Harvard Business Review

No company can afford to ignore climate change. Hoffman and Woody call it a “market shift.” In making the case for a business focus on the issue, they highlight the change in energy prices and the spillover into pricing of other resources.

There is, however, an even broader logic for folding climate change (and environmental thinking more generally) into your company’s core strategy. In fact, four distinct drivers are combining to make environment and related energy issues a critical point of competitive differentiation in many industries.

First, as everybody knows, energy prices are up. At over $100/barrel, every company (as well as every community and family!) needs to recalibrate its investment in energy efficiency. Compared to a few years ago (when oil prices hovered around $30/barrel) the optimal level of energy conservation is now much higher. Resources put into green building design; energy efficiency in computers, servers, and information systems; efforts to cut electricity use by improving the efficiency of lights, heating, and air conditioning; as well as logistics optimization, and other activities with an energy dimension are much more likely to pay off now.

Second, new climate change regulations are coming. With the field narrowed to Obama, Clinton, and McCain, we know to a high degree of certainty that the next president of the United States is going to support more aggressive action to limit greenhouse gas emissions. While there are still some obstacles to congressional action, both the House and Senate look poised to pass some form of carbon charge in 2009. So companies with high carbon footprints face a competitive disadvantage that is likely to grow in the coming years.

Third, in some industries, nature is impinging in ways that could have significant business effects as the impacts of climate change such as global warming, sea level rise, changed rainfall patterns, and more intense windstorms emerge. So if you are in the ski industry (facing reduced snowfall), you need a climate change game plan (more snowmaking?) even if the government has not acted.

Finally, a widening array of stakeholders is now asking about corporate strategy related to climate change. It used to be that environmental questions came from government regulators and the occasional environmental group. But today you have to expect inquiries about carbon emissions and reduction efforts from the communities you operate in, employees, customers, and even capital markets. Nothing like Wal-Mart CEO Lee Scott’s sustainability initiative, including a promise to improve energy efficiency and reduce greenhouse gas emissions not just within his stores but up the company’s supply chain, to motivate companies large and small to step up to the climate change challenge. Likewise, the Carbon Disclosure Project’s September 2007 release of its most recent report of corporate climate change impacts received broad coverage. Simply put, it is becoming increasingly unacceptable not to know your carbon footprint or not to have an emissions reduction game plan.

So whether you are in the new economy or an old industry, a big player or a small business, focused on local or global markets, climate change strategy has become a core element of strategy and a business imperative.

The “sucker-in-the-game” poker saying is the perfect lead-in to this discussion. Professor Hoffman’s three-step strategy is strategically appropriate, but its analytical precision does not convey the message of how brutal this game will be played. The major stakes on the table will bring out the best (e.g., innovation) and worst (e.g., political treachery) in mankind. Indeed, worst-case scenarios include global famine and warfare.

In my travels throughout the corporate world, I have witnessed the excitement generated by marketing programs such as GE’s Ecomagination. Judging from the mounting media coverage, the green buzz is approaching a roar. But the strategic attention by executives appears to be focused on grabbing the green marketing winnings and not on strategically positioning to hedge one’s bets for this long-term game. The best marketing minds may be currently at the table, but what about the rest of the team? The corporate environmental managers with whom I talk appear to be consumed by day-to-day regulatory-required tasks. In other words, they are still playing in yesterday’s game.

To Professor Hoffman’s list I’d add a fourth step: Check to see if you have the right players with the required skills. Like no-limit hold 'em at the World Series of Poker, this game is not for the faint of heart. I believe that business executives today do not fully understand the urgency or the stakes involved. It takes resources to aggressively and comprehensively pursue the first three steps. From what I’ve encountered, few companies are yet ready to make even this limited commitment.

Richard MacLean
Executive Director
Center for Environmental Innovation, Inc.
http://www.Enviro-Innovate.org

Climate change has become a pressing strategic issue for energy companies and has moved far beyond the realms of the environment and sustainable development teams that flagged its importance over a decade ago.
Whilst we see oil and gas maintaining an important role in society for many years, we must nevertheless put in motion a series of major initiatives to manage our carbon footprint going forward. These include the development of carbon capture and storage and advanced biofuel technologies, more focus on energy efficiency both for us and how our customers use our products and importantly for today ensuring that our voice is heard as policy approaches are developed. The latter has a profound impact on the profitability of deploying the technologies we are developing. In our business, the rules governing emissions trading, biofuel mandates and low carbon fuel standards will be pivotal to the success or otherwise of these technologies.
Without such an integrated approach to the issue, as highlighted by Hoffman and Woody, value will be lost.

Yes, yes, and yes, to the three comments above. And "yes, but" in another sense, or perhaps two:

(1) Strategy. At a dinner of technology executives a couple of months ago, there was a smart, interesting presentation about climate change--basically a plea to put this on executive committee agendas. Like the old line at the beginning of "Hill Street Blues," the message was, "Let's do it to them before they do it to us." Most of the audience were Silicon Valley CEOs or equivalents; some were involved in Green Grid activities (www.thegreengrid.org), some not. A lot were entrepreneurs. One of the latter, a fabulously outspoken woman, broke the consensus by saying, in essence, "Yeah, yeah, yeah, been there done that, and there's no there there." She went on to say that her company had done a zillion things to try to clean up. Recycling, two-sided xeroxing, cutting down on bottled water, lowering (or raising, depending on the season) thermostats, yadda yadda, and that it hadn't amounted to a hill of beans. Her bottom line: I'm in the software business, not the energy business, and this climate stuff is none of my business.

Well, it is, actually. This company in particular, which I'm not naming because the dinner was private but which some of you might be able to identify, makes software that is used in transportation, construction, and manufacturing, among other industries. There's probably a huge strategic opportunity for them to develop software that helps their clients make and operate/control products that are dramatically more efficient. Indeed, that company can probably do more to reduce carbon emissions by what it sells than it could EVER do by making its own carbon footprint small enough to fit into Cinderella's glass slipper.

But the CEO couldn't see that virgin-territory of opportunity because she could see climate only in terms of her own operations. My questions: (a) how do you help this woman? and (b) How does one audit not just one's sins of emission--that is, in operations--but also one's sins of omission: the opportunities that exist outside the four walls of the business? Is there a framework for each?

(2) I want to hear from Wall Street (or maybe the City). What's going on among (a) institutional shareholders, such as pension funds, etc.: Are they pressing companies to disclose carbon footprint as a risk? (b) investment bankers: Does carbon footprint enter into their calculations in deal-making, and if so, how? I've heard one European CEO in an energy intensive business say, "My question is, am I sitting on an asset or on a liability?" and (c) securities analysts.

Maybe we can rope some of those Wall St. types into this discussion.

Tom

Markets may be overly-optimistic on the prospects for short-term coordinated global action on climate change, whether through cap and trade or any other form of mandatory greenhouse gas reduction targets. Yes, the three remaining US presidential candidates favor cap and trade and would represent a significant shift from the Bush Administration. But the details of their proposals may not fully align with EU goals in the post-Kyoto process, particularly on questions related to the use of international carbon offsets. China will also be unlikely to respond to US action in the short term, given the precarious state of their coal-dependent power grid as demonstrated by weather-related disruptions in recent weeks. China is also likely to bristle at any US legislation that includes a tariff or sanctions clause targeting imports from states without hard caps on GHG emissions.

In this context, the most promising technologies for clean energy and energy efficiency may be undermined by the lack of regulatory visibility. Indeed, with $100 oil and growing market fears of a coal shortage in Asia, it hardly seems like the market is betting big on clean energy crowding out fossil fuels anytime soon. In this context, clean energy technologies that are more mature and proven -- therefore less risky -- are likely to outperform more exotic, unproven alternatives. In our book, that is a bet on natural gas, nuclear power, and hybrid vehicles over cellulosic ethanol, solar, and carbon capture and sequestration.

Ian Bremmer
Eurasia Group

What keeps managers awake at night? Uncertainty -- not knowing where the world is headed. Firms are great at channeling resources toward the pursuit of some particular goal. The problem is in choosing that goal. Where do you put the mark on the horizon for the firm to head toward? If you choose the wrong goal, much time and energy gets wasted, and the firm may never recover.

Right now, there's a great deal of uncertainty about what climate change will mean for business over the coming years. There's the larger question of how the world might change because of changing climates, but there's the more direct issue of how regulation might change the rules of the game by which businesses play. We all know something has to be done about carbon emissions, and most folks are tired of waiting -- they just want to know what will be done. New regulations will require the stress of adaptation, but it would be a welcome relief to simply know the new rules -- to remove the uncertainty so that firms can get busy implementing, rather than guessing and hedging.

Managers would like to not only know what’s ahead, but they’d also like to control it. It’s one thing to know where to set the mark on the horizon to head toward; it’s a whole other thing to be able to set the mark in a place that most benefits your firm. And so firms do seek to control regulatory agendas. And it’s here that I urge some restraint.

Firms have powerful voices in the regulatory process – a good chunk of the time, those who regulate have come from the firms they’re regulating, and will probably go back into them. It’s a system chock full of conflicts of interest. But there’s one interest we all share – that of the planet’s continued vibrancy. If the planet goes out of business, we all go out of business.

The problem is, individual firms can gain much now by shaping regulations in ways that lead to the most private profit, and not necessarily the most public profit. We have a hard time grasping how giving up a penny of private profit now might lead to a nickel, dime, or arguably, an infinite amount of public good in the future. We need long-sighted government to set these regulations in such a way that we don’t give in to the tendency to over discount future public good relative to short-term private profits. So firms should seek the certainty in having a clear standard for carbon reduction established soon, and one that does so without unnecessary economic hardship, but I hope they avoid the temptation to control the regulatory agenda in such a way that this standard is short-sighted. Firms have some power to control regulatory agendas, but they have no power to control the weather – and that’s the larger problem here.

Mike Barnett, Research Fellow, Kiran C. Patel Center for Global Solutions, University of South Florida

It raises stakes and issues that are causing considerable problems for incumbent environmentalists in the business arena in terms of justifying their position in the climate change and business debate.

Responding to climate change is not a corporate social responsibility and I do not believe it is essentially an ethical obligation either – it’s about making sensible and pragmatic business choices. All the studies of business reducing its carbon footprint mention how much less energy they have used and how much those savings are - how better their share price is performing and how easier and cheaper it is to raise capital - how much their sales have increased - how many new products are coming through – how much innovation has increased - how happier their investors and customers are. And that’s down to market forces and regulation.

We should be concentrating on reducing the impact of climate change on business rather than business’ impact on the environment. There is already enough environmental regulation and enough legal weight behind the stick that governs corporate conduct to ensure that environmental damage is limited. By putting corporate response to climate change into the hands of the CSR department (or outsourcing it to an NGO for that matter), we are approaching the issue from the wrong direction – companies that do this not only miss the point of responding to climate change they are also in danger of missing the boat of opportunity that it affords.

Climate change is a boardroom issue. It should be handled as a strategic component of change management because developing a response to climate change will bring about a complete business transformation from oily chrysalis to wind-powered imago. The social responsibility is government responsibility; the same as it is for education, healthcare and welfare. Undoubtedly business has a part to play in delivering these services not because it should, but because it can. Those companies will be the winners because they will focus on their core business activities, whatever the weather.

Jeremy Blow, Publisher of Carbon Business
jeremyblow@carbon-business.com

To Andy and John’s point that companies’ climate-change strategies must create opportunities, and Tom Stewart’s comment about the software executive who doesn’t see the opportunities in helping customers be more efficient – I’d add that, in the green realm, reducing the risk is an important way to create opportunity. Late in January, for example, Staples severed its contracts with a major paper supplier, Asia Pulp & Paper, because of its poor environmental performance. Other buyers have also cut APP loose. (Staples' VP of environmental issues, Mark Buckley, told the Wall Street Journal that to remain an APP customer would be "at great peril to our brand" http://online.wsj.com/article/SB120240874246651263.html). That move opened Staples’ doors to more environmentally friendly suppliers who discovered competitive advantage in being greener than APP. Similarly, as Wal-Mart turns its attention to greening its supply chain, vendors who don’t make the grade on its environmental friendliness scorecards can expect to be summarily let go. Likewise, companies that reduce their carbon footprint now will find, as emissions are increasingly penalized, that they will be able to do what they do at a lower cost (including, probably, access capital) than less efficient competitors. That will create advantage. While companies need to be thinking strategically about creating opportunities in a carbon-constrained world, they should be mindful that a good offense is a good defense.

I certainly support what Andy and John have written, as well as many of the points made in the follow-on discussion. I began discussing these topics in public 10 years ago when I was CEO of BP America and BP had broken ranks with its industry colleagues and declared that 'climate change' was an issue worth addressing. It is amazing to me how far things have come. Ten years ago my job was about raising awareness, and today Climate Change is a topic well known to just about every one in this country.

I would like to argue two provactive points with respect to climate change and the oil companies. First, I would like to take issue with those who say that the oil companies should follow the lead of companies such as BP and Shell and do more with respect to Climate Change i.e. invest more in alternative/renewable energy. However, having taken that tact, I would recommend, they should in fact be doing just that.

The typical oil CEO faces a daunting agenda, from employee safety to operational integrity and aging infrastructure to expropriation and rebel attacks on facilities to changing fuel regulations/requirements to extremely volatile markets and prices and rapidly excalating costs of rigs and steel. However, the most pressing issue of all is the difficulty of adding to oil and gas reserves and production in the face of fast growing global demand, fueled in large part by the developing world's much needed elevation of living standards.

Today the world runs on oil and gas. In order to generate the wealth needed to raise living standards AND invest in a more sustainable future, oil and gas will be needed in the short to intermediate term -- just to keep the trains on the track so to speak, and there are many who believe that we are approaching a time when oil production can no longer rise i.e. 'peak oil'. Suffice it to say the oil industry needs to run pretty fast in order to avoid severe economic disruption in the short term.

With this in mind, do we really want the oil industry to take its 'eye off the ball' by diverting attention to new energy forms or do we want it to stick to its core mission while others find new solutions. There is an issue of competence. Oil companies are good at bringing oil and gas to market. However, that doesn't mean they are good at perfecting alternative energy! In fact, they have proved themselves highly deficient in this regard in the past.

The oil industry does have skills/assets that will play in a future lower carbon energy paradigm. They have the resources and technologies to expand the use of natural gas, in transition. They know how to inject CO2 into underground geologic formations. They are excellent at exploiting energy efficiency, and they have the logistical skills necessary to bring biofuels to market. They already produce and consume large quantities of hydrogen. Nevertheless, 'beating' on the oil companies to plow profits into new energy forms is both unfair and unwise. It is better to let them reinvest to keep the 'lights on' and pass profits on to investors to channel those funds to those technologies and entrepenures with the right skills to create a new sustainable energy paradigm.

Having said all that, my advice to the oil industry is different. To quote Bob Dylan, 'you better start swimming or you will sink like a stone, for the times they are a changing.' Most nations are acting on Climate Change throught the auspices of Kyoto. Even in the US, many states and municipalities are acting, and Climate is clearly on the Congressional and Presidential Candidate radar screens. Customers, and in particular business customers are setting targets and making requests up their supply chains. Investors/banks/insurers are asking about future risks and liabilities. New employee recruits are weighing this issue in their decision making. And probably of most importance, your competition is getting 'on board'.

With these shifting sands, isn't this the best time to figure out how to create competitive advantage through new products and services, new and more efficient processes, new partners, and energized employees. At the very least, shouldn't an oil company be minimizing risk and hedging bets to avoid getting stuck in an old energy paradigm defined by a declining resource base with rapidly rising oil prices which are thereby attracting either higher royalities, production taxes, or expropriation. If I weren't retired, I know what I would be doing.

Steve Percy
CEO BP America (retired)

Andrew Hoffman’s short list of climate strategy steps is a good starting point, but each of his items is a densely packed bag of questions. An edition of HBRGreen could be dedicated to each. I would like to unpack number 3: business positioning in the climate policy process. As Dan Esty says, the U.S. climate policy wild-card is a lot clearer now that McCain is the republican front runner. The next administration, Democrat or Republican, will implement climate regulations. The uncertainty now is what those regulations will look like. The outcome is vital because, as Hoffman’s post title says, it will determine the winners and losers in a carbon constrained economy.

One way to view it is in terms of continuity versus discontinuity solutions, which comes from the economist’s idea of path dependence. Our past choices have lead us down a path of fossil fuel dependence. Going forward we can continue down this path and find a way to eliminate the climate problems of our existing energy system. This has worked in the past for environmental issues like acid rain. This approach could be called the “Sustainable Carbon Economy” path. The other alternative is to throw out today’s fossil fuel-based systems and develop a replacement. This could be called the “Non-Carbon Energy” path. There are pros and cons, as well as supporters and detractors, of both alternatives.

For many the term “Sustainable Carbon Economy” is an oxymoron. Fortunately, there are technologies that promise to mitigate the climate damage from burning fossil fuels. Collectively known as Carbon Capture and Storage (CCS), or sequestration, they basically put the carbon released from combustion back into geologic storage. It’s already occurring to a limit extent in places like Norway and Texas, but it would have to be dramatically expanded to stave off climate change. Vocal critics argue that CCS just postpones an inevitable transition away from fossil fuels, and thus avoids the problem.

The alternative is the development of non-carbon energy systems. Renewable energy technologies like wind and solar energy are promising substitutes that can provide the world’s energy long after fossil fuels are no longer economical. Renewable energy, however, has different characteristics than fossil fuel power systems. Implementation will most likely be decentralized, with local energy generation instead of large centralized power plants. Detractors focus on the current high costs and the dramatic change it may mean for society. But civilization has experienced major technological changes in the past, like moving from canals to trains to cars. These transitions create dynamic economic growth, and a shift to a renewable energy economy could conceivably create similar economic dynamism. However, they also create big losers, as the canal and train manufacturers can tell the car makers.

All the alternatives have large unknowns around them. While it is too early to know which solutions will dominate in a post climate change world, it is important for managers to evaluate which of the end games they favor. Early coordinated support of a solution, perhaps through demonstrated commitments in strategic investments and policy outreach, can tip the playing field. But as the climate policy endgame begins, the time for proactive political strategies is quickly coming to an end.

GREGORY UNRUH
Thunderbird School of Global Management

I have enjoyed the foregoing conversation and agree with essentially all of it. I especially want to second Steve Percy’s comments about the role of oil companies. I agree with him on all counts. However, in full disclosure, Steve and I are old friends, college classmates and we served in the oil industry at the same time, he in the leadership of BP and me across the river as head of scenario planning for Shell.

Let me add two elements to the conversation, urgency and uncertainty. We are likely to experience the very serious impacts of climate change in some places in the world very soon if it is not already underway. The image of a world gradually warming is inaccurate. When a turbulent fluid like the atmosphere changes state it does so in jumps and starts not a smooth and even transformation. The reality is that an increasing number of places in the world will begin to experience increasingly extreme weather more often with more frequent catastrophic effects. There will be more severe storms, extended droughts, sea level rise and flooding. The disruptions of human systems such as agriculture, coastal zones and transportation will be profound. The levels of CO2 we have already achieved and are likely to add substantially to mean that a great deal of climate change is inevitable. This is in part because of the enormous momentum of our energy system. The real energy scenario for the future is more coal and oil with some uncertainty on how much more. This includes doing all the efficiency, renewables and nuclear we can. The growth in the world economy and the distribution of coal, oil and gas resources in the world mean that we will exploit them extensively for decades to come, even as we are reducing our carbon footprint by every means possible, including carbon sequestration. This means that the level of CO2 will continue to rise rather than fall and with it a greater climate impact. This perception of the inevitability of climate change, and the growing need to adapt will put even greater pressure on companies to take carbon reduction strategies seriously with greater urgency.

This sense of urgency is compounded by a positive surprise. William F Ruddiman in his recent, brilliant and readable book, Plows, Plagues and Petroleum documents how human beings have been inadvertently changing the climate for thousands of years. Clearing forests, agricultural practices, especially rice growing, human plagues and finally the industrial revolution have all been part of how human societies contributed to climate change for the last ten thousand years. We may even have prevented the onset of another ice age a few thousand years ago by raising the levels of CO2 and methane. But if Ruddiman’s analysis is right than relatively small changes by human beings can have meaningfully large impacts on the climate. Perhaps taking large steps to reduce green house gas emissions rapidly might have a greater impact for the better sooner than we think. Thus acting sooner makes a bigger difference intensifying the need for urgency.

The uncertainty arises from the same turbulence that introduces urgency. Over any brief period of a few years the track of the climate is quite unpredictable. It is a bounded turbulent chaotic system. Not just anything can happen, but there can be a lot of movement within the boundaries and it can be very difficult to predict the next few moves. Because the level of CO2 is so high any sustained cooling is virtually impossible, but a brief period of two or three years of slightly cooler weather at least in some places is not impossible even as the average is moving on an unbroken path upward. It could happen any time, therefore, the heat could literally be taken out of the issue making strong action today look foolish and over anxious. Like Y2K before it, the concern over climate change would be seen as excessive and misplaced. Business leaders need to communicate that we are talking about climate change not sustained and gradual warming and that the disruptions for human societies come from an unstable climate even more than from a warmer world. We need to make clear that climate change will be with us for a long time to come…decades at a minimum. And that we will be thinking about how to adapt and how to change the climate for decades as well.

So the business implications are that the impacts and uncertainties of climate change may be greater and worse than we think, but that we may be able to do more about it than we think. That re-perception puts a high premium on effective corporate responses today rather than in the future. Action now has a very high value in creating future maneuvering room.

From my perspective, in sitting in Washington and working on all of the environmental issues, (including climate change), every company has opportunity with Climate Change. It comes down to three critical, but simple components of doing business: leadership, innovation and authenticity.

I have had the good fortune to work closely with Patagonia, and from what I've seen, it's Chouinard's unyielding ethics that separates Patagonia from the others. Sure, they are privately held, but in the end, they are incredibly profitable as well. It's no coincidence that Chouinard was on the cover of Forbes this past summer. Everyone is chasing him and his grand experiment. If you don't agree, ask Lee Scott who has had the greatest influence on the transformation that Wal-Mart has undergone? I guarantee that Chouinard isn't sitting around and waiting to see what regulations the government will come up with to address climate change.

As for the comment about "social responsibility being government responsibility; the same as it is for education, healthcare and welfare," I'd have to respectfully disagree.

There's no question that government does have social responsibility, but so do other sectors. Ask consumers. Ask corporate board members about shareholder resolutions and activism. Ask the winners and losers in education, healthcare and welfare (which have been addressed by the public sector). It's no coincidence that Enron and Worldcom had their ethical lapses around the same time the private sector began it's transformation. The global emergence of CSR is a very real part of doing business today, and to ignore it would be naive. CSR needs to be part of the strategic discussion, because the social side of climate change provides fertile ground that will help to separate the winners from the losers.

Prof. Andrew Hoffman poses an interesting question: "In a carbon constrained world, will you be a winner or loser - and how are you going to figure it out?" To me it translates into: "Are you an eco-efficient company ? If not, how are you going to survive in the long run?"

Carbon linked climate change (and the related carbon trade) is no doubt a compelling addition to already existing business imperatives for energy and material efficiency in products and operations. I do not think that anyone will disagree to improving efficiency, including energy efficiency, to remain competitive. Energy Efficiency Improvement projects in operations in the past were not driven by Climate Change considerations,but by cost considerations. I know of examples of companies that have reduced their specific energy consumption by over 70 % in the last ten years; the driver,of course, was cost reduction. I believe that there is a tremendous opportunity for innovators to come out with energy efficient products - for the common man the cost of energy will be a motivator to opt for energy efficient products. That is what happened with CFLs...to start with it was the total cost of ownership (mainly made of operating energy costs) that made the product attractive to the customer. Now there are quite a few approved CDM projects using CFLs for claiming carbon credits !!! Climate Change issues (and policies) have enabled the CFL market to grow (through ban on tungsten filament lamps in some countries over a time period). The point is that Climate Change issues do offer opportunities for expanding markets for the existing energy efficient products and potential markets for new and improved products. But the driver to invent CFL was the energy cost in the late 1970s.

My submission, therefore, is that "Climate Change Opportunities" should be looked at within the wider "eco-efficiency" (or resource productivity) strategy. If an organization does not have a green strategy already, it is time now to think. It is never too late to start a good thing...including the journey towards greening the organization. It is obvious as to who is the winner and who is the loser.

If you want to hear from Wall Street on this issue, then you will want to take a look at our recently released study: Corporate Governance and Climate Change: The Banking Sector. (http://www.riskmetrics.com/pdf/ceres_climate_change_banking_report2008.pdf) In this report we evaluate the banking sector's response to the risks and opportunities of climate change. The text below first appeared as a blog on our website (www.riskmetrics.com), and seems appropriate for this forum.

Climate Change is in the Wind

Although Super Tuesday did not resolve who will be our 2008 Presidential nominees, it did make one thing almost certain: the United States will embrace climate change legislation in the next administration. All three leading candidates—Sens. Clinton, McCain and Obama—have made it clear this issue would be high on their agenda after entering the White House. Congress is also getting ready to act, with the introduction of no less than seven congressional bills proposing greenhouse gas (GHG) controls in the past year. This leaves little doubt that the U.S. is gearing up to follow Europe—albeit belatedly—in placing a price on carbon emissions.

This change in political winds hasn’t been lost on U.S. chief executives, including in the banking sector. A price on carbon will inevitably alter costs of production, the pricing of securities and the assignment of credit and asset valuations. It will also bring new opportunities for banks to engage in carbon trading, develop new climate-focused products and invest in the burgeoning clean technology sector. As Mindy Lubber, president of the investor and environmental group coalition Ceres, said at the RiskMetrics Governance Conference held in New York City this week, “it is unimaginable that the banks will be anything other than one of the most important players” in addressing climate change.

A month ago, RiskMetrics Group produced a report commissioned by Ceres that examined how 40 of the world’s largest financial institutions are preparing themselves for climate change. The study found that while banks are not high emitters of greenhouse gasses themselves, they are the primary financiers of the world’s most carbon-intensive industries. And while most banks are beginning to focus on their own emission footprints—and in many cases pledging to go “carbon neutral”—only a handful are factoring a price for carbon in their lending and investment decisions.

As a recommendation, the report, Corporate Governance and Climate Change: The Banking Sector, called on banks to “explain how they are factoring carbon costs into financing and investment decisions, especially for energy-intensive projects that pose financial risks as carbon-reducing regulations take hold worldwide.”

Carbon Principles Announced

Only a month later, three big banks on Wall Street have responded. On Monday, Feb. 11, Citigroup, JPMorgan Chase and Morgan Stanley have adopted the “Carbon Principles,” a set of guidelines for advisors and lenders to evaluate carbon risks associated with new investments in the U.S. electric power sector. This framework comes after nine months of dialogue with leading environmental organizations, including Environmental Defense and the Natural Resources Defense Council. Seven of the nation’s largest coal-burning utilities also were consulted and have written statements of support for the guidelines.

While banks have been stepping up their commitment to address climate change in recent years with a huge increase in support of renewable energy investments, they have largely shied away from acknowledging any material risks associated with their continued financing of carbon-intensive energy sources like coal. In fact, some of the same companies that advocate policies to combat climate change also are the largest global financiers of the coal industry. Under the “Enhanced Diligence” framework called for by the Carbon Principles, it now will be more difficult for U.S. electric utilities to build new, conventional coal-fired power plants.

The evaluation process calls on utilities to see if cost-effective demand reductions can limit the overall need for new generating capacity. Moreover, consideration should be given to renewable energy and low-carbon distributed energy sources as an alternative to building new, large baseload power plants. Finally, any new coal-fired generation should take into account whether carbon emissions can be economically captured and stored, rather than released to the atmosphere. Only after these other options have been ruled out should banks consider financing of new, conventional coal-fired power plants.

The Carbon Principles leave some key questions unanswered, however. One is whether they will extend beyond the United States eventually to serve as a litmus test for new power generation around the globe. Another question is what price on carbon will be assumed for this Enhanced Diligence framework. If the assumed carbon price is too low, it may not have much affect on final decisions regarding new power plants.

Clearly, banks’ role as the primary financiers of the country’s most carbon-intensive industries is a place to start to “make a difference.” While the Carbon Principles will not preclude new coal-fired power plants from bank lending portfolios, they do ensure a more rigorous evaluation process in evaluating the risks associated with financing carbon-intensive projects. It will be interesting—and telling—to see whether other banks and utilities follow suit and sign on to the Carbon Principles in the weeks and months ahead.

Doug Cogan and Emily McAteer
RiskMetrics Group

The title of the Hoffman and Woody article says it all; it is the shape of the regulatory “constraining” that will determine the winners and losers, and such is independent of any scientific discussion of warming or cooling “climate change”. To be clear, what is being labeled “green” really means how individual companies will achieve more or less green in their pockets as a result of future redistribution of wealth by regulations that enjoy too much celebrity/popular support not to pass in some form. Like the Chinese symbol for the word “crisis”, the future business of being green presents both danger and opportunity. The degree to which companies think through this chess game will determine if they are to be the participants or non-participants of available new opportunities, or in a few instances, the sucker in the game. Some may be well positioned to be either at the moment, but a few have made brilliant plays that are likely to improve their future fate. For example, one company has gobbled up at low cost a lot of really nice sites for new lower-cost nuclear. Game changing technology is occurring at a solar company that will not be "the" answer, but will certainly assure them as a player. On the other hand, ethanol from corn ignores calorie mass balance, and wind power has other physics problems that means that such "solutions" will only be feasible if subsidized with a lot of hot air by Washington. And in the long term we simply must find technologies to use coal in a manner that nets less respiratory disease, as America has a lot of both. But as Hoffman and Woody infer in their third action item, the winners and losers will be picked in the short term not by physicists, but by politicians. Such regulations are sure to further raise the price of energy for all, and by doing so stimulate (a) new technology, (b) conservation and (c) production by loosening the constraints on now safe nuclear that have been in place in this country for decades.

I would agree, as a previous VP Environmental for enterprises comprising a range of greeness, that the three steps suggested by Hoffman and Woody are appropriate steps for all major point source emitters, but I would suggest that much opportunity for influencing the real rules of the game for this group has now passed. But for the software company discussed, as well as a host of other companies, their link in the value chain is farther removed from the issue of emissions and how to play it is not therefore obvious and so there is still time to make an early chess move. For the non-smokestack crowd, rather than trying to focus on emissions, companies may get a better glimpse of their green future by considering the energy consumption not of their own companies but by their customers; because it's going to be all about the calories and not necessarily about emissions.

Like any newly created market, be it Tulip bulbs or the Internet, lots of short-term speculative money will be made and lost on the margins. After all, someone has to be the first to figure out that some consumers will use their debit cards to buy Renewable Energy Credit cards at the checkout stands of Whole Foods. But for companies with a longer view, it seems a safe bet that in the future everyone that will be using less energy per capita and paying more for it, and so it will be all about the consumption and production of calories and the technology that cuts the cost of doing either. If you can change any of these parameters for any point source emitter, that will be worth some bucks. It may seem overly simple, but like the mentioned software executive, its way too easy to get caught up in the emissions discussion and not be able to see its all about energy. That's how you figure out how you place your company in the winning camp in the future.

Kyle Dotson
www.dotsongroup.com

Great posts here, very little disagreement. If climate regulation is so imminent as to make carbon strategy inevitable, what is special about it? If competitive environmental strategy in general and carbon strategy in particular are simply extensions of good corporate strategy, what is the contribution here? What about this carbon game makes it any different from business as usual? I suggest three considerations:

First, as Hoffman and Woody point out, nearly all sectors of the economy will be affected. By altering the cost of energy, climate regulation has the potential to impact nearly every industry. This kind of transformation is not routine.

Second, the window of opportunity to influence the policy process is limited. Climate regulation will evolve over multiple iterations, but precedents set in the first round will become more and more difficult to alter in the future. If companies want a seat at the table with credibility to leverage, they need to move fast.

Third, the avenues by which these changes will impact corporations are numerous and not always obvious. Climate regulation will impact some companies directly, others indirectly, and not simply via cost increases among suppliers and distributors. Swiss Re has taken a keen interest in the climate issue for years, and changes to insurance costs are important regardless of a company’s direct exposure to a particular version of climate legislation. Other avenues include investors, trade associations, and NGOs as exampled by Environmental Defense’s influence over utility development in Texas. And these avenues speak mostly to the risk side of the equation. New opportunities for products and services in a carbon constrained economy provide the largest and potentially the most lucrative unknown.

What is different about carbon strategy? It requires capacity for public policy development, stakeholder management, and discontinuous innovation –none of which are routine. To profit from this ‘market shift’, managers need a ‘mind shift’ that encompasses these greater considerations. Hoffman and Woody’s three steps are a prudent start, but only a start.

The article "Winners and losers in a carbon-constrained world" raises a number of extremely important points for companies contemplating climate change strategies.

The first and most important consideration is that reducing emissions also means reducing cost – and boosting profitability. Many emissions reductions can be achieved simply by reducing consumption and improving efficiency. There are many excellent examples of how companies are doing this in The Climate Group's publication "Carbon Down, Profits Up." You can view the publication here: http://theclimategroup.org/assets/resources/cdpu_newedition.pdf

There are also many strategic reasons for acting now. It is clear that climate change policy is evolving, and evolving quickly. In the absence of national policy on climate change, cities and states are moving forward with their own greenhouse gas reduction plans. International pressure on the US is mounting following the dramatic events at the Bali summit in December of 2007. And national policy is sure to change quickly once a new president is in the White House in 2009.

Increasing awareness on climate issues is also changing consumer attitudes, affecting their views on specific products and the companies that make them.

Companies that ignore the rapidly shifting market and likely changes in greenhouse policy may be doing so at their own peril. From a strategic, business perspective, companies should begin working now to address the carbon question – if not for the short-term benefits gained from cost reductions, then for the long-term need to prepare for the eventuality of doing business in a low-carbon economy.

Chris Walker
North American Director
The Climate Group

Excellent information available; highly informative for youngsters like me who wish to understand the carbon angle in their career and optimize the knowlwedge of the shape of business in coming years under the purview of environment.

Climate change is such an important issue we need not explain how important it is for the planet where we live. I applaud Andrew J. Hoffman and John Woody for a fantastic thought-provoking article.

It does look like a near-certainty that legislation will come, one way or another, to put some type of price on carbon emissions. It's about time, too. I think we will look back on the last two hundred years as a crazy period of time when companies could completely externalize the consequences of their emissions--something like the way we look today at the old-time chemical companies that would simply dump their toxic waste into the creek down the road.

Don't expect this transformation to come in an orderly way. The disruptions and battles we can expect as the new capping disciplines are haggled through their difficult birth will most likely rival or perhaps exceed any of the ugliest transfers of wealth in history.

Entrenched interests will of course invest huge resources in protecting their domains. The big decisions will be set and made by politicians. Means of measurement and verification and assigning value and setting prices will be up for grabs. Entrepreneurs will jump in to work their angles, and some of them will be fabulously successful. Expect big winners and big losers. Think of the Wild West, with all of the excitement and violence that comes to mind.

The paradoxical truth is this: every company should watch these developments closely, but even with careful attention the likely outcomes will be very difficult to predict. So we know that significant changes are most likely coming, but attempting to capitalize on those changes will be an exercise in speculation. Where do we get our bearings for business decisions?

The simplest answer just might be the best one: do the right thing. A number of thoughtful contributors opine that this isn't an ethical issue, and Andrew and John focus on the business impacts in their introductory piece. And we do need to be sure that shareholders are taken care of. But is that the real issue here?

Very often, I sense that we mention the business benefits of sustainability, which are real, because we're just plain hesitant to call this out as an ethical issue. I propose that this absolutely is an ethical issue.

I've seen Chouinard in action, and I'm convinced that he did not drive Patagonia down the "green path" to make more profit. The fact that he most likely has made much more profit doesn't mean that's why he set the course. He chose the path that aligned with his personal values. The fact that his sales, and his brand value, skyrocketed was not the result of MBA-driven market analysis, but showed a much deeper effect: the resonance of consumers with his value-oriented direction.

We have executed a number of sustainability-oriented projects with large organizations and I am constantly amazed by the energy and innovation that is unleashed when people get a chance to do the right thing.

In my opinion, the winners in this new age of carbon constraint will not be the ones with the calculators and spreadsheets. They will be the courageous thought leaders that drive their businesses forward in line with their personal values.

Michael Potts
CEO, Rocky Mountain Institute

Thanks to all who have contributed to this discussion. We are pleased with both the quantity and the quality of comments. As we review what has been posted, we see several common themes, but the one that resonates the most is that the time for action is now. All appear to agree that we have reached a tipping point due to a confluence of factors, including rising energy prices, impending climate legislation, noticeable physical effects from climate change, and increased awareness on the issue from businesses, investors, the media, and the general public. While there is still uncertainty, that does not mean there is additional time to delay to begin thinking about climate change as a boardroom issue. As Jeremy Blow said, “We should be concentrating on reducing the impact of climate change on business rather than business’ impact on the environment.”

While you, as a business executive, are running out of time to get ahead of the curve on this issue, you still must realize that there are numerous opportunities to create value and innovate to create solutions to the problem. It is not a zero sum game, and the uncertainty can either cause you to stall or cause you to aggressively pursue innovations, policies, and organizational change that will better equip your company for a carbon-constrained world. The best time to start is now.

There were several posts that called for additional depth on the three stages of developing a climate strategy. Those details and much more are covered in Climate Change: What's Your Business Strategy? forthcoming in May 2008 from Harvard Business Press. We close the book with two provocations that we'd like to introduce into this discussion at this midway point of the posting.

1. Adaptation is the next big thing. Most of the discussion of climate strategy has focused on mitigation strategies. But as the impacts of climate change become real, companies that have high dependence on water and regional climates will be forced to alter their operating practices. We can see this already with companies that work north of the Arctic Circle and can no longer rely on the same amount of ice bridges; or municipalities (such as Chicago) that are beginning to plan for more severe rainstorm events. If you are in any one of a number of industries (soft drinks, agriculture, energy, forestry. etc), you should be planning for climate change to alter your operating parameters in ways that can be both negative and positive.

2. Will climate change become an issue of fiduciary responsibility? As we begin to develop a cost for carbon and real changes in the climate, senior executives (and the companies that insure them), must begin to consider climate change vulnerabilities as a "material" issue under Sarbanes-Oxley. That will drive the issue deeper into the corporate mindset.

So, as we put it all together, we conclude where we started, "What's your business strategy" for this very real business issue?

Andrew Hoffman
Holcim (US) Professor of Sustainable Enterprise at the University of Michigan
Associate Director of the Frederick A. and Barbara M. Erb Institute for Global Sustainable Enterprise

John Woody
Deal Associate
MMA Renewable Ventures

I think that it is great that you have a discussion forum on the
environment, in today reality, companies and people have to adapt to climate change, we have to become more efficient in business
and less dependent on oil. We need to develop alternative forms of
energy .

The moot point is not whether corporates should or should not indulge in constraining their carbon-footsteps. There need to be strategic level redesign in the way businesses operate. But, I still feel the kyoto outcomes aren't worth. Disruptive innovation is where I see the solution of the climate crisis from corporate side that can provide the unique competitive advantage, which needs to be backed by awareness and empathy in us. One eureka to alter the world of energy is all I hope and dream for.

~ Ronak R. / RokZRooM

I'm a little late to the discussion, but I have to concur with John Woody and Andrew Hoffman. The current focus on mitigation has been a boon for the first movers in Europe, especially when considering the ability of European Industry to take advantage of the ETS. But despite these efforts, focusing on mitigation is only half of the solution—adaptation to climate change probably the best strategy available to business. Luckily, these two go hand in hand and much of the mitigation techniques being employed are part of an adaptation strategy. I'd like to thank both of you for bringing adaptation back into the conversation.

Timothy Patrick Fox
Engage Carbon