To read about policy developments taking place this year, see “Looking for Signs Along the Road to Copenhagen.” Listen to advice from Ryan on positioning your business at “Reading the Tea Leaves of Evolving Climate Change Policy.”]
As global leaders prepare to negotiate an updated version of the Kyoto Treaty at the U.N. Climate Change Conference in Copenhagen in December, the big question is whether China and the United States will join the 183 countries that have already signed on. If that happens, we’ll be on our way to a serious global effort to stabilize the climate.
What would this mean for your company? An agreement that includes China and the U.S. — the world’s No. 1 and No.2 emitters — will commit all signatory countries to broad reductions in domestic emissions. Beyond outlining general principles for international cooperation, however, the treaty likely will leave it up to countries to figure out how to do so. Therefore, an evolved global agreement will help speed up and synchronize country-level efforts, but national governments will continue at the helm of climate policy design.
Through that lens, consider the following ways in which policy will impact individual companies, starting with the most direct effects.
1. The Price of Carbon
From global to local, the essence of climate policy is putting a price on carbon emissions, which means either direct regulation by taxes or what’s known as “cap-and-trade” — a requirement for companies to buy tradable permits when they exceed a certain threshold of emissions. Generally, when experts talk about the “regulatory risk” of climate change, they’re referring to direct exposure to just such a price, and this is rightly considered one the most immediate and tangible climate-related risks.
The onset of a carbon price affects companies directly in two main ways. First, for those paying, there is a per-unit price, which, in recent years, has ranged between $1 to more than $50 per ton of carbon in voluntary carbon offset markets and regulatory schemes like the European Union Emissions Trading Scheme (ETS). The Economist suggests that range may move and narrow to between $38 and $63 in the future.
The second direct impact on companies is the uncertainty over what the price will be, and who will have to pay it. This may be more profound than the price impact itself, which is why companies in the U.S. Climate Action Partnership are asking for a system of regulation. Since most emissions come from fossil fuels, regulation is closely related to the supply and the cost of energy. And because corporate energy expenses are so substantial — many companies spend more on energy than they do on taxes — an increasing number of firms see regulation as a good deal, as long as the government clarifies it soon.
2. “Supporting” Policies
In addition to direct regulation, there are various supporting policies. One main type is standards, which include transportation sector fuel economy specifications and efficiency requirements for energy-using products in the information and communications technology (ICT) industry. Standards typically set out requirements for end products, but as international sectoral approaches take shape, standards increasingly will cover production processes as well.
Another main type of supporting policy is technology incentives, which include funding for R&D, the removal of barriers to enter new industries (particularly energy), and financial incentives such as tax credits to encourage companies to generate renewable energy on site.
While the three instruments mentioned so far tend to constrain emissions, there is also a widespread movement to develop “market mechanisms” that create positive incentives by taking advantage of the commodity aspect of carbon. For instance, since a ton of carbon emissions is a ton anywhere, it’s possible to use the market to promote activities being done at the lowest-cost locations — where investments in activities that reduce carbon emissions are cheaper. With market mechanisms, companies can buy reductions when it is cheaper than “making” them. Examples of markets include the U.S. Regional Greenhouse Gas Initiative and United Nations’ Clean Development Mechanism.
Despite the promise of environmental finance-based market systems, two big questions loom: whether and how carbon instruments can be “imported” from elsewhere, and whether forestry-related carbon instruments should be allowed at all.
3. All Policy is Climate Policy
Policies that reduce carbon emissions are not always named as “climate” policies. Case in point: Transportation accounts for a third of emissions in the U.S., so climate will be a significant topic when the U.S. transportation bill comes up for its six-year reauthorization in September. Also, with 20 percent of global emissions caused by forestry and land-use change, and with the food and agriculture sector looking for rewards for good behavior, climate considerations are also likely to come into play in agricultural policy.
In addition, climate issues are becoming ubiquitous in policies that address economic and social issues. For example, the growing risk of international legal and border disputes, the greater likelihood of damaging weather events, and the increasing vulnerability of energy security all mean climate change is a key security policy issue (PDF). It’s no coincidence that the first carbon tax bill — America’s Energy Security Trust Fund Act, which was introduced in the House earlier this month — has “security” in its name. Climate relations are also ground zero for trade issues. Realizing there is a legal basis (PDF) for using trade measures to enforce environmental initiatives, the U.S. and China are debating who is ultimately responsible for cross-border emissions. In other words, climate policy is trade policy.
4. Society as the Policy Authority
Ultimately, policy is part of a general contract between business and society, and social groups may start to hold companies accountable via direct pressure. These actions, according to a recent Harvard paper (PDF), can range from events targeting single companies to strikes and riots deriving from social instability exacerbated by climate change.
To stay ahead of this risk, companies should conduct broad policy assessments of sociopolitical situations, using resources like the Economist Intelligence Unit, the International Country Risk Guide, Business Environment Risk Intelligence, and S. J. Rundt & Associates.
5. Everyone is Affected
According to the Peterson Institute and World Resources Institute, the most vulnerable industries are those that have high energy intensity of production, low potential for efficiency improvement, little ability to switch to low-carbon energy sources, and high elasticity of demand. These include, in particular, energy utilities and heavy manufacturing sectors.
This analysis, like many, focuses on policies that likely will have a direct impact on a relatively small number of players — for example, the U.S. Environmental Protection Agency’s proposed reporting rule covers 85 to 90 percent of domestic emissions by focusing on just 13,000 facilities. Nonetheless, all of the policies mentioned so far may reverberate to impact the fundamental conditions on which all businesses depend. For instance, a carbon tax impacting the price of carbon-intensive energy could lead to reduced availability of carbon-intensive inputs such as steel. Such a tax could also lower demand for products that create higher emissions during their use.
These types of policies could also influence competitive dynamics. For example, incentives for renewables might lower entry barriers for ICT companies in the energy sector, while feed-in tariffs might enable consumer products companies to develop better cost positions over rivals. Also, with investor groups like the Carbon Disclosure Project demanding more information about companies’ self-appraisals of policy risk, those firms that are willing and able to disclose more have increasingly preferential access to capital.
Putting it in Perspective
By no means are the effects of climate policy all negative. The economy as a whole stands to benefit from comprehensive climate policy. Without it, a wide scale of human rights, health, disease, and energy problems will likely result.
But more pragmatically, for most climate policy risks, there is also opportunity. Companies that generate and rely on low-carbon energy are set to prosper, as are those that can exploit technological breakthroughs in resource efficiency and materials. Those firms generating new forms of energy — in particular, renewables — will participate in a massively growing market. Companies in industries that address adaptation problems, such as pharmaceuticals and biotechnology, stand to gain. In the end, as the world’s climate policies are developed and strengthened, there will be important roles for companies from almost every industry.
First posted at Greenbiz.