"Global warming did not eat my homework," Bart Simpson wrote repeatedly on the blackboard before he launched his skateboard down the hall at the sound of the recess bell. While the TV show's writers poke fun at Bart's attempt to shirk responsibility -- and the level of humans' contributions to climate change continues to spark controversy -- more and more U.S. companies are taking the subject very seriously and voluntarily taking significant actions to curb carbon dioxide (CO2) emissions and disclose to investors their related risks to the company. CO2 is one of several greenhouse gasses (GHGs) associated with climate change.
According to the Carbon Disclosure Project, which catalogs companies' self-reported carbon emissions and energy costs for hundreds of institutional investors, the number of Standard & Poor's 500 companies that participated in this year's study registered 56 percent, up from a 47 percent response the previous year. And while electric utilities and materials companies -- the two most carbon-intensive industries represented in the S&P 500 index -- had the highest response rate, the rate increased across all industry sectors represented in the index.
Many firms that maintain that the risk carbon emissions pose to their business is not material may soon be prodded into action. Companies including Unilever, Cadbury Schweppes, and Procter & Gamble are already engaging their supply chains to report carbon footprints and climate change-relevant information such as greenhouse gas emissions data, emissions reduction targets, and climate change strategy through the CDP. "By engaging their supply chains in the CDP process, companies will encourage suppliers to measure and manage their greenhouse gas emissions and ultimately reduce the total carbon footprint of their indirect emissions," says CDP chief executive Paul Dickinson. "For many companies, it is the supply chain that makes up the vast majority of their emissions, so this initiative is vital in helping them to reduce their total carbon footprint."
And when CFOs in any sector consider the broad-based concerns relating to a carbon-constrained economy, it becomes crystal clear that the effects of carbon emissions on businesses are pervasive. "When you think about the economic consequences to individuals, the consumption of energy should be a top priority of every household, especially low-income ones," says Thomas A. Fanning, executive vice president, CFO, and treasurer at Atlanta-based Southern Company, an electric utility holding company. "So you need to think through the impact that any new U.S. policy on carbon emissions would have on everyday Americans' standards of living. Any new proposal that isn't well thought out and balanced could result in sending some manufacturing jobs overseas and impact the cost of goods in the economy."
Even "clean businesses" are already stepping up to the plate and crafting concrete policies for reducing carbon emissions. For consulting firm A.T. Kearney, the goal of achieving a carbon-neutral model within two years illustrates the momentum of CO2 emissions concerns throughout the supply chain. "In measuring our carbon footprint, it became clear that airline travel was the major driver of our carbon emissions," says Daniel Mahler, a partner in the firm. "It represents more than 80 percent of our carbon footprint. We're developing a series of alternative delivery mechanisms for providing consulting services that include reducing the frequency of travel and using technology to maintain the firm's collaborative working style in a more environmentally sustainable fashion." Mahler says that the firm will also limit internal travel; shift necessary travel from air to rail as feasible; select services from among carbon- efficient airlines, hotels, and rental car companies; and increase the use of public transit.
The firm expects to garner credibility with business partners and clients as a result of these efforts. "We also believe that the sustainability initiative will drive cost savings for A.T. Kearney as well as improve work/life balance for our consultants," says Mahler.
While companies that do business with major utilities and manufacturers are in the early stages of addressing risk management and disclosure issues related to CO2 emissions, giants such as Alcoa Inc. that use massive amounts of energy in manufacturing processes continue to raise the bar.
"In 2001, we set a series of goals, one of which was to reduce greenhouse gas emissions by 25 percent of base year 1990 by year 2010," says Kevin Lowery, director of corporate communications. "As a result, we achieved a 25 percent reduction two years ago -- as we increased production. We want to keep driving that number down, and we're investing money in technologies to accomplish that." The aluminum industry as a whole is expected to be GHG- neutral by 2020, so Alcoa is on the fast track.
Alcoa is a founder of the United States Climate Action Partnership (USCAP), a group of businesses and leading environmental organizations that was formed to press the government to address the global dimensions of climate change.
According to the information Alcoa provided to this year's CDP, best practices at the company are widespread and continually evolving. In addition to rapidly deploying appropriate best-practice technologies to reduce GHG emissions, apply detailed metrics to measure current emissions, and predict future emissions, the company engages employees at virtually every level across the organization as well as its supply chain members in its efforts. "One of our programs involves educating employees about the power of recycling," says Lowery. "It takes 95 percent less energy to recycle aluminum into a new, reusable form than it does to generate it from the get-go, and there are enormous benefits to the environment and the company as a whole in recycling."
Alcoa's business unit leaders have various incentive mechanisms in place to reward both managers and associates for meeting key nonfinancial indicators such as emissions performance targets. "And in Australia, we have a major program for the families of Alcoa employees and their immediate communities to determine their carbon footprint," says Lowery.
Regulatory Pressures Increase
Experts agree that federal regulation of carbon emissions is coming within the next several years, and businesses with the most at stake want to be out in front of regulators, helping to shape policy. "We need an economy-wide proposal that is balanced and as broad-based as possible, focused on all sources of emissions," says Fanning, who, among other Southern Company executives, is on the front lines of regulatory developments. "I wouldn't want to disadvantage the U.S. relative to other economies, including China and India. And I don't think that any American sees that taxing ourselves enough to produce a burden on the economy is a good answer. We need to focus on the development of technology that will attack the problem of carbon emissions directly, and we're doing that at Southern Company."
Southern is investing $4.6 billion over the next three years to add additional environmental controls, which will further lower emissions of greenhouse gases. One of its initiatives is helping to design the world's first near-zero-emissions coal-based power plant.
Institutional investors and their advisors are also nipping at the heels of the U.S. government to take action in the area of disclosure of carbon risks by public companies. In October, a group of institutional investors petitioned the SEC to tighten disclosure requirements related to climate change. Their request did not seek new regulations but requested clarification that existing disclosure requirements mandate the disclosure of climate change risk. Disclosure is currently voluntary. According to a Calvert Investment and Ceres report, electric utilities and automakers are currently providing more detailed disclosures than other industries. Still, the group petitioning the SEC asserts that these disclosures remain inadequate.
According to a July 2007 study by KPMG, while many companies are reporting business opportunities associated with climate change, few are identifying its financial risks. The most frequently disclosed risk was the threat of increased energy costs, reported by only 20 percent of the companies surveyed.
If the SEC does decide that clarification of carbon risk is necessary, the commission could issue guidance through an informal staff document or a more formal act, according to law firm Waller Landsen Dortch & Davis, LLP.
"America reached the tipping point on greenhouse gas this year and moved from ambivalence to a position of dogged determination," says Larry Goldenhersh, CEO of Carlsbad, Calif.-based Enviance, which offers an Internet-based application for automation and management of environmental, health, and safety compliance. "This sea change means that carbon's going on the balance sheet. Companies must address how they'll deal with that new cost and how to reduce it."
"As we move from an involuntary to a mandatory regime, it will be interesting to see how companies come to grips with the need to disclose to investors the potential cost of carbon on the balance sheet and how the investment community responds to what they perceive to be a failure to adequately disclose. I believe that we'll see investors retain counsel to find out if failure to disclose carbon cost constitutes material nondisclosure under a statute like Sarbanes-Oxley," Goldenhersh says.
Companies that are molding best practices in this area are least likely to find themselves in such an uncomfortable position, but all businesses face obstacles in determining the profit and loss impact of carbon emissions. "The challenge is that research shows huge variations in financial impact not only from sector to sector but also within the same sector," says says Matthew Kiernan, CEO of Innovest Strategic Value Advisors, an international research and advisory firm whose clients include large institutional investors. "So if you're looking at a large-cap U.S. utility sector company, for example, we found among the top 26 companies in the sector that net risk exposure to climate varies by a factor of 30. So investors aren't looking just at a sector level but also are drilling down into a company, which means that there continues to be a strong need for improved and more standardized disclosure."
"The analysis must look at other factors and drill down into the company's footprint and see where the emissions occur and what kind of regulatory consequences the company faces. Investors need to look at the risk management capability of the company and its ability to identify and capture upside opportunities and take into account the trajectory of its footprint. It's one thing if a company has a big footprint, but if it's managing it down dramatically and getting year-over-year improvements that are twice those of industry peers, that's a significant finding for investors. But company-specific research is elusive. As Yogi Berra once said, 'Predicting is really hard, especially if it's about the future.' Nobody knows what the price of carbon in five years is going to be, and this is clearly the single biggest driver of the bottom-line impact. I don't know what the price is going to be in 2010, but I can guarantee that it's not going to be zero," says Kiernan.
"When investors see good, clear, and reasonable environmental disclosures and transparency, they feel more comfortable with that company's overall management," says Mike Wallace, vice president, North American operations, for Trucost, a firm that advises institutional investors. "When there is an absence of good, clear, environmental disclosures, investors begin to worry. They worry even more if they can look across an entire sector and see transparency on these issues, but then one company says absolutely nothing. They start to wonder if the company can't measure, won't measure, or won't tell."
For example, this year a Citigroup analyst downgraded BMW stock, citing the company's vulnerability to climate-change regulations as reflected in the relative lack of fuel efficiency in its cars compared to those of other auto manufacturers.
But could there be such a thing as too much disclosure? "Our 10K has about four pages of environmental disclosure, and I think that we do a terrific job of discussing the potential effects for current or prospective investors," says Fanning. "Some people want you to go further and talk about economic consequences, but, frankly, nobody knows. It's so premature right now, so I think it would be even misleading to try to quantify to any reasonable degree what the consequences might be. We are still so far away from consensus on important national carbon emissions issues. Right now, we are at exactly the right level of disclosure."
Does lowering emissions have a positive effect on shareholder value? "It's very tough to demonstrate that lowering emissions positively impacts shareholder value," says Peter Breitstone, CEO of Aon Environmental Services Group. "We do know that to some extent being more efficient in how you use energy should reduce your costs -- just like low-energy light bulbs that cost more save money over time. But there's less of a direct link between actions and shareholder value, which is a problem in sustainability issues."
However, according to a survey on reporting the business implications of climate change in sustainability reports conducted by the Global Reporting Initiative (GRI) and KPMG's Global Sustainability Services, most companies surveyed reported a target to reduce their greenhouse emissions and/or energy use, and where companies reported financial implications of reductions, in almost all cases these showed savings or positive returns on investment.
Carbon Trading Systems Develop
Under a new U.S. carbon regulatory regime, major carbon emitters may be required to cut back or buy carbon "credits" in the future. According to Stanford University's Dr. Lawrence Goulder, writing for The Stanford Challenge, under a cap-and-trade system, the government places a cap on the overall level of allowed emissions and then distributes a specific number of permits -- each equal to a unit of the target substance such as carbon dioxide -- to emission-heavy industries.
Those plants that are able to reduce emissions below the required amount end up with excess permits that can be traded or sold to other companies. The plants that face especially high costs in order to limit their emissions have the option of purchasing permits rather than installing expensive new equipment, decreasing their cost of compliance. Thus, the system rewards both sellers and buyers, while keeping total emissions within the overall cap.
Alcoa supports institution of a cap-and-trade system in the U.S. "Alcoa believes an economy-wide cap-and-trade program needs to be at the core of a comprehensive U.S. climate program," said Kevin Anton, Alcoa vice president and president of materials management, who spoke before a U.S. Senate subcommittee on global warming in Washington, D.C., in late October. "Unlike traditional command-and-control regulations, under a cap-and-trade program, government sets the environmental goal and industry decides how best to achieve it -- which is the right division of labor. And unlike a tax, a cap-and-trade program lets the market, not the government, set the price."
A trading system for carbon credits is already operating in Europe, and the world's largest banks, which see the potential for a major new business, are pushing the U.S. toward the introduction of a lightly regulated system for trading carbon emissions permits as soon as possible.
The Chicago Climate Exchange offers a system for companies that wish to move ahead and start reducing carbon emissions now. "The company can establish a baseline of the carbon emissions created by its operations and can join the exchange, which binds it to reduce its emissions by 1 percent per year for a minimum of five years," explains George P. Nassos, Industry Associate Professor at the IIT/Stuart School of Business in Chicago. "Any reduction of its emissions beyond that obligation can be sold on the exchange as carbon dioxide credits. If the company does not meet its obligation, it will have to purchase the credits from the exchange. So reducing a company's carbon emissions can show up on the bottom line."
Former president Bill Clinton, who released to the public the results of the Carbon Disclosure Project in late September, emphasized that there are, in fact, significant commercial opportunities for companies at the forefront of change related to climate risk, and the S&P 500 index companies that participated in the study agree. A wide majority of them view climate as posing a material commercial opportunity. Best-practice companies believe that they're poised to take advantage of new business opportunities, giving them an edge over companies that hang on to business-as-usual strategies.
Authoring a "Coming Clean" Action PlanThe largest GHG emitters, such as utilities and large manufacturers, are at the forefront of implementing best practices in managing the carbon-related risks and disclosing those risks to investors. But as more of these companies extend their disclosure to include their supply chain partners, businesses in a wide range of sectors will be working toward reporting metrics and creating company-wide policies related to emissions. Here are some of the actions that companies facing major CO2-related risks have already put into place: • Addressing climate change risk and regulatory pressures in SEC filings. Currently, there are no generally accepted standards for disclosure, but best-practice companies strive for transparency. "Serious discussion of risks in the Management Analysis & Discussion section of the annual report is a best practice in certain sectors where the risk is very intensive, such as utilities and oil and gas," says Eric Kane, senior analyst at Innovest, a firm that tracks climate change risk for investors. "Imagine looking through a list of U.S. utilities and finding that all but one has reported their CO2 in the same way," says Mike Wallace, vice president, North American operations, for Trucost, a firm that provides carbon emissions data for investors. "The last one says, 'CO2 isn't a business issue. It's not regulated, and therefore we're not going to waste our time measuring it or telling you about our risk management policies around it.' What would an investor think of that company's management?" But while disclosure is important, "It's only the first baby step in going the distance you need to understand what real risk and opportunities the company is exposed to from an investor's point of view," says says Innovest CEO Matthew Kiernan, who emphasizes the importance of setting emissions reduction targets and reducing energy costs. • Factoring carbon pricing into capital investment decisions. According to the Carbon Disclosure Project (CDP), while many capital investment decisions involve multiyear planning processes and have long payback periods, only 8 percent of their 2007 survey respondents said that they are factoring projected costs of carbon emissions into their decisions. Half of those that are doing so are electric utilities. Only a few have set an explicit carbon price or range of prices as part of their decision-making process. • Completing a Greenhouse Gas (GHG) inventory using GHG Protocol. The GHG Protocol Corporate Standard provides guidance for GHG emitters in preparing an inventory of greenhouse gases. It covers the accounting and reporting of the six greenhouse gasses covered by the Kyoto Protocol. The purpose of the inventory is to estimate financial risks under future state, regional, or national climate-change policies and regulations; to report emissions and risks to shareholders; and to identify opportunities to reduce emissions. • Extending disclosure to include suppliers. The companies leading the charge toward best practices are engaging their supply chains to report carbon footprints and climate change-relevant information, such as GHG emissions data, emissions reduction targets, and climate change strategy, according to the Carbon Disclosure Project. The granddaddy of retailers, Wal-Mart Stores Inc., announced this October that the company would begin measuring energy use for seven product categories in a partnership with the CDP. Apparel company VF Corp. is moving ahead and addressing GHG emissions "on a brand-by-brand basis as well as within our corporate-wide supply chain," says Senior Vice President and Chief Financial Officer Robert Shearer. "We have many social responsibility programs in place or under way. Greenhouse gases represent one of the many important issues we're addressing internally." • Linking carbon emissions strategy to individual performance. Best-practice companies foster a corporate culture that supports their carbon emissions reduction strategy, including instituting incentive mechanisms to reward employees for attainment of reduction targets. • Speaking publicly about the importance of climate change and what the company is doing to manage risk. Chief executive officers and chief financial officers of organizations that are heavily impacted by climate change risks are speaking out about related financial and social issues at investor meetings and industry conferences and in the halls of Congress. |
Climate Change's Legal LandscapeLitigation Continues to Drive Climate-Change PolicyUntil recently, the subject of passing a U.S. regulation that provides for mandatory reduction of greenhouse gas (GHG) emissions was reminiscent of the old joke that everybody talks about the weather but nobody does anything about it. According to the Carbon Disclosure Project (CDP), as of August 2007, there were over 110 climate-related hearings held and 150 climate-related bills introduced in Congress, setting a record for legislative activity. While none of these bills has yet been signed into law, a bill introduced in late October by Senators Joseph Lieberman (I-CT) and John Warner (R-VA), the America's Climate Security Act, is gaining traction. The act would reduce total GHG emissions as much as 19 percent below the 2005 level by 2020 and as much as 63 percent below the 2005 level by 2050. Currently, the CO2 emissions of operating plants in the U.S. are not regulated by federal law. However, power plants are required to measure and report their CO2 emissions under the Clean Air Act. According to Environmental Protection Agency (EPA) spokesperson Roxanne Smith, the agency is working to develop an overall strategy for addressing CO2 emissions and other greenhouse gases under the act. Meanwhile, state and local governments have moved forward with well-intentioned laws and regulations that form a patchwork quilt that may confuse the companies that must comply with them. Seventeen states have adopted economy-wide, non-industry-specific, greenhouse gas emission reduction targets. Meanwhile, institutional investors and state attorney general offices are prodding the SEC to require public companies to disclose the economic and financial risks associated with climate change in their filings. Disclosure is currently voluntary. This past September, an investor coalition and state officials filed a petition with the SEC requesting that the agency require public companies to assess and fully disclose their financial risks from climate change, providing material information including physical risks that are material to the company's operations or financial condition; financial risks and opportunities associated with greenhouse gas regulation; and legal proceedings related to climate change. "While this isn't the first attempt to persuade the SEC to require disclosure of climate change risk, it marks the first time that such a prominent group of institutional investors and government officials has formally petitioned the SEC for guidance," says Michael Lufkin, a Seattle-based environmental attorney. Litigation continues to play an important role in driving climate change policy. This year, New York State Attorney General Andrew Cuomo issued subpoenas to five energy companies seeking information regarding their analyses of climate risks and the disclosure of these risks to investors. Environmental attorneys such as Lufkin see a big increase in litigation coming. "Over the next couple of years, you'll continue to see litigation used by the states to try to force the federal government's hand," he says. "Once there's federal regulation and states start implementing policies, actual obligations placed on companies to comply with those new regulations will bring the kind of litigation that's typical whenever there are comprehensive new regulations or policies, as everyone figures out what the new law actually requires. So, even when the federal government acts, it's not going to be the end of climate litigation." |