Feature Winning in a low carbon world

  • Date:01 May 2010
  • Type:CompanyDirectorMagazine
While future carbon legislation remains uncertain, there is no escaping the emerging low-carbon world. Zilla Efrat reports on how companies that do not manage the risks will lose out.

Winning in a low carbon world

No escape

Carbon emissions cannot be ignored because:

  • Sooner or later, there will be a price on carbon and tougher regulations
  • Energy prices continue to escalate
  • Reputations could be damaged
  • Employees, customers and shareholders may walk away
  • Cost savings and other opportunities may be lost
  • Competitors may sneak ahead

Many Australian directors are not fulfilling their responsibilities by failing to gain a basic understanding of climate-change issues, the direction of public policy and the effects of a rapid decarbonisation of the economy on their businesses.

That’s the view of Jonathan Jutsen, executive director for business development at Energetics, who believes that, in general, Australian companies have not advanced their thinking much past ensuring compliance with existing regulations.

While some well-known organisations are taking a considered, long-term position on climate change and are making serious investments in carbon mitigation, Jutsen says: “I still encounter boards which announce to me that many of their members are carbon sceptics. My response to this is that I am not interested in their religious beliefs, only whether as board members they are interested in mitigating business risks and taking advantage of new business opportunities.”

According to Freddy Sharpe, CEO of Climate Friendly, Australian companies are still in the early stages of exploring all their carbon risks. “Most of the large companies required to report and understand their footprints have done so. Many of those are going to the next step, which involves proactively and voluntarily reducing their emissions. But to be fair, this is still patchy. I wouldn’t say there is a comprehensive consensus about how this should be done but certainly we are beginning to see this happen.”

Sharpe adds: “Small to medium-sized enterprises (SMEs) are much more aware of their power consumption. The power consumption of most large commercial companies is probably between three and five per cent of their total input costs. That is not enormous. The power consumption of smaller companies is usually a higher percentage of input costs. So they are more actively focused on this, but have fewer options available to them as they do not always have the economy of scale to effect large changes.”

Lagging our international competitors

Jutsen says businesses in Europe and Japan are generally far more advanced in carbon mitigation than their Australian counterparts. “This is a result of their far greater focus on the efficient use of energy in their operations resulting from historically high energy prices, combined with well-established carbon mitigation policies,” he says.

“The European Trading Scheme, covering 28 countries and 4,000 energy or industrial facilities, is a driver for greater focus for companies in the European Union,” adds Planet Cool director Rod Wills.

But according to Sharpe, research conducted last year by New Energy Finance found that the third-largest market for corporate action on climate change was Australia, behind Europe (including the UK) and the US. This suggests that Australian companies are acting voluntarily on climate change and are ahead of competitors in many other parts of the world.

A key factor holding them back, however, is the deadlock between political parties on climate-change legislation. “The lack of regulation has caused many Australian companies to adopt a wait-and-see approach, which has slowed down serious investment and the focus on reducing carbon footprints. This is a risky strategy as it can put these organisations at a disadvantage if their competitors are already taking action,” says Wills.

Jutsen says delays will end up costing businesses dearly as energy prices continue to escalate rapidly. “There will be big winners and losers in the wake of carbon mitigation. Some companies will develop game-changing new business models to take advantage of this change to cement business dominance. Boards should be considering whether they want to be in the front seat of the carbon-management car, seeing the road ahead and leading into new markets, or be dragged along reluctantly behind the car, suffering all the additional transaction costs while gaining none of the market opportunities.”

While the immediate future for carbon pollution legislation is uncertain, he says the only thing crystal clear is that within five years (and probably within two) there will be a price on carbon. There will also be much tougher regulations on energy use in buildings and appliances, and there will be strong policies and probably incentives supporting the improvement of energy efficiency in the economy.”

The risks of not acting

Jutsen believes directors would be negligent if they failed to understand the scale of their organisations’ emissions, reporting obligations, the potential effects of a price on carbon emissions and new business opportunities resulting from a transition to a low carbon-emission economy.

But there are a host of other risks that could result from inaction.

According to Sharpe, these could include damage to the organisation’s reputation or being seen to be a laggard or not taking a leadership position. Companies seen not to be embracing carbon-emission reductions or managing the risks of climate change could also find their employees, customers and shareholders moving on to companies that do.

Indeed, organisations such as the Carbon Disclosure Project (which acts on behalf of 534 institutional investors with US$64 trillion in assets and 60 large purchasing organisations) and the Investor Group on Climate Change (which represents institutional investors with around $500 billion in funds under management) are monitoring how companies manage climate risks and are turning up the heat on them.

“If you look around the world, there has been a real push from shareholders for companies to take into account the wider impact they have at an environmental, social and economic level. There are also many examples that show companies that take sustainability seriously tend to be well run and prove to be good investments,” says environmental expert Jon Dee, author of Small Business, Big Opportunity: Sustainable Growth.

Wills adds: “In terms of gaining competitive advantage today, consumers do react positively to companies that are genuinely focused on reducing their carbon footprints and actively supporting environmental issues.”

Dee observes that many companies are on the lookout for other companies that have a stronger approach to managing carbon risks and will increasingly do business with these kinds of companies.

He says: “We are seeing a large rise in sustainable procurement and directors need to be across this. By putting in place a sustainable procurement plan across its whole organisation, Marks & Spencer, for example, realised savings in the last year alone of £50 million. And, Wal-Mart has just written to its 100,000 suppliers asking a series of questions about their environment impacts.

“We are now starting to see major corporations flexing their green purchasing dollar and they are finding they can achieve efficiencies and productivity gains by ensuring their suppliers become more efficient in their use of resources. They are finding their suppliers are able to do more with less. This is a growing issue. If companies want to continue to do business with their customers, they are going to be increasingly asked how sustainable their operations are, what carbon footprint they have and how they are reducing it.”

According to Dee, research on staff retention also shows that the environment is a crucial issue, especially for younger staff members.

“If they have the choice of a number of different companies before them, the issue of how that company performs environmentally will become a consideration in who they choose to work with and stay with,” he says.

Will adds that regardless of whether a company will be part of a regulated industry or not, all organisations will be affected either directly or indirectly by increases in energy costs.

“But the strongest reason for company directors to act now is that a carbon-reduction strategy within the organisation will also, in most cases, lead to cost reductions. Costs associated with adopting carbon-reduction activities, and even becoming carbon neutral, often breakeven within a short timeframe and go on to provide significant cost savings in energy expenses within an organisation,” he says.

20 questions for boards

Not managing an organisation’s carbon footprint, climate change risks and regulatory demands could have huge implications for boards. Here is a checklist of some of the questions directors should be asking of management:

  1. What is our carbon footprint and do we trigger any compliance reporting requirements now or in the next couple of years?
  2. Have any possible legal liabilities been identified and confirmed?
  3. How has emissions data been collected, calculated and reported?
  4. Is there an emission monitoring plan and detailed, complete and transparent documentation of the monitoring methodology?
  5. Have all relevant activities been included in the organisation’s greenhouse gas inventory?
  6. What greenhouse gas emission-reduction targets has management set, if any, and how challenging are they? Does management track and report progress against these targets?
  7. What government or industry support or investment may be available to help us reduce implementation costs?
  8. Do we understand the bottom-line effect of expected energy price escalation combined with a carbon price of $10, $25, or $50 per tonne that might be expected in the next one, two or five years?
  9. What are comparable companies to ours doing about carbon mitigation in Australia and internationally – are we at the forefront, in the middle of the pack or straggling at the back?
  10. What is management’s assessment of how the company will or could be affected by existing or potential government regulations in the key jurisdictions in which it operates?
  11. Do we have a strategy for carbon management that aligns with our core business strategy?
  12. What do we see as the key opportunities arising for our business from rapid decarbonisation of the Australian economy?
  13. What innovation and technology opportunities, if any, has management investigated to reduce greenhouse gas emissions and gain any competitive advantages?
  14. Is our carbon strategy aligned to the expectations of our staff and other stakeholders such as our customers and investors? Have we surveyed them to determine their expectations? And, how could we beat their expectations?
  15. What impact, if any, could climate-change issues have on the company’s financial condition and liquidity?
  16. How do the company’s mandatory and voluntary public disclosures about climate change compare with those of competitors?
  17. How has management ensured that information reported on corporate websites or in voluntary reports is consistent with that provided to government or regulators?
  18. How does the company’s executive compensation system support the integration of climate-change issues into decision-making and performance throughout the organisation? What KPIs do we have in place to measure this?
  19. What is management’s plan, if any, for responding to physical risks to the company arising from climate change? For example, to address input shortages or disruptions in its supply chain due to adverse weather events or climate changes affecting suppliers?
  20. As a board, what governance structures have we established to enable us to appropriately oversee the management of climate- change issues?

Sources: Jonathan Jutsen at Energetics, Freddy Sharpe at Climate Friendly, Alexander Stathakis at UQ Business School, Rod Wills at the Planet Cool and the Chartered Accountants of Canada.

Under the insurer’s microscope

Be prepared to discuss climate-risk issues, corporate governance steps and planning for regulatory or shareholder action with your directors’ and officers’ (D&O) insurers.

That’s the warning from Michael Herron, regional manager – Commercial Management Liability & Crime at Chartis.

He says: “Environmental risks have long caught the attention of D&O insurers. The 1989 Exxon Valdez incident made sure of this, demonstrating the highly charged and potentially devastating exposure faced by directors. Similarly, climate-change and carbon-footprint issues demand D&O insurers’ attention.”

Paul Venning MAICD, national general manager of Corporate Risk Services at Aon, adds: “D&O insurers have for many years shown vigilance around pollution and environmental risks, particularly in some industry sectors such as mining, engineering and energy. Insurers will assess the environmental and sustainability exposures relative to each client. The Australian Government’s proposed Carbon Pollution Reduction Scheme, together with the reporting requirements under the National Greenhouse and Energy Reporting Act (NGER) 2007, has further focused insurers’ attention – the NGER places liability on directors with civil penalties being equal to that of the company.”

Herron says the key issue for directors is disclosure – not just through carbon reporting, but also how they keep the market informed of price-sensitive issues via continuous disclosure.

“Misleading statements, failure of due diligence and a breakdown in governance can expose directors,” he says. “Directors face personal liability for defence costs, compensation, consequential loss, remediation and fines. Pressure can be exerted by consumers, employees, regulators, shareholders and institutional investors.”

Venning adds: “Insurers are looking closely into companies’ environmental governance statements and protocols in their annual reports and we find that in client meetings, insurers will enquire into the company’s risk-management and governance framework as well as seek to ascertain the experience of the environmental committees. Insurers will
at times also seek information from independent sources that measure and rank corporate governance policies, including carbon-disclosure reporting for many of Australia’s publicly- listed companies.”

Herron continues: “Companies on ‘climate watch’ lists or with poor scorings on climate change governance checklists will raise red flags for D&O insurers. Rankings and indices also reveal analysts’ perceptions (real or otherwise) that D&O insurers will want to address.”

He warns that increased transparency is exposing directors who are lagging behind. “Investor groups representing institutional investors with significant funds under management are seeking information from ASX 200 companies on how their directors are managing climate risks.”

He notes that D&O cover related to climate change may depend on whether the directors can show they are taking prudent steps to prevent losses associated with the management of climate change. Questions being asked include:

  • Does your company allocate responsibility for the management of climate-related risks?
  • Are there independent board members tasked with addressing climate-related issues?
  • What progress, if any, has your company made in quantifying, disclosing and/or reporting its emissions profile and planning for future regulatory scenarios?