Climate Change: "Fundamentally a Business Issue, Not a Moral One"
from
May/June 2007
by John R. Engen
James E. Rogers is in the front ranks in the war on global warming. The chairman and CEO of Duke Energy has committed to cutting the company’s emissions by 5% between 2000 and 2010. Duke, the nation’s third-biggest burner of coal—which is public enemy No. 1 in the world of climate-change politics—has given $600,000 to the Nature Conservancy for the purchase of pristine rain-forest land in Belize to offset its carbon emissions elsewhere, and earlier this year Rogers joined a group of luminaries such as Chad Holliday Jr. and Jeffrey Immelt, the chairman and CEO of DuPont and General Electric, respectively, to lobby for new federal regulations that would treat carbon emissions as a commodity that can be bought and sold, much like air rights.
Does all this make sense for Duke’s shareholders? As the CEO admits, new regulations could cost Duke billions in technology upgrades and other charges. Asked to explain his motives, Rogers, 59, cites something he calls the grandchildren test: “I want mine to look back when they’re my age and say, ‘The decisions my granddaddy made about the environment were good ones for us.’”
But a soft heart doesn’t preclude a sharp nose for the bottom line. The Europeans have already capped corporate carbon emissions, several U.S. states are doing the same, and federal limits are all but inevitable. Rogers and his board reckon that the sooner those rules are in place, the better Duke can plan ahead. “Over the next 10 or 15 years, we’re going to be building coal, nuclear, and gas plants,” he explains. “They’ll last 50 years, so we’d like more certainty about the regulations so we can make the right investment decisions.”
Welcome to what is emerging as one of the make-or-break issues of the coming decade. From Hurricane Katrina and Al Gore’s Oscar-winning
An Inconvenient Truth
to a recent UN-sponsored study concluding that the 28 billion metric tons of carbon dioxide or its equivalent in other greenhouse gases spewed into the atmosphere each year is causing air and water temperatures to rise, climate-change concerns have moved from an environmentalist sideshow to the political and business mainstream. For board members, the shift raises significant challenges—and it doesn’t really matter if you believe the science or not. New regulatory schemes and heightened public concerns promise to create a host of problems, related side issues—and business opportunities. Companies that adjust to or capitalize on regulatory changes could wind up winners; those that don’t could see their reputation, profits, and share price evaporate.
“This is fundamentally a business issue, not a moral or scientific one,” says Robert Fri, 71, a visiting scholar at Resources for the Future, an economic think tank in Washington, D.C., and a director at American Electric Power, a utility in Columbus, Ohio, that is the country’s biggest coal burner. “It’s no different from any other kind of business threat. As a director, you have to gauge its impact on the company and on shareholder value.” Nell Minow, editor of the Corporate Library, a governance watchdog, compares today’s concerns about climate change to the belief in the late 1990s that every company needed an Internet strategy. “We’ve reached the tipping point. It’s moved from the ‘wouldn’t it be nice’ category to the ‘this is costing us money’ category,” she says.
Investors are turning up some heat of their own. Proxy adviser Institutional Shareholder Services says 36 companies faced shareholder resolutions this year demanding that boards explain how they are preparing for expected climate-change regulations. Last May a group of 17 institutional investors went after Exxon Mobil, charging that the oil titan “lags far behind its competitors in developing a strategy” to compete in a world where the burning of fossil fuels might be penalized. The group demanded a meeting with the company’s independent directors—among them IBM chairman and CEO Samuel Palmisano, 55—to see what they were doing to catch up. The company ignored the request, says Doug Cogan, deputy director for social-issues service at ISS, whose focus is on climate change.
Perhaps the scariest shadow to fall across boardrooms is that a company’s strategy for limiting emissions could become “material” under Sarbanes-Oxley reporting rules, which means that companies would have to spell out those plans in Securities and Exchange Commission filings. “Shareholders are going to have a right to know your carbon exposure. If they believe you’re too exposed, you might see an impact on your share price,” warns Andrew Hoffman, a professor with the Erb Institute for Global Sustainable Enterprise at the University of Michigan.
A growing number of companies have already made commitments to reduce the emissions created by their plants and production facilities. Others are working to sell them the stuff they’ll need to do this. Corning Inc. invested $250 million in a facility that is making sophisticated new diesel filters, for example. “When you have a system that takes out 90% of the soot from emissions, we think it’s a good bet,” says James O’Connor, 68, former chairman and CEO of Unicom, a Chicago utility, and Corning’s lead director. Soot, “black carbon” to some, may be twice as damaging as regular carbon.
These steps alone, however, don’t address the question of how climate change might singe a company’s bottom line. “Investors want to know about how you’re going to protect revenue streams,” says Miranda Anderson, a vice president at David Gardiner & Associates, an Arlington, Virginia, consulting firm that analyzes climate-change issues for large shareholders. At the very least, regulation promises to make the use of energy more expensive and put pressure on all sorts of companies to reduce energy consumption and greenhouse-gas emissions. While no one can be sure exactly what form regulation might take, the best bet—and the one being pushed by Jim Rogers and his group—is some sort of “cap and trade” system modeled on existing regulations to control sulfur-dioxide emissions. Companies that beat their targets could sell their excess capacity, in the form of credits, to those that are exceeding their emission maximum. The system could prove a lucrative source of revenues for companies that effectively manage their carbon output, and an ugly cost center for those that don’t.
That’s only the tip of the melting iceberg. The issue of climate change is so big and its ramifications are so broad that few companies will escape its touch. Already some property insurers, nailed by increasingly severe storms, floods, and fires, are incorporating climate-change forecasts into their premium-setting models. Automakers are playing catch-up to Toyota’s Prius gas-electric hybrid. The big investment bank Morgan Stanley purchased $3 billion in emission credits on the fledgling global carbon market in 2006 to help prepare itself for a role in an eventual U.S. market for this new commodity.
On the flip side, strategies that are perceived as flawed or callous can spark negative publicity and perhaps political interference. Last April the board of TXU, a big Dallas power company, announced plans to invest $10 billion in 11 new pulverized-coal power plants. TXU argued that its plan was the best way to ensure cheap energy in the future. But the Rainforest Action Network, an environmental group, predicted the plants would emit 78 million metric tons of greenhouse gases each year, the equivalent of putting 14 million new cars on the road. Other environmental groups were burned up, and if new regulations don’t grandfather that output into TXU’s emission limits, shareholders will be too. “It will make those plants more expensive to operate,” Doug Cogan of ISS says. The odds-on risk that the plants could invite unwelcome attention from regulators did not escape Kohlberg Kravis Roberts and Texas Pacific, the buyout firms that have agreed to pay $45 billion for TXU. A promise that they’d kill the plan to build eight of the plants was part of their bid.
In some instances, a company can be perceived as at once progressive and a scofflaw. In January, the Environmental Protection Agency acclaimed Wells Fargo & Co. as the nation’s top purchaser of renewable energy. (The company paid an undisclosed sum for 550 million kilowatt-hours’ worth of renewable-energy certificates, representing 42% of its energy usage, which help finance the development of wind power.) A month later, the San Francisco banking concern found itself on a “watch list” of companies missing the climate-change train—a lineup put together by Ceres, a network of investors, environmental organizations, and other public-interest groups. Ceres (pronounced “series”) cited Wells Fargo for making factory-construction loans when it didn’t have the staffing, systems, and process to review the emissions they might produce. Its competitors, including Bank of America and JPMorgan Chase, routinely do this, according to Ceres.
Mary Wenzel, vice president of environmental affairs at Wells Fargo, says the company has “demonstrated a very sincere and meaningful commitment to the environment.” She notes, among other things, that it has an environmental advisory board, composed of outside experts, to advise management. But Wenzel concedes that the company’s board does not “interface” with management on climate change.
This inattention seems widespread. Only 47% of S&P 500 companies surveyed last year responded to questions about their climate-change preparedness from the Carbon Disclosure Project, which is backed by 225 global institutional investors that control $31 trillion in assets. That compares with 72% of the companies in the Financial Times 500, the largest global outfits.
Does the same lack of interest characterize boards? It obviously shouldn’t. Directors don’t need to dig into the minutiae of climate change or the various bills being weighed by Congress; those matters can be left to management. But they should educate themselves in “the basic science, the range of policy options, and where the company is at in terms of risks and opportunities,” says Kathryn Fuller, 60, former president of the World Wildlife Fund and a director of aluminum producer Alcoa. Its board has been particularly aggressive in finding solutions to the problems of climate change.
Of course, it’s no coincidence that the boards of heavy manufacturers and power producers have been most active on the issue, since they have the most at stake. Electricity production from coal-burning power plants accounts for about one-quarter of all greenhouse-gas emissions. The directors of American Electric Power, the Ohio utility, began studying climate change in 2002 with a simple, forward-looking question, board member Robert Fri recalls: “How would limiting emissions affect our business?” Directors read white papers exploring both sides of the scientific debate and listened to management’s perspectives. That basic preparation served them well when, in early 2004, shareholders asked the board for an assessment of what greater regulation would mean to AEP’s bottom line. The board appointed a subcommittee of independent directors, chaired by Fri, which produced a report recommending, among other things, that the company develop a model to prepare for trading credits and accelerate adoption of so-called integrated gasification combined-cycle coal plants. These plants cost more to build but boast lower emissions because they convert coal into a cleaner-burning gas. Another benefit: They’d help the company confront an equally touchy issue, the political need to continue using coal. “We operate in a lot of states—Kentucky, Ohio, West Virginia—where coal production is important to the local economies,” says Fri. Local politicians wanted a corporate commitment to coal, and this technology “allows us to do that but still meet whatever standards emerge.”
With so much at stake, climate change promises to be much like the weather. People just won’t be able to stop talking about it. One big difference: Boards will be able to do something about it.
