The Business Case for Sustainability: An Inconvenient Reality?Sep 25th, 2011 | By Lawrence Heim | Category: Sustainability
For years, those of us in the environmental and sustainability (E&S) profession have sought credible metrics to quantify the economic value of our efforts. Studies dating back to the late 1980s attempted to demonstrate “E&S value.” Most of these studies either showed rather tenuous links between E&S initiatives and valuation or used pseudofinancial metrics not relevant in the eyes of the financial community.
Interestingly, most of these studies link E&S performance to equity markets, most notably stock prices. Why stock prices? Maybe because stock prices grab headlines, are tied to compensation, or are the target at which boards of directors and senior executives generally aim performance. They are easy to relate to.
However, E&S improvements don’t fit into this stock-price model because these improvements either are not financially material or can’t be demonstrated with economic certainty in the “current quarter” myopia of corporate management, financial markets, and analysts.
How Markets View Environmental and Sustainability Risks
A recent article on this topic, published in The International News, included an interview with Kevin Parker, CEO of Deutsche Asset Management (DeAM), which manages more than US$ 775 billion in assets. The subject of the interview was how capital markets currently view E&S risks.
With simplicity, clarity, and unquestionable credibility from the financial market viewpoint, Parker made several key points:
- Bond markets are poised to punish polluting companies in the aftermath of the Macondo (Gulf of Mexico) oil spill and Fukushima nuclear crisis.
- Because of the catastrophic nature of these two events, the process of re-pricing carbon and environmental risk is already underway.
- Investors in longer-term debt, including bonds, will increasingly avoid unsustainable companies, a trend that will push up these companies’ borrowing costs.
- By contrast, shorter-term equity and commodity markets have continued to chase high-carbon opportunities, including the voracious demand for coal.
As Parker states, “What this boils down to is risk in capital markets, and capital markets know how to price risk once they understand it.”
Parker’s point is that equity and commodity markets “understand” that short-term E&S risks for carbon-intensive industries are unimportant. Many E&S professionals bristle at the thought, but a different perspective emerges when this situation is viewed through the financial market lens.
Factors Affecting the Market View of Environmental Impacts
Consider a few developments from recent years that helped form the market’s understanding of the financial risks:
- Historical pricing of greenhouse gas (GHG) trading units under the original Kyoto Protocol never reached or sustained a financial “pain point” significant enough to speed either technological development of alternatives or viable pollution control technologies.
- A global glut of emissions allowances and permits concurrent with increased carbon dioxide emissions indicates that underlying technical and market assumptions were faulty.
- Systemic corruption and fraud in the European Union’s GHG emissions trading schemes and markets undercut confidence for traders, participants, and regulators.
- No post-2012 Kyoto Protocol agreement has been developed or ratified.
- In the Northeastern United States, state support for and participation in the Regional Greenhouse Gas Initiative is shrinking as states pull out.
- The Chicago Climate Exchange, the largest GHG emissions trading platform in the United States, has collapsed.
- The U.S. political will has, over the past 10 years, failed to develop a national GHG emissions reduction, trading, or taxation program or even to articulate a direction for GHG policy.
- Oil pricing trends have, for the past 10 years, demonstrated continued price increases, generally inelastic demand (i.e., we buy every gallon extracted and refined and continue to demand more regardless of the price), and continued growth in exploration and production—all manifesting as record revenues and profits for blue-chip energy companies.
- Commercially viable, cost competitive, and scalable alternative fuels and related infrastructure will not be available in the foreseeable future.
Additionally, corporate GHG program successes during the last several years (typically expressed as operational cost savings or efficiency gains) demonstrate that low-cost emissions reductions are possible—even easy—in the short term without major capital outlays or negative impacts on business fundamentals. Taken as a whole, the equity-side view of short-term upside for carbon-intensive industries is supported by
- Relevant historical trends spanning more than 10 years
- Lack of foreseeable political, legal, and technological certainty
- Validated success in low-cost, short-term, nondisruptive emissions reduction strategies
- A global economy demanding low-cost energy with no near-term replacement source
Shifting to a Long-Term Horizon
E&S practitioners looking to define viable equities-based value contributions have a difficult battle against these proven and overwhelming macroeconomic truths and the financial community’s “understanding” of E&S short-term impact and importance that is at their core.
Pension fund investment managers, in contrast, emphasize stability and a long-term investment horizon over short-term pricing swings. They therefore focus on stable debt investments and returns that extend far beyond the current quarter. There seems to be less recognition by E&S practitioners of the importance of debt investments, evidenced by the amount of studies, white papers, and pseudofinancial metrics related to E&S that emphasize the equities side of capital markets.
Perhaps a major driving force for using a stock-price benchmark for E&S success is the pressure for corporate E&S staff to justify their existence and for consultants to come up with short-term metrics to justify the cost of their services. Environmental, health, and safety and sustainability media outlets are only too happy to report stories and studies on these tenuous links as they vie for the limited attention of their readership, and they may not fully understand the subject matter themselves.
Given Parker’s comments—and the lackluster historical success of valuing E&S performance within stock prices—perhaps it is time to redirect our efforts towards finding relevant and credible financial metrics that better reflect E&S outcomes and associated risk reduction. Concurrently, we may also need to adjust our expectations on the true financial significance of these outcomes relative to capital markets.
In limited circumstances, the financial value of E&S initiatives can result in material short-term impacts, supporting the financial arguments made by others. Generally, however, the reality is a little inconvenient.
About the Author
Lawrence Heim is a director with The Elm Consulting Group International LLC. He has more than 25 years of experience in the environmental and sustainability field, including the areas of auditing, risk management, and performance/financial metrics. Areas of focus include the development and implementation of EHS audit programs, and integration of risk management and valuation concepts into EHS programs.
Other Articles by Lawrence Heim in the EHS Journal
Photograph: Digital Board by Ilco, Izmir, Turkey