'No Place to Hide': The Pressure on Companies to Address Global Warming Heats UpPublished: April 30, 2008 in Knowledge@Wharton
The scientific community now overwhelmingly agrees that earth's 6.5 billion inhabitants are contributing to global warming through heat-trapping greenhouse gas emissions. As companies respond, many are finding that investments in greener operations can offer more payoff than they expected, and some observers see large green-related market opportunities still sitting on the table for innovators to grab.
But along with opportunities come new challenges and risks. Public pressure for quicker action is rising, and new carbon emission regulatory regimes are coming soon, according to experts from business and academia who spoke at the recent First Annual Conference-Workshop on Business and the Environment. The conference was organized by the Initiative for Global Environmental Leadership (IGEL) at Wharton/Penn.
Speakers offered analyses and solutions to the challenges in two of the conference sessions -- "Integrating Environmental Concerns in Business Decision-Making: Internal Processes and External Pressures," and "Business and Climate Change: Mitigation and Adaptation; Regulation and Costs."
All signals suggest a global warming trend is under way, according to Robert W. Corell, global change director at the H. John Heinz III Center for Science, Economics and the Environment in Washington, D.C., a nonprofit group that works to improve the scientific and economic foundation for environmental policy. How much of the trend is natural variability and how much is driven by greenhouse gases remains an open question, but the vast majority of the warming trend is man-made, most scientists believe.
Whether earth is undergoing a long-term warming or cooling trend today does not matter when it comes to the prescription for action, however. "The problem is the rate of growth of the human population and the rate of growth of its demand for energy, which would have produced climate crises at any time in earth's history," said Robert F. Giegengack, a professor in the department of earth and environmental science at the University of Pennsylvania.
Until recently, either government regulators or non-governmental organizations (NGOs) have tended to set the agenda for how and when companies must respond to environmental abatement measures. But today, the biggest pressures to act on greenhouse gas emissions arise outside of government, coming instead from "the community, banks and insurers," among other stakeholders, said Patricia A. Calkins, vice president of environment, health and safety at Xerox, who moderated the session on business decision making.
Or, as Paul R. Kleindorfer, Wharton emeritus professor of operations and information management, put it: "There's no place to hide. The pressure is coming from all over."
According to Helen Howes, vice president of environment, health and safety for Exelon, an energy services provider headquartered in Chicago, even the utility industry has witnessed a sea change over the last year regarding its attitude towards climate change. "When you start to see EEI (Edison Electric Institute), which is the industry association, say 'We think it's real, we think we need to do something about it,' that's significant."
Eric Orts, founding director of IGEL, and conference head, said companies have many motivations for wanting to neutralize the effects of greenhouse gases on climate change. One common view is that companies always apply a "net present value analysis" or profit-oriented view in evaluating the environmental effects of a new product or service. But that is not always so. Some companies take voluntary steps that might relate only indirectly, if at all, to a cost-benefit analysis, Orts said.
Consumer pressure and worries about being targeted or "portrayed as a polluter" move some companies. Sometimes, CEOs take the lead and decide they have "an ethical responsibility to manage that issue because it will affect future generations, including their own grandchildren," said Orts, a professor of legal studies and business ethics at Wharton. Other companies think that being a leader on environment issues might help them win the war for talent. "This generation of students is more concerned about the environment than previous generations, and some companies may want to address this [in order] to attract the highest caliber" employees.
What came though clearly, Orts said after the conference, is that the business community is serious about tackling global warming. "I think that only a few large businesses believe that climate change is an issue that they can ignore -- or lobby against." In the past year, especially since the Nobel Prize was awarded to the United Nations' Intergovernmental Panel on Climate Change and Al Gore, "It has become clear that the U.S. will soon join with Europe and Japan in adopting serious and mandatory climate change regulation," Orts added. "It will also become clear that serious climate change regulation will carry significant costs, including, most likely, higher energy prices."
Opportunities for Innovators
This dramatic shift in expectations is posing market challenges, but also significant market opportunity, Calkins and other presenters suggested. For Xerox, "the bottom line is walking the talk," she noted, which means reducing the company's "environmental footprint" and staying ahead of regulatory compliance.
The increasing constraints on greenhouse gas emissions (primarily CO2) open opportunities to create economic value, Calkins said. "We want to move away from a reaction or mitigation focus, and drive more shareholder value and growth in the corporation." To do that, the company needs to integrate less energy-intensive, more environmentally friendly technologies and processes in its strategy, Calkins added. In practice, that might mean creating more Energy Star-rated products -- those meeting certain U.S. government energy efficiency standards -- which help the company reduce the carbon footprint for itself and for customers while offering positive talking points to help drive sales.
"We have to bring our partners along," Calkins said. "That means our suppliers, our own operations, our customers and everything in between," from inputs to packaging. And the effort must go beyond the "carbon footprint." Xerox looks at its "environmental footprint across the value chain," which includes the company's impact on biodiversity, air, water and its efforts at waste prevention and management.
Kleindorfer cited one example, Mattel, a leading global toy maker headquartered in El Segundo, Calif., which cut transportation costs "significantly" after the company's CEO pressed staff to reduce energy usage and increase carbon efficiency. This "top-down" drive for energy innovation led the company to reconfigure its two U.S. distribution centers.
Under the old arrangement, Mattel shipped one discrete group of products from its Los Angeles distribution center and a second group from its center in Dallas, with each distribution center shipping its unique inventory of products nationwide. Under the new plan, each distribution center carries inventories for the company's full range of products. The Los Angeles center now serves roughly the Western half of the U.S., and the Dallas center serves the Eastern half. The number of distribution centers and the service levels remain the same, but the company reaped a "huge reduction" in energy use while other shipping costs were not greatly affected, Kleindorfer said.
Other logistics professionals worldwide are "doing some excellent work bringing traction to a green supply chain," reducing their industrial footprint and promoting "logistics sustainability," which has become something of a buzz phrase, Kleindorfer said. Huge energy-related transportation challenges remain, however. Containerization, which is the standard method for moving freight internationally on container ships, railroad cars, planes and trucks, is expected to double over the next 10 years as global trade doubles, he pointed out. Because transportation is energy-intensive, expect to see "more pressure from the outside to extend greener supply chains," Kleindorfer said.
Windows and Refrigerators
The need to respond to pressures to slash CO2 emissions will create many business discontinuities. It will also create many opportunities, "just as volatility in a market can," said Stephen Doig, vice president of the energy and resources team at the Colorado-based Rocky Mountain Institute. Reliable studies show there is a lot of money to be made or saved through simple efficiency measures -- adding insulation and better lighting to buildings, and "making better use of motors," Doig said. In some cases, only 10% or less of generated electricity actually gets consumed by the end user. The rest is lost through transmission or in other inefficiencies. That leaves significant room for improvement.
Yet unlocking that value proves difficult because, in many cases, it is "highly distributed" -- spread out among lots of buildings and people, Doig noted. The challenge is to develop relatively low cost, replicable business mechanisms which can drive cost-effective energy efficiencies, "whether that is blowing in insulation or replacing windows or using higher-efficiency motors." Doing so would not only save energy, it would create jobs as well.
Another area of opportunity requiring innovation involves "bringing scale economies to leading-edge technologies," said Doig. Household refrigerators offer a good example. While a basic Energy Star-rated unit might cost $500, the few consumers willing to spend six times that amount today -- $3,000 -- would gain only two times the energy efficiency. "There's no good reason why that gap exists," Doig noted. Some entrepreneurs could come in, start engineering out the costs, and produce a refrigerator that is twice as efficient. "The question is, 'How do you take the margin out? How do you bring in scale?' I guarantee that if you make five million of these refrigerators, they are only going to cost 5% to 10% more than a current $500 refrigerator, and the payback will happen in half a year."
In Doig's view, making inroads on reducing CO2 emissions will also require behavior change. Many consumers, for example, do not understand the solid payback already available from some of today's energy-saving alternatives. Green consumer education and green marketing could go a long way towards building awareness, Doig said. One idea: Give every house a meter by its front door that calculates electricity use in dollars per hour rather than in kilowatt hours. "Show people what they are spending and they would automatically save 10% on their own," Doig said.
He also recommended the power of partnerships to help reach greenhouse gas emission goals, and suggested home building as fertile ground. On a small scale, some utility companies offer rebates for homeowners that use energy efficient heaters, for example, and this kind of partnership should be expanded. "Imagine the possibilities if the right incentives could bring together homebuilders, utility companies, appliance makers and other suppliers to come up with some creative solutions. So far, the market has failed to provide a solution and government action has not been quite as nimble and creative as it should be."
While it will take new levels of technology (and more than 200 years, according to Giegengack) to fully reverse greenhouse gas effects on global warming, presenters posed other examples of how existing technologies can be more fully exploited. Howes noted that Exelon recently renovated 10 floors of its "1970s-vintage" headquarters building in Chicago with good results. "We used high-quality, high-end equipment and we thought we would get a 30% energy savings. We got 50%. So the energy savings on those 10 floors is pretty dramatic and I think that is something that can certainly be applied in other sectors."
Mandatory, not Voluntary, Measures
While such retrofitting can make big contributions towards reducing CO2 emissions, getting to a more carbon-neutral world will require some form of government regulation and new technologies, according to Howes. "Roughly one third of greenhouse gases come from utilities, and so utilities absolutely have to be regulated," she said, noting that Exelon produces "roughly 90%" of its electricity from nuclear plants. Voluntary measures have had limited success. "Less than 10% of utilities have voluntary commitments [on CO2 emissions]. They must be mandatory and nationwide."
Another one-third of greenhouse gases come from the transportation sector and the remaining third from industrial, commercial and residential sources, according to Howes. "I would argue that we must also regulate the other two-thirds [of greenhouse gas sources]. This is the challenge for the industry and for R&D."
Utility companies today have "a target on their backs for carbon legislation," in part because they are stationary generation sources and in part because "they have always been regulated" in other areas, such as rates, Howes pointed out. In general, legislation is inevitable. All the presidential candidates say there will be federal regulatory legislation, and states already are regulating in the East and increasingly in the Midwest, Howes said.
According to David B. Struhs, vice president of environmental affairs in the U.S. for International Paper, a Memphis, Tenn.-based maker of paper and packaging with global operations, "the key question -- how best to regulate CO2 -- is just as problematic as it was 15 years ago." Does the admirable U.S. record in slashing air pollution levels over the last three decades offer some clues on how to approach greenhouse gas emissions? Since 1970, the U.S. has reduced air pollution by 54%, although the economy has tripled in real terms. Americans became more mobile, and population and energy use grew by 50%, Struhs pointed out.
"So we have had great success uncoupling air pollution from population and economic growth. But carbon is different." Destroying hazardous materials requires significant energy and releases more carbon into the air. That means "you can't burn your way out of a carbon problem," Struhs said.
He has sat on both sides of the fence when it comes to regulation. Before joining private industry, he worked as a federal environmental regulator for 20 years and held top regulator positions in Florida and Massachusetts. He said that the U.S. faces three choices on regulation. First, it could adopt a quantity-based approach -- some form of cap system which would hold emissions at a desired level, then allocate emission allowances among industries and companies. A variation on this cap system is a cap-and-trade regime, such as the European Community's Emissions Trading Scheme (ETS), under which companies that can more efficiently control emissions are able to earn emission credits and sell them to companies that find that it more difficult to lower emissions. Proponents argue that this method has the virtue of being more efficient overall for an economy.
According to Struhs, the second method available to regulators is a cost-based or tax system, for example, a per-ton carbon tax (derived from fossil-fuel use levels), also called a "carbon penalty." A variation of this approach is to auction off emission rights, which in effect ends up being the equivalent of a tax, Struhs said, because it sets an emissions price that functions like a tax. Proponents argue a tax approach gives governments the flexibility to tamp down the taxes during economic down cycles, or ratchet up the taxes when times are good.
Either of these two models offers a workable way to "monetize the environmental externality of CO2 emissions," Struhs suggested. The third choice for greenhouse gas emissions control is a mix of the two, a cap system that uses an auction to make initial emission allocations. Struhs argues that mixing the systems creates the worst of both worlds, and simply adds significant overall costs into the system without lowering emissions much more than the alternatives, at least in the short run.
"My concern is that people will look at this like vitamins," Struhs said. "One vitamin is good for me, so I might as well take two or three, because that would be even better." But "layering regulatory systems on top of each other can result in much higher costs, much less public support for our objectives, and in the end you don't get any superior environmental results."
The third way, or hybrid choice, however, is the most politically expedient model because it avoids the very tough job of either making allocations under a quantity-based system or imposing taxes directly under a cost-based system, according to Struhs. "This is a very interesting economic and social choice that we have to make. And we want to ensure that people view it as a choice, and that we don't take the easy way out and say, 'Let's do it all.'"
Roberta Mann, a law professor at the Widener University School of Law, favors a tax approach to emissions control, which she said is more efficient. She argued that taxes are simpler than cap-and-trade, which must determine emission levels, how allowances get allocated and whether to concentrate charges upstream or downstream. A tax would also provide the government with a windfall that could help lower other taxes, fund additional carbon-savings projects or be used for other purposes, Mann said.
Few observers think a direct tax is likely, however, and U.S. legislators instead have been drawing closer to passing emissions cap-and-trade legislation. There is even a slim chance that some form of cap-and-trade could pass through the U.S. House and Senate before the end of 2008, according to Vicki Arroyo, director of policy analysis for the Pew Center on Global Climate Change.
According to Arroyo, cap-and-trade sets an environmental target and then allocates emission allowances. This offers the following advantages: First, greenhouse gases are mixed in the atmosphere so it "doesn't really matter where you get the reductions from;" second, the emissions goal is key and the "environmental certainty" provided is preferable to the "cost certainty" of a tax; third, it allows the U.S. to link to other global trading programs; and fourth, it can use the allocation of allowances to ease the transition.
Conditions are ripe for a cap-and-trade system, Struhs said. Fifteen years ago, while consulting for a brief period, he founded a newsletter on managing greenhouse gases which foundered because it was ahead of its time. But market conditions have changed dramatically. Today, the value of the global carbon commodities trade is "higher than the value of the entire U.S. meat market."
Howes recommended that for utilities under a cap-and-trade system, the allowance allocation should get directed to the distribution utility (rather than the generating utility: Exelon owns both kinds of companies). "We think the company to whom you pay your electricity bill, because they are closest to the customer, can use the sale of those allowances for rebates and offsets to lower-income customers who pay a proportionally higher part of their income to energy bills. It can also encourage more demand side management."
Meanwhile, the success of all of the emission-reduction plans and partnerships in the U.S., however, will count for nothing if two of the world's largest countries and fastest-growing economies are not part of the greenhouse gas solution, according to Giegengack. "If we don't address the question of the escalating energy requirements of China and India, nothing we are talking about will make any difference in terms of the CO2 content in the atmosphere. It won't make any difference what we [in the U.S.] do overall.
"We should be taking steps, if nothing else, to preserve our petroleum reserves and to provide leadership for the rest of the world," Giegengack added. "What we learn by doing that ourselves, we can then transfer, but if we don't transfer it to the developing world, it's pointless. And if we do, then in a couple of hundred years, we will reduce the CO2 in the atmosphere."
Bottom-up Control of Greenhouse Gases
Other ideas addressed at the conference were environmental information management and consumption-oriented, rather than production-oriented, control of greenhouse gas emissions. Regarding environmental information management, a rising number of corporations worldwide are issuing environmental sustainability or social impact reports, Orts noted. While some are verified by accounting firms, the reports generally lack the relatively clear standards applied in financial reporting.
Environmental reporting shows a significant difference among companies on which costs get reported, Orts added. Some reports are anecdotal, sometimes written by marketing departments to build image. "Others seem more serious, and provide clear or verified data on energy use or greenhouse gases, perhaps as part of an effort to build a baseline, or for gaming with respect to future regulation." Companies that are serious about energy performance must measure results, because you "manage what you measure."
"Consumption-oriented" or "bottom-up" control of greenhouse gases, is an alternative to conventional production-oriented measures, such as those covered by Kyoto Protocol standards (a treaty by some 170 countries either to reduce or report on greenhouse gas emissions under the United Nations Framework Convention on Climate Change. The U.S. has not signed the treaty).
Kyoto's standards "place a bubble over a whole country," measure the output of greenhouse gases and then work at reducing those levels, Orts said. Those favoring a consumption-oriented approach, however, contend that this method fails to measure everything. "What about what you buy? If you ride your bike to the store and buy a pair of jeans, there is no accounting for any greenhouse gases emissions in that purchase." Yet those items carry some level of greenhouse gas footprint.
One consumer-oriented solution noted at the conference is to have such goods carry a label noting the amount of CO2 expended in the product's life cycle. With this approach, "You don't have to focus on individual countries and what they are emitting, which has been a big political roadblock," Orts noted. Instead, borders disappear.
While much of the conference focused on greenhouse gas emissions, Orts added, "Environmental issues are much broader than just climate change, and other major issues -- including resource scarcity, biodiversity loss, and air and water pollution, especially in developing countries -- will continue to provide significant challenges to business, academics and policy-makers."