing of the Kyoto Protocol in late 2004 and President Bush’s early 2005 challenge to US industry to reduce greenhouse gas (GHG) emissions by 18 percent by 2012 have reinforced the idea that accountability for GHG emissions is now a mainstream subject. Today there is increasing awareness that harmful emissions can entail multiple expenses, including environmental clean-up and healthcare costs, and lost productivity and tax revenues resulting from lost working days. The indications are that sooner or later these costs will be assigned to those who produce them or benefit directly from them.
Today’s investors want to know more about the long-term risks associated with the potential cost of climate change. ‘They want to know how they can make most money, which also involves knowing how to avoid losing money,’ explains Paul Dickinson, project coordinator at the Carbon Disclosure Project (CDP), representing the interests of 143 large institutional investors with over $20 tn under management.
‘There are three risks,’ explains Simon Thomas, CEO at environmental research group Trucost. ‘Increased insurance premiums, increased risk of catastrophe as a result of extreme weather conditions, and risks involved in adapting a firm’s business model in light of the price assigned to carbon emissions.’ And the development of trading schemes on both sides of the Atlantic means carbon emissions do indeed have a price.
A 2003 report commissioned by the Boston-based Coalition for Environmentally Responsible Economies (Ceres), whose members manage investments totaling over $400 bn, notes that the hottest years since records began in 1860 have all occurred since 1991. The Intergovernmental Panel on Climate Change (IPCC), a global body of thousands of scientists, agrees that rapidly rising temperatures are – to an unspecified degree – attributable to GHG emissions. Many governments are preparing to limit the risks associated with extreme weather events exacerbated by global warming.
Indeed, regulatory developments are already having an impact. The Austrian and Swiss governments recently imposed tolls on goods lorries in transit to limit the amount of heavy traffic on their roads. Transport firms such as P&O are upping investment in their intermodal transport options – from ship to train, in P&O’s case – and limiting their trucking operations where possible. Quoted in Logistics Business magazine in 2004, Bart Verbeke, intermodal general manager at P&O, says ‘many blue chip companies are looking for environmentally friendly solutions to move their cargo.’ Anticipating a developing trend, P&O recently ordered 500 high cube containers in order to optimize ship-to-rail movement.
Asking for rules
Governments are taking the problem seriously, as shown by the broad consensus on Kyoto – although it is yet to be ratified by the US or Australia. In the UK the operating and financial review (OFR) becomes law this month and will require companies to provide broader information on their environmental impact. According to Dickinson, OFR requirements will ensure that what was once a narrative on non-financial information will evolve into a more useful tool for investors. ‘Non-financial information won’t necessarily be non-financial for much longer,’ he muses.
Thomas agrees. ‘The EU trading scheme started in January and in Europe CO2 emissions are currently valued at around €8 per tonne,’ he explains. ‘Carbon emissions will soon find their way onto balance sheets.’
The same may be true for the US, where an informal emissions trading scheme has sprung up over the past year. ‘US investors decided to take action because the government wasn’t,’ says Ariane van Buren, senior manager of investor outreach at Ceres. ‘Top firms aren’t just looking for government guidance; they’re looking for opportunities to invest.’
Even so, many companies would prefer a clearer lead from government than they are getting. ‘There has been difficulty in producing a standard set of rules in the UK, although the OFR guidance offers some specifics,’ observes Thomas. But OFR guidance falls short of telling companies what to do, leaving much to the discretion of company directors. ‘Many firms that have consulted us have expressed an appetite for more prescriptive guidance,’ Thomas confides.
It’s a similar story in the US. Julie Sloat, vice president of IR at American Electric Power (AEP), says her company would be interested in seeing specific legislation on environmental impact. ‘It would reduce uncertainty and allow appropriate planning of capital expenditure,’ she explains. According to Andrew Logan, program manager at Ceres, the same goes for investors. ‘Business people planning very large investments would prefer to have regulation sooner rather than later – they want regulatory certainty,’ he says.
Investors are no longer satisfied with non-financial narratives, either. They want numbers relating to impacts, potential liabilities, cost savings and future opportunities. As for measurement methodology, consensus is developing. ‘With regard to calculating carbon emissions, there is a good degree of standardization emerging,’ says Thomas, while Van Buren points out that the Global Reporting Initiative (GRI) has enjoyed broad participation, ‘establishing reporting criteria and getting constituencies on board.’
Companies that have been aware of the issue for some time are finding themselves at an advantage as investors’ and governments’ disclosure requirements broaden. ‘After some years’ experience we believe we have well-proven information collection and reporting systems for environmental emissions,’ notes Kevin Ball, director of energy efficiency at BP. ‘Our data are subject to rigorous internal and external audit.’
Logan believes the largest electric power companies are also making significant progress in disclosure. ‘AEP is the largest single emitter of CO2 in the US,’ he notes. ‘AEP’s CEO, Michael Morris, says it’s the fiduciary duty of the company and the board to evaluate the risks this entails, and they have taken the initial steps to do so.’ An independent board subcommittee noted that the firm’s biggest challenge lay in ‘making decisions about large investments in long-lived assets in a setting of uncertain public policy and rapidly evolving technology’. The recommendations included proactive leadership in technology development and operation, and continued transparency of action.
Areas of resistance
Not everyone is pulling in the same direction, however. ‘We have seen some important areas of resistance at US federal government level and from many companies in the oil industry,’ says Van Buren. The watering down of Environmental Protection Agency legislation might make it more difficult for individual states to take issue with companies whose emissions arrive from across state boundaries.
Van Buren also points out that ‘some insurance companies are refusing to see GHG emissions as an issue, or saying they don’t have the capacity to deal with it.’ Others, such as Swiss Re and Munich Re, have made inroads in the area of insurance against extreme weather, and will find themselves at an advantage as requirements grow.
Sloat sees other practical problems. For example, investors are showing great interest in new technology whereby coal is ‘gasified’ to produce electricity, with resultant CO2 being deposited underground. However, the ‘integrated gasification combined cycle’ (IGCC) plants needed for the process ‘are more expensive to run than traditional coal plants and AEP locates them only in states where some kind of relief mechanism is available,’ as pricing could not otherwise be competitive – so current cost structures still favor ‘dirtier’ energy.
The first CDP report in early 2003 noted: ‘Those companies surveyed that were quick to reduce gas emissions stand to gain a competitive advantage, in terms of both cost and market risk management.’ For example, between 1997 and 2001 BP cut annual CO2 emissions at its plants by 10 percent, gaining some $650 mn in present net value through increased operating efficiency. ‘The numbers reflect the value of extra hydrocarbons sold as a result of focusing on energy consumption in our own productive processes,’ explains Ball. ‘This energy was captured rather than wasted, particularly in the upstream (exploration) part of our operations. The aim was to get as much product to market as possible.’
This isn’t altruism: it’s good business sense. ‘There is a climate change aspect involved, but we really got our environmental agenda moving by translating it into a business question,’ recalls Peter Hall, director of IR at BP. Other companies are also recognizing the potential risks and picking up on the opportunities. For example, says Dickinson, ‘wind energy and tidal power are now fairly established, and new clean energy technologies are emerging.’
Looking ahead
‘We believe there is value in the role our products play today and will play tomorrow in helping our customers address environmental challenges,’ confirms Steve Ramsey, VP of environmental programs at General Electric. ‘GE sees business opportunities in the drive to reduce GHG emissions.’ Ramsey notes the company’s growing renewable energy portfolio in wind, solar and hydro, and renewable, special and natural gas engines. And while seeing opportunities in the development of energy efficient products like IGCC plants, GE is expanding its focus. Earlier this year, GE Commercial Finance announced a new initiative to provide a full range of financing products and services to companies that deliver clean or renewable energy or develop new technologies for cleaner and more efficient energy generation and distribution.
Swiss Re estimates that within a decade extreme weather events linked to rising temperatures could have a yearly impact of $100 bn on the world’s economies. ‘And as understanding of emissions rises, there will be a growing call for those who benefit from them to pay the costs,’ predicts Logan. ‘Firms need to be sure of their level of emissions to understand the risks and work toward improvement,’ advises Ball.
On its web site, BP underlines the paradox: the energy that provides society with heat, light and mobility, fuelling economic growth and development, simultaneously presents it with serious environmental and social challenges. ‘Shying away from these challenges is not an option for an energy company that plans to be successful in the long term,’ notes the site.
‘We continue to show that it’s possible to reduce your emissions and still create shareholder value,’ concludes Ball. Investors as well as environmentalists expect companies to take note.
