The Carbon Economy

February 25, 2009

Moving Australia into the low carbon lane will mean economic change of a sort that comes around only once a generation.

It means, in effect, creating an imaginary, parallel economy that trades in something which will never exist – tonnes of carbon not emitted – alongside the ‘real’ economy of things and services. It means pricing something that has not been priced before, create generating carbon dollars where none existed.

Before a single tonne can be traded however, an entire infrastructure has to come into being. Consultants, technicians, financiers, strategists and a broad variety of carbon professionals are flocking into an industry with huge potential. It is boom time in carbon town.

How big is the market?

Australian emissions are estimated at about 450 million tonnes annually. Even at a relatively modest carbon price of $20 a tonne (the EU is pricing carbon at about euro 25 a tonne at the moment) that adds up to $9 billion market in carbon, much of which will be traded, launching in just a few years.

None of that counts counting the opportunities internationally. With international trading possible under the Kytoto Protocol – using clean development mechanism (CDM) and Joint Initiatives (JI) – the market for carbon abatement is effectively infinite.

Measurement

Before you can trade carbon, you have to be able to measure it, but measuring emissions is a complex business. Internationally the debate is led by the Greenhouse Gas Protocol (GGP), a decade-long partnership between the World Resources Institute and the World Business Council for Sustainable Development. The protocol provides an accounting framework for many of the greenhouse gas measurement and reporting frameworks around the world.

In Australia, the big accountants each have significant practices developing around the art of measuring and auditing carbon. Since July 1 this year, corporations which emit more that 125 kilo tonnes of CO2 equivalent or use or produce more than 5090 terrajoules of energy must register and report using the National Greenhouse Accounting Factors and Guidelines, which provide methods for calculating greenhouse emissions from the energy, industrial process and waste sectors.

Many of these practices are business development initiatives, looking to profit from the huge amount of accounting and change business that will come their way in a few years. But there will be plenty of work to be had. According to Andrew Petersen, a partner in the sustainability & climate change practice at PricewaterhouseCoopers in Sydney, the amount of change that has taken place since the introduction of the carbon trading system in Europe in 2005 is immense.

“There is a huge lack of preparedness amongst Australian industry around their strategies for a low carbon economy,” he says. “In Europe the winners were those who had assessed the impact and had taken abatement action, had mapped their carbon liabilities and got out of carbon heavy activities, and started the process of switching before carbon was priced.”

Carbon is now a corporate governance issue. The raw numbers – the amount of companies carbon liabilities and assets – is in great demand from investors and other stakeholders.

Global institutional investors have banded together under the banner of the Carbon Disclosure Project, a not-for-profit which has collected emissions data from 8,000 companies this year, including over 50 from Australian companies such as AMP, Foster’s and Wesfarmers. The CDP has 385 signatory investors including Merrill Lynch, Goldman Sachs, Morgan Stanley, AIG, Barclays and HSBC. Rupert Murdoch, Bill Clinton and Angela Merkel appear on the project’s homepage in video endorsements.

In Australia, the CDP is supported by the Investor Group on Climate Change, representing institutional investors with close to $500 billion in funds under management, including Colonial First State and Goldman Sachs JBWere. It pressures Australian companies to disclose their carbon liabilities and prepare for a low carbon world.

With all this disclosure, there is plenty of work generating and analysing greenhouse data, and this has spawned a whole class of specialist consultancies. Companies such as Carbon View, Emissions Logic, Energetics, and Environmental Resource Management stand at the ready with their carbon meters and clipboards.

The big IT providers too are on the case. In May SAS launched an environmental management system designed to integrate carbon issues into the financial and human resource management systems of large organisations.

What is the impact?

Commissioned by Bob Welsh, CEO of VicSuper, a big voice in the climate change debate, Trucost, a London-based firm has analysed the impact of a carbon price on the ASX 200. If these companies had to put a price on carbon it would cost them on average 3% of earnings – but these numbers are highly dependent on the price of carbon, and the carbon intensity of the companies themselves. Almost half of emissions from these 200 companies come from just four companies: BHP Billiton, Rio Tinto, BlueScope Steel and Qantas.

This work built on the analysis of Citigroup analyst Elaine Prior, who, in 2006 Elaine Prior, an analyst at Citigroup, published a 125 page report at the end of November last year outlining the implications of climate change for Australia’s Top 100 companies. She separated companies into climate “winners” and “at risk”.

In the short term, climate change winners will include alternative energy producers, energy companies that will benefit from higher air conditioning demand, and recycling businesses. In the longer term, health care companies that will benefit from the spread of tropical diseases are a good bet. On the “at risk” side, coal exporters, agricultural and industrial companies with water exposures, and emissions intensive industries, “depending on the nature of carbon regulation”. In the longer term, property exposures in high risk areas, such as coastal Queensland, and insurers that “may mis-price catastrophe risk”.

Rating for trading

The launch of a carbon trading system will require a completely new trading infrastructure – a trading platform, legal and settlement services, auditing and compliance requirements.

The government has set up an advisory panel that includes over 25 companies offering consultancy, legal, systems, and carbon science services. Baker & MacKenzie, whose climate change practice is headed by Martijn Wilder, is there, as is Booz Allen Hamilton, engineers URS, and Access Economics.

Jesco dAlquin heads Tradeslot, on eof the company’s on eht governmetn’s advisory board, selected for its expertise in providing electronic markets for trading commodities and government assets – such as carbon. “You can’t get it wrong,” he says. “If you misallocate permits it will have a hugely negative effect and distort behaviour.

“In getting one of these things to go live you need to think about the legal environment, contracts, offer and acceptance, settlement and all the issues around that. Real deals are being done here, and their success will be determined by the effectiveness of regulation and how they reflect government objectives.”

Carbon accounting is complex, but the more complicated things get, the more scope there is for innovative consulting. Things begin to get really obscure when you introduce an international angle – the trading of carbon credits across the globe. This, under the auspices of the Kyoto Protocol’s and JI mechanisms has been happening for years.

Carbon Bridge, for instance, is a Shanghai-based company that sources carbon offset projects in the developing world and wholesales the resulting carbon credits to buyers in the west who need them to fulfill their carbon abatement responsibilities.

But it is not a particularly transparent business – there is plenty of scope for information and analysis. One London-based firm, IDEAcarbon, chaired by climate change guru Lord Nicholas Stern himself, has launched itself into the business of applying ratings to the “carbon-credibility” of CDM projects.

A “carbon credit rating”, according to the company, measures the probability that a project, approved by the United Nations, will actually achieve the reduction in carbon emissions it is designed for.

This is complicated stuff. Imagine a dirty coal power plant, spewing out carbon in China. Your company may decide that it would be cheaper to improve this Chinese power plant than it would be to clean itself up. It applies through the CDM, and the United Nations assesses the amount of carbon that won’t be emitted if you do the Chinese project. You can then use the carbon credits created by that project to trade on your local carbon exchange.

A carbon rating, as promoted by IDEAcarbon, assesses the probability that those carbon credits will (a) materialize at all, and (b) be worth anything when they do.

Given the rating industry’s success at predicting the creditworthiness of sub-prime mortage products, applying the same sort of methodology to as yet unbuilt projects in the developing world might strike some as being a tad ambitious. But Stern says that the market for offsetting projects could reach $1 trillion by 2030, and someone has got to be analyzing their creditworthiness.

Don’t be offset

The market for carbon offsets – financial instruments that represent reductions in greenhouse gases – may eventually be worth $1 trillion, but they have a long way to go.  In 2006, according to the World Bank, $5.5 billion of carbon offsets were purchased to help companies comply with emissions reductions targets, but just $91 million was spent on personal offsetting – people buying certificates to offset their air travel and the like.

Nonetheless, with the slow but steady uptake of pollution reduction schemes across the globe, the market is growing fast, and attracting its fair share of capital and attention from the worlds of industry, investment banking and venture capital. Most of the major banks have carbon arms, with an ever proliferating array of carbon-linked financial instruments for trading and investment.

In February this year UBS launched a proprietary “greenhouse index” that combines changes in the weather – a proxy for global warming – with actual emissions data. Investors can bet that global warming will accelerate or decelerate, potentially getting rich as Hurricanes blow through Florida and the US stymies carbon limits.

Macquarie Bank, too, never backwards in coming forwards when there’s a dollar to be made, has stepped into the carbon arena. It invests in renewable energy, advises companies on carbon abatement strategies, and is developing its own over-the-counter and exchange traded carbon instruments with financial engineers and trading company Financial & Energy Exchange.

The global head of Macquarie’s Climate Change Investment team, Oliver Yates, has garnered the expertise of scientist and former Australian of the Year Tim Flannery in designing rainforest projects for carbon offset and sequestration.

The broad idea is to save rainforest from deforestation – one specific project in Kalimantan in Indonesia, for instance is protecting the habitat of 600 orangutans in order to sell the carbon offsets to Australian industry – or plant new forests to create carbon sinks, and with them, carbon credits that can be traded. But, says Flannery, there is an important link between science and money that is all too often ignored by the capitalist boffins with their trading hats on.

“There are lots of people who understand the economics of all of this,” says Flannery, “but don’t necessarily understand the carbon cycle – and all of these are actual interventions in the carbon cycle.”

Yet there is a real economy of projects underlying this frenzy of speculation, and plenty of investment muscle behind it. Climate Change Capital has over $1.6 billion under management, financing emissions reductions schemes. Run by former Baker & Mackenzie Climate Change leader James Cameron, the firm provides investment banking services for “investment opportunities created by the low carbon economy”. Much of this will be spent in the alternative energy space, the source of what many are saying will be the next big investment boom.

Cameron also has a seat on the board of GE’s “ecomagination” subsidiary, the company’s $14 billion environmental services arm. The subsidiary, run by 20-year GE veteran Lorraine Bolsinger, invests in climate change projects such as a “biomethanation” plant in Ludhiana, India, and wind turbines in Ireland. GE’s ecomagination also spreads to offering a credit card that automatically offsets your purchases. According to the company, spending $750 a month on your credit card will offset the direct emissions a typical American produces in a year.

Strategic initiative
Carbon pricing will be a change, but where there is change there is no shortage of change management gurus. Michael Porter, the doyen of strategy thinking, has in recent months turned his attentions to the strategic implications of carbon costing. The impact on companies will be twofold, he says: firstly, organisations will need to understand where the carbon costs in their operations lie, and change their business models accordingly, and secondly they will need to understand their exposure to the risks of climate change – shifting patterns of rainfall, more frequent and severe storms, reliability of energy and water supplies, infrastructure and prevalence of infectious diseases.

A company which has an intricately designed just-in-time inventory system which is heavily reliant on cheap transport, may find that it is no longer economic in an economy that charges for carbon. Porter says that, in common with all change, the opportunity goes beyond the operational to the strategic: “Some firms, in the process of addressing climate change, will find opportunities to enhance or extend their competitive positioning by creating products (such as hybrid cars) that exploit climate-induced demand, by leading the restructuring of their industries to address climate issues more effectively, or by innovating in activities affected by climate change to produce a genuine competitive advantage.”

Forest Reinhardt, Harvard Business School’s business and the environment thinker, agrees that the carbon economy can be more of an opportunity than a risk, but that it will take big thinking to take advantage. “Success in a carbon-constrained world will be determined not by short-term balance sheet effects or efficiency initiatives but by innovation, management acumen, and leadership,” says Reinhardt. “The companies that have seized the big opportunities in changing economic landscapes have been those with bold visions of the future, not necessarily those whose hard assets seemed to position them best for success.”
It’s a message not lost on some of our leadership community at least. According to Steve Sargent, chief executive of General Electric in Australia and New Zealand told an American Chamber of Commerce lunch last month (August) “For us, we look at this (climate change) as the biggest business opportunity of the century… We expect to see about $US23 (billion) to $US25 billion of revenue from solely environmentally friendly technologies by 2010.”
Clear communications

With all this change, the prolific investment and trading activity, you’ll be needing some expert communication advice. Tom Whitehouse, former BBC journalist, will be happy to offer the aid of his ten person team at Carbon International, a PR firm that specialises in “communications for the environmental economy”. Or you could go straight to the source, by getting in the ears of any number of journalists who specialize in carbon issues, from Gabrielle Walker, science writer, broadcaster and author, through to  Emma Duncan, deputy editor of The Economist and specialist on climate change issues.

The blogosphere, too is a significant influence on the carbon economy. According to BlogPulse, a monitoring tool developed by Neilsen, on July 24, a random day, 3.25% of all blog posts contained the words “carbon economy”. Communications agencies are building a business tracking what is said about your company online and tailoring responses. Sites such as desmogblog.com or climatechangenews.org can be influential in altering perceptions.

And there is no shortage of specialised information services. Enviornmental Finance, Point Carbon, and if all that isn’t enough, Australia’s first carbon market expo will be launching in the Gold Coast in October, sponsored by Baker & Mackenzie, Nab Capital and Barclays Capital. Clearly, the carbon economy is flourishing.

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