Let’s Talk About The Weather
from
January/February 2006
by Rob Norton
To
paraphrase Bob Dylan, you don’t need a weatherman to know which way the
hurricanes have been blowing or where the earthquakes have been
shaking. Extreme weather (and the victims of the havoc it causes) have
dominated headlines, and the costs, notably of recovery operations and
energy, are still with us. For forward-looking boards, a big issue is
how to prepare for what many worry will be more of the same.
To get some answers,
Corporate Board Member
turned to Susan Tierney, 54, managing principal of the Analysis Group,
a Boston consulting firm, and a board member at Catalytica Energy
Systems, a California manufacturer of emissions-control products for
the power-generation and transportation industries. Tierney previously
held various positions with state and federal agencies, most recently
the U.S. Department of Energy, where she was assistant secretary for
policy from 1993 to 1995. She spoke with Rob Norton. Excerpts:
Why should directors worry about global warming?
Many
companies—and not just those in the energy business—face a variety of
short- and long-term risks relating to climate change and the
possibility that the U.S. will adopt laws and regulations to address
it. Any changes in the law will also bring about new competitive
pressures. At the same time, there’ll be significant upside
opportunities as the global economy adapts to the need for cleaner
energy technologies. Many companies aren’t waiting for the enactment of
new climate-control rules—they’re taking a proactive stance. They feel
they would rather have certainty about future government regulation so
they can develop road maps for complying and adapting, especially if
they’re making long-term capital investments.
Global
warming remains controversial. Many, especially in the private sector,
are skeptical that the problem is as imminent or serious as
environmentalists claim. Are they wrong?
There are
a couple of dimensions. Within the peer-reviewed scientific community,
there is an overwhelming consensus that man-made emissions, primarily
from the combustion of fossil fuels in transportation, industry, and
electricity generation, are leading to climate change. This was most
recently reflected in the Joint Science Academies Statement on Global
Response to Climate Change, signed last June by the heads of the
national science academies of Brazil, Canada, China, France, Germany,
India, Italy, Japan, Russia, the U.K., and the U.S.
A
separate question is whether or not global warming is to blame for the
kind of severe and volatile weather conditions we’ve been witnessing,
notably 2005’s hurricane season. Most scientists would say that it’s
hard to pin down the causality, but most would also say that these
changes in weather patterns are consistent with the expected impacts of
global warming.
Those include more variable
precipitation in many areas, rising sea levels, melting snow cover in
parts of the Northern Hemisphere, and increasing occurrences of floods,
landslides, and forest fires in some areas and droughts in others, as
well as shifting forests, heat waves in northern latitudes, and milder
winters in cold-winter areas. Scientists predict significant additional
environmental, health, economic, and distributional impacts from
projected global warming over time.
Over what sort of time? A year? Fifty years?
Different
time frames for different effects. Some are already observable.
Greenland’s ice melt has expanded over the past decade. I recently
heard that the Arctic Climate Impact Assessment expects that there
won’t be polar bears in Hudson Bay 20 years from now. The
Intergovernmental Panel on Climate Change predicts that global average
sea-level rise could be four to 30 inches by the end of this century.
Which companies are most exposed to climate-change risks?
Risks
can arise in many different forms—in addition to higher costs, there
are regulatory risks, risks to physical assets, and litigation risks.
So there is no simple answer. Energy companies are most directly
impacted; many will face additional costs and competitive pressures in
the future. Financial institutions also face significant exposure,
because the companies they lend to can be subject to the same risks.
Many
other types of businesses face climate-related risks. Any company with
a large energy bill—for electricity, heating, or fuel expenses for
trucking or automotive fleets—can be impacted. Companies in the tourism
business in certain high-risk areas, such as ski resorts and coastal
regions, may face business risks. Companies in agriculture and forestry
may be exposed. Companies with property in areas subject to coastal
storms or flooding may see higher insurance costs. For example, Swiss
Re, the world’s second-largest reinsurer, reported receiving a record
$49 billion in property insurance claims for damage caused by
hurricanes, typhoons, and other natural disasters in 2004, according to
a recent report by David Gardiner & Associates. Swiss Re attributed
the high number of windstorms that year, including 13 hurricanes in the
U.S. alone, to above-average sea-surface temperatures and the high
year-round average temperatures measured in the last decade. And that,
of course, isn’t counting their exposure for the severe weather we saw
in 2005.
What about companies that could benefit?
The
upside opportunities will be in devising and selling new products and
services that result in lower carbon emissions. These could include
things like efficient lighting and heating, ventilation and
air-conditioning systems, efficient appliances, smart energy-management
electronics in buildings, renewable resources, and nuclear technology.
What’s the likelihood of mandatory climate controls in the near term?
Many
observers believe it’s only a matter of time before controls are
written into law, and that they will affect energy prices. Alan
Greenspan has predicted that rising energy prices and the resulting
shift to alternative fuels will have a major impact on future economic
growth. You can make the case that the likelihood of future changes in
climate-control policy is already affecting forward prices for energy.
At
the state level, the governors of nine Northeastern and Middle Atlantic
states have released for comment a proposed rule for reducing emission
of greenhouse gases at power plants. The final rule is expected to be
out in early 2006, and they plan to begin implementing it in 2009. It
will be phased in with a cap on greenhouse-gas emissions for the first
five years, followed by a 10% reduction over the next five.
At
the federal level, the new U.S. Energy Policy Act of 2005 addresses
climate change only minimally. There are incentives for
less-carbon-intensive energy production and use, but the act doesn’t
contain a mandatory program to reduce greenhouse-gas emissions from
sources in the U.S. economy. The Senate version of the bill, however,
did have a provision stating the need for a mandatory carbon-reduction
program, and senators passed a “sense of the Senate” resolution in July
2005, calling on Congress to act. Senator Pete Domenici, chairman of
the Committee on Energy and Natural Resources, has stated that he wants
to make climate-change legislation a priority in the next Congress.
Internationally,
there is broad support for controlling greenhouse gases, evidenced most
notably by the Kyoto-based international carbon-control regime. Even
though the U.S. declined to ratify it, Kyoto and other overseas
regulations will affect multinationals as well as other companies that
operate in global markets.
When the U.S. rejected the
Kyoto treaty, a main reason was the expectation that the net effect of
significantly reducing greenhouse-gas emissions would be to poison the
economy. Is that perception right?
It’s not what
the economic studies of Kyoto costs show. There is a range of estimates
of economic impacts on the U.S., from positive benefits to negative
costs. But even the ones that show negative impacts are on the order of
1.5% of GDP, and most studies ignore potential benefits. That doesn’t
sound like poison to me.
Are there any requirements that companies analyze and report climate-related risks to investors?
Not
at present, but there is growing pressure from stakeholders. The
Investor Network on Climate Risk was launched by 10 institutional
investors in 2003 to focus on climate-related risks. Its members
include a long list of fiduciaries and other institutions, including 13
state treasurers, pension-fund managers such as Calpers, public-sector
retirement systems, and many of the managers of the largest union
pension funds.
Among other things, the group wants the
Securities and Exchange Commission to enforce better corporate
disclosure of climate risks under Regulation S-K, which requires
companies to disclose trends and uncertainties that are likely to have
a reasonable impact on operations. It also wants the SEC to modify its
proxy rules to give shareholders the right to vote on resolutions
requiring companies to disclose climate risks.
More
specifically, in 2004 shareholders filed a total of 33 climate-related
resolutions—two-thirds with U.S. firms and the rest with Canadian
companies. Last year 41 resolutions had been filed by May.
How are companies reacting to the prospect of increased regulation and disclosure?
For
one thing, some executives are calling for greater certainty in the
nation’s climate policy so that they can better plan for
climate-related impacts on energy prices and investment decisions. Ford
CEO Bill Ford, for instance, has acknowledged the emerging consensus
around climate change and has said that the company believes it is time
to take appropriate action. Paul Anderson, CEO of Duke Energy, has a
similar position. He’s said that by helping shape public policy, the
company can advance the interests of its investors and customers while
also addressing the issue itself. The CEO of Royal Dutch Shell, Jeroen
van der Veer, has said that national borders no longer protect
companies from the impact of climate change and that it is time to move
beyond the present debate.
Could you give some examples of companies and boards that have taken concrete action regarding climate control?
Investor
pressure has led some of the major utility companies to publish
risk-assessment reports on climate change. These are companies that are
making long-term capital investments whose market value will be
affected by future policy changes. American Electric Power, one of the
largest coal-burning utilities, was the first. In response to a
shareholder resolution in 2004, the board set up a subcommittee of
independent directors to look at the impact of increasing regulatory
requirements, competitive pressures, and public expectations of reduced
greenhouse emissions. The committee met with outside experts and with
management, both to understand the actions the company had taken and
the technologies available to reduce greenhouse emissions, and to
analyze the likely impact of different future scenarios, including
mandatory reductions in greenhouse-gas emissions.
The
report—which is available on the company’s website, www.aep.com—was
comprehensive and included several recommendations for future
management action. Since then other utilities, including Cinergy, the
Southern Co., and TXU, have published similar risk-assessment reports.
Several
banks have positions on climate issues that affect not only their own
environmental footprint but also their business practices and
investment and loan portfolios. Bank of America has committed to assess
its own environmental policies, to take action to limit climate risk,
to report on energy-sector emissions, and to evaluate financial-sector
risk in greenhouse-emission-intensive industries. JPMorgan Chase is
encouraging clients to disclose climate risks and develop
carbon-mitigation plans.
General Electric’s
“ecomagination” campaign is another well-publicized example of a
company taking the climate situation seriously. [CEO] Jeff Immelt told
Nature
magazine that GE was investing in environmentally cleaner technology
because it would increase the company’s revenues, values, and profits,
not because it’s trendy or moral. In other words, GE believes the
investment will accelerate its growth and make it more competitive.
What’s the best way for boards of directors to make sure their companies are up to speed?
It depends on the company. At a minimum, board members need to make sure they understand how energy-price trends and different climate-change policy scenarios could affect operations and investments, and how well management understands the risks. Depending on how material those risks are for the company, the directors may decide to commission the kind of risk-assessment report that AEP and other utilities have published. For companies with smaller exposures, it might be appropriate to address this as part of the normal enterprise-risk-management process.
