CLIMATE BUSINESS

Climate Business | Business Climate

From the Magazine (October 2007)

Grist: A Strategic Approach to Climate

by Michael E. Porter and Forest L. Reinhardt

Climate change is now a fact of political life and is playing a growing role in business competition. Greenhouse gas emissions will be increasingly scrutinized, regulated, and priced. While individual managers can disagree about how immediate and significant the impact of climate change will be, companies need to take action now.

Companies that persist in treating climate change solely as a corporate social responsibility issue, rather than a business problem, will risk the greatest consequences. Of course, a company’s climate policies will be affected by stakeholder expectations and standards for social responsibility. But the effects of climate on companies’ operations are now so tangible and certain that the issue is best addressed with the tools of the strategist, not the philanthropist.

From Effectiveness to Strategy

There is no one-size-fits-all approach to climate change. Each company’s approach will depend on its particular business and should mesh with its overall strategy. For every company, the approach must include initiatives to mitigate climate-related costs and risks in its value chain. Business leaders need to start treating carbon emissions as costly, because they are or soon will be, and companies need to assess and reduce their vulnerability to climate-related environmental and economic shocks. Every firm needs to get those basics right, as a matter of operational effectiveness.1

A firm that has more employees than it needs in its shipping department is operationally ineffective; its managers are wasting resources and creating a drag on performance. In the same way, a firm that produces excess emissions in its shipping operations is also operationally ineffective—it is wasting resources and incurring unnecessary costs that are certain to rise. Implementing best practices in managing climate-related costs is the minimum required to remain competitive.

In addition to understanding its emissions costs, every firm needs to evaluate its vulnerability to climate-related effects such as regional shifts in the availability of energy and water, the reliability of infrastructures and supply chains, and the prevalence of infectious diseases. The firm’s leaders should systematically assess these risks and then decide which to reduce through redesigning operations, which to transfer to others through insurance or hedging contracts, and which to bear.

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For some, but not all, companies, the approach to climate change can go beyond operational effectiveness and become 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. For example, operational response to climate change in outbound logistics or after-sales service might involve more-efficient engines on delivery and service vehicles, or modified schedules to reduce traffic delays. By contrast, strategic approaches could involve reconfiguring the activity entirely: In outbound logistics, firms might replace physical books or manuals with electronic versions, and in after-sales service, they could supplant physical visits by service technicians with remote diagnostics and treatment programs.

Inside Out and Outside In

To set a firm’s approach to climate change and assess the strategic opportunity, business leaders need to look “inside out” to understand the impact of the firm’s activities on the climate and “outside-in” at how changing climate (in both it’s physical and its regulatory manifestations) may affect the business environment in which the firm competes.2

To understand the inside-out impact, managers need to study the firm’s value chain. Any value-chain activity—inbound logistics, operations, outbound logistics, marketing, sales, after-sales service—can generate emissions. The simple ratio of profits to total emissions in the value chain can be a very telling measure of potential climate impact. If new regulations put a price of, say, $10 a ton on emissions, would that put a significant dent in the profits or even swallow them altogether? “Carbon exposure” rises with the impact of carbon costs on profits. Like other risks, carbon exposure carries opportunities as well as challenges: Forestry companies, for example, may find that removing carbon dioxide from the air by planting trees may be as profitable as cutting them down and producing paper or plywood.

The emissions impact of activities in the value chain can be direct or indirect. Emissions can be generated by activity under the firm’s direct control or induced by the firm in the activities of suppliers, channels, and customers. A company needs to understand the emissions it causes its business partners to produce, as well as those it generates itself: Both types are important targets for reduction.

These changing inside-out impacts have potentially revolutionary implications. For example, modern supply chains, with their transportation-intensive, just-in-time inventory management systems, may no longer be optimal in a world with more costly emissions. Similarly, e-commerce, with its proliferation of small shipments, may face real limits. And in some cases, offshoring, which drives up emissions by lengthening transportation hauls, maybe supplanted by lower-emissions onshoring to nearby clusters of suppliers.

High carbon exposure, as revealed by an inside-out analysis, does not by itself mean that climate is strategic for a firm. Once managers understand their firm’s overall carbon exposure and the emissions impact of specific activities in the value chain, they can devise an action plan to address them. Emissions-intensive activities that add little value are candidates for elimination or outsourcing to more-efficient firms. Those that are important to value may become strategic if a company can reduce its exposure relative to competitors through improved performance.

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Inside-out analysis helps shed light on the logic behind Wal-Mart’s approach to climate. Wal-Mart’s activities are logistics- and transportation-intensive, and the firm is actively seeking to reduce the resultant emissions. At first blush, this approach looks purely operational: The firm is reducing energy use to mitigate the potentially harmful effects of emissions on costs in its value chain. Wal-Mart’s emissions-reduction programs will be strategic, however, if it can use its scale, scope, ability to invest heavily in technology, and reconfiguration of its value chain to reduce emissions in a way that is difficult for its smaller rivals to replicate. Wal-Mart seems to be making a strategic bet that it can reduce its carbon exposure more than competitors can and keep it lower.

In tandem with inside-out analysis, an outside-in look can reveal a new array of opportunities and threats. Climate change will affect a firm’s business environment in two broad ways: through shifting temperature and weather patterns, and through regulations that increase the cost of emissions. Either can affect the availability of business inputs; the size, growth, and nature of demand; access to related and supporting industries; and the rules and incentives surrounding industry rivalry. Business leaders should evaluate how climate change may affect each part of this context for competition.

While property insurers’ own carbon emissions may be low, for example, carbon exposure may be high for companies that insure or reinsure coastal real estate that is threatened by rising sea levels. Similarly, most of the carbon emissions associated with oil come not from oil companies but from their customers. Restrictions on emissions will constrain the demand for these companies’ products. Or consider the multifaceted outside-in impact on a food company like Nestlé. Climate change will alter the relative productivity of various regions in which the firm buys agricultural commodities, affecting input costs. At the same time, the regulatory responses to climate change will raise the costs of energy used in keeping ice cream cold in retail outlets, which will affect demand conditions. And so on.

Firms can address outside-in effects strategically if they can manage them in ways that competitors cannot readily match. Nestlé eschews upstream vertical integration and instead outsources its raw material production. That makes its supply chain more flexible, which could provide a valuable strategic advantage if the productivity of various regions shifts and Nestlé’s competitors find themselves constrained by their more rigid supply structures. Likewise, drought-resistant crop strains and vaccines,  and treatments for insect-borne diseases will become increasingly valuable (as long as their innovators can protect their intellectual property).

Periodically, major new forces dramatically reshape the business world—as globalization and the information technology revolution have been doing for the past several decades. Climate change, in its complexity and potential impact, may rival them both. While many companies may still think of global warming as a corporate social responsibility issue, business leaders need to approach it in the same hardheaded manner as any other strategic threat or opportunity.

 

Michael E. Porter is the Bishop William Lawrence University Professor at Harvard University; he is based at Harvard Business School in Boston. He is a co-author of Redefining Health Care: Creating Value-Based Competition on Results (Harvard Business School Press, 2006). Forest L. Reinhardt is the John D. Black Professor of Business Administration at Harvard Business School. He is the author of Down to Earth: Applying Business Principles to Environmental Management (Harvard Business School Press, 1999).
  1. For more on operational effectiveness and strategy, see “What Is Strategy?” by Michael E. Porter (HBR November–December 1996).
  2. A full explication of inside-out/outside-in analysis is available in Michael E. Porter and Mark R. Kramer’s article, “Strategy and Society: The Link Between Competitive Advantage and Corporate Social Responsibility” (HBR December 2006 ).

Risk: Investing in Global Security

by Peter Schwartz

Climate change may happen abruptly, and its effects could be devastating. How global companies respond today in the regions that may be hardest hit will affect the viability of the markets in those areas. Rather than retreat from them, however, companies need to improve their future resilience. This is as much a matter of strategy as corporate social responsibility.

In the coming decades, we can expect to see sea levels rise and more extreme droughts, storms, and flooding. These events become security concerns for businesses when people are forced to flee, infrastructure is destroyed, ecosystems fail, agriculture is disrupted, economic volatility increases and some regions become uninhabitable.

We know that climate extremes can destroy thriving business environments and even societies. The long, monstrous war in Darfur is properly understood as genocide caused by a struggle for resources that resulted from the kinds of events that will accompany climate change. Hurricane Katrina so severely damaged local infrastructure that many businesses still haven’t recovered. Imagine what will happen when, with even a modest sea-level rise, flood-prone Bangladesh experiences increasingly severe monsoons and is all but submerged: More than one hundred million people could be forced to seek refuge in neighboring India or China, causing dangerous social and economic strain. Or imagine a drought in southern China that radically reduces the flow of the Mekong River, which runs through six Asian countries. The conflicts that would arise around access to water—for irrigation, for households, for the industry—could disrupt this region’s fast-growing economies.

Companies need to anticipate the ways that climate change may directly affect their businesses, including supply-chain breakdowns, employee migrations, increases in disease, or even impact on reputation (multinational corporations may be blamed for climate-related environmental problems). But they also need to evaluate their risks more broadly, identifying whether the environments they operate in are susceptible to catastrophic, cascading climate-related disruption. To do so, they should systematically assess the vulnerability of these environments to floods, droughts, and storms, paying particular attention to areas that have a limited ability to anticipate and adapt to climate change. The most vulnerable will be places where, for example, the state has limited capacity to respond, the local ecosystem is fragile, urbanization is accelerating with few social services, and the water supply is already stretched. Haiti is perhaps the most extreme case, but India, the Philippines, and parts of Central America are all at risk. In such a stressed system, a severe, prolonged weather event could launch a crisis of interconnected events from which recovery might be impossible.

 

Companies can help vulnerable regions plan for climate change, reducing their own risks by making proactive investments and supporting policy initiatives that they might have resisted in the past, such as tougher local air and water quality standards. And, of course, firms can be prepared to help with urgent relief efforts when some of the worst effects actually do come about.

In fact, the system’s vulnerabilities created by climate change can turn into “systems opportunities” for businesses to develop novel partnerships with the government, other players in the supply chain, and even traditional competitors, for example in preparing the infrastructure needed for disaster recovery. By taking a leadership role in helping regions anticipate climate change and mitigate risk, companies can advance their interests while building goodwill in the communities in which they do business. Coca-Cola’s recently announced partnership with the World Wildlife Fund to help protect global water resources and improve the firm’s own water management is a good example of a company’s effort to address climate change both directly in its own operations and in the wider society it serves. Coke’s actions are likely to help both the company and local communities while enhancing the company’s image around the world.

Multinational firms prepared to take the long view can avoid the worst consequences of climate change and perhaps help businesses build a stronger reputation as a powerful agent of societal well-being.

Peter Schwartz (schwartz@gbn.com) is a co-founder and the chairman of Global Business Network, a strategy consultancy in San Francisco and part of the Monitor Group. His related white paper “Impacts of Climate Change” is available at www.gbn.com/climatechange.

Forecast: How Will a Warmer World Look

During this century, climate change will cause extreme phenomena that will have significant repercussions for humanity, industry, and the environment. The timing and exact nature of the effects are uncertain, but scientists’ best estimates, summarized in the table below, can help businesses think strategically about their response.

Projected Changes This Century

Transparency: What Stakeholders Demand

by Daniel C. Esty

As Apple sped toward the June 2007 launch of its innovative iPhone, the company hit an awkward bump in the road. An environmental group called Climate Counts released a scorecard ranking major corporations on their tracking, reporting, and reduction of greenhouse gases. Apple came in dead last in the electronics industry category, with a score of 2 out of 100. Accounts of Apple’s abysmal performance spread instantly in the blogosphere and were reported by MSNBC, the Wall Street Journal Online, Reuters, and other mainstream media.

Should Steve Jobs be worried? Absolutely. Increasingly, customers, employees, and capital markets—as well as governments and NGOs—expect companies to release public reports on greenhouse gas emissions, make progress in improving energy efficiency, and hit targets for reducing emissions. Companies that fail to meet those expectations face potentially serious business consequences, for four broad reasons.

First, the subpar environmental performance has become hard to hide and threatening to a company’s reputation. The Climate Counts ranking of Apple was only the most recent in a series of damning evaluations of the company by such organizations as the Carbon Disclosure Project. Poor marks on reporting and managing climate impact are putting Apple’s reputation for being cutting-edge and cool at risk. That may seem far-fetched, given Apple’s robust performance and passionate customers. But some environmental NGOs have begun raising consumer awareness about Apple’s lack of environmental effort, the most notable being Greenpeace with its “Green myApple” campaign, which took the company to task for its “iWaste,” and company executives, including Steve Jobs, have privately expressed concern about a backlash against the firm for its poor environmental ratings. In a May 2007 letter posted on Apple’s website, Jobs acknowledged the criticism of the company’s environmental performance and pledged to henceforth “openly [discuss] our plans to become a greener Apple.”

Second, smart management of environmental issues has become a way to positively shape brand image and attract new customers. To date, the evidence on this front is anecdotal rather than rigorously statistical. But growing public interest in climate-friendly companies and products is driving many major firms to put a green stake in the ground.

Carbon reporting and emissions management has become a public relations battleground among supermarkets in the UK, for example. After Tesco pledged to invest £100 million in environmental technologies to reduce its energy consumption, Marks & Spencer announced that it would go “carbon neutral,” coming out with a 100-point action plan on climate change and the environment. Conveying a dramatic sense of urgency, company CEO Stuart Rose observed, “We are calling this ‘Plan A’ because there is no ‘Plan B.’ “A few days later, Tesco responded by promising to label all 70,000 items it sells with data on each product’s carbon footprint. Highly visible moves like these reveal a keen understanding of customers’ shifting attitudes.

Third, reporting signals a company’s seriousness about climate change and provides a gauge of its ability to track and manage emissions. That capability is seen by many observers, including Wall Street analysts, as a proxy for good environmental management, which studies show correlates with good general management and superior stock market performance over time. Reporting is similarly seen as a measure of corporate trustworthiness and good governance.

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Fourth, financial markets are beginning to recognize that inattention to greenhouse gas emissions may soon have real cost and risk implications. Last spring more than 50 U.S. investors with a combined total of $4 trillion under management called on the U.S. Congress to enact legislation to curb carbon emissions. In a statement, the signatories, including investment funds for labor unions, state pensions, insurance companies, and major asset managers, wrote, “In the current unpredictable national climate policy environment, it is exceedingly difficult and risky for businesses to evaluate and justify the large-scale, long-term capital investments needed to seize existing and emerging opportunities….” Dozens of funds now screen companies for environmental and sustainability factors, including emissions reporting, and exclude poor performers. In July, for example, Citigroup downgraded coal stocks across the board, explaining in an equity research report that “[coal] company productivity/margins are likely to be structurally impaired by new regulatory mandates applied to a group perceived as landscape-disfiguring global warming bad-guys.” Meanwhile, the number of environmental resolutions before shareholders in the 2007 U.S. proxy season set record highs, led by demands to address climate risks.

With the United States moving toward regulating emissions and Europe already imposing greenhouse gas limits, large companies that don’t report are assumed to have high emissions. They’re thus considered to be exposed to forthcoming carbon charges, as well as to current high energy costs, risks that could undermine their competitiveness. Meanwhile, companies that track greenhouse gases closely and report results appear better positioned to undertake serious emissions-control efforts and to minimize the consequences of new regulatory requirements.

Indeed, when buyout powerhouses KKR and Texas Pacific Group made a deal to acquire TXU, the big Dallas-based utility, they changed little except the company’s plan to build 11 new coal-fired power plants, cutting that number to three. The private equity firms concluded that investing in coal today when carbon emissions were sure to be costly in the future made little sense. A broader trend here is worth noting: In 2006, TXU’s stock price suffered after Environmental Defense activists launched a campaign opposing the coal plants, which made the company vulnerable. The prospect of a takeover by powerful private equity groups is likely to force a discipline on any company that fails to calculate its carbon exposure and adjust its strategy accordingly.

Beyond responding to stakeholder pressures, careful tracking, and management of emissions prepare companies to manage climate change challenges systematically. Those who fail to monitor, report, and mitigate emissions face the prospect of mounting competitive disadvantage.

Daniel C. Esty (daniel.esty@yale.edu) is the Hillhouse Professor at Yale University in New Haven, Connecticut, and the director of the Center for Business and the Environment at Yale. He is a co-author, with Andrew S. Winston, of Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage (Yale University Press, 2006).

Why should businesses care about voluntary reporting on carbon emissions?

It’s the fiduciary duty of any company to ask, Is this issue important to our stakeholders? Today it is very difficult for a company to say that greenhouse gas emissions are not a subject of material interest to stakeholders. If you’re a supplier to Wal-Mart, you have to answer yes. If you’re in the oil and gas business, you have to answer yes. If you’re a company looking for good access to capital markets, where more and more investment firms are considering climate change impact as part of a company’s risk profile, you have to answer yes. Whatever sector of business you’re in, disclosure is increasingly expected, and failure to disclose can put you at a strategic disadvantage.

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How does the reporting process help a company address climate-related risks?

Companies quickly realize that reporting can’t happen without strategy development. As firms start the process of putting a report together—talking to stakeholders, examining core businesses—they’ll have to back up and ask, What is our strategy on climate change anyway? What is our approach to managing this risk? The discipline of sorting out which activities are material to report on and in what depth, and what data will be used to document progress, forces companies to formulate strategies. For companies that haven’t been engaged in climate change and need to catch up with competitors that are disclosing, the reporting process is a stimulus for opening up a dialogue with stakeholders about the issue.

Just as important, the report serves as an accountability mechanism. It allows a company to make commitments and show through performance that it is doing what it said it would do. If you think about the “plan, do, check, act” cycle of corporate management, reporting provides the check: Here are our goals; here’s the system we’ve put in place. Now let’s see how we’re progressing and where we need to readjust.

Aren’t disclosures of potential trouble areas risky?

Companies’ natural instinct, which we’ve seen across the board, is to avoid public disclosure on potential risks, whether it’s greenhouse gas emissions or something else. But we’ve also seen how reporting creates a communications avenue through which companies can effectively and accurately position themselves with their stakeholders—investors, customers, regulators, and so on. You can’t walk through an airport in Europe, for example, without seeing a BP poster for its “Beyond Petroleum” campaign. In this initiative, BP draws on hard facts from its reporting process as it works to shape the carbon-emissions debate and position itself as a leader in renewable energy sources. It’s using report data—this is not greenwashing—to demonstrate its nimbleness as a company to adapt to emerging risks and be on the cutting edge of new opportunities.

From a governance standpoint, how much weight should information from the reporting process carry?

It’s a primary responsibility of the board and the CEO to determine the implications of their company’s future climate risks and (a) report them and (b) mitigate them. Companies are adept at assessing their financial performance, but too many are afraid to look in the mirror and face potential risks that could damage their business. Directors want to know that a company will be as competitive over time as it is in the short run. That requires looking beyond the quarterly financial results. Financial reporting of course allows you to understand only a certain slice of a company’s true market capitalization. Consider Coca-Cola: 20% of its market cap can be attributed to its book value, that is, its hard assets. Eighty percent of its value is attributed to intangibles—brand, R&D, risk management, ability to innovate in a globalizing and resource-constrained world—all things that are not captured in a financial statement. Sustainability reporting focuses squarely on those areas, which businesses traditionally have not done a good job of understanding and managing.

—Christina Bortz

Regulation: If You’re Not at the Table, You’re on the Menu

by Andrew J. Hoffman

When the companies of the United States Climate Action Partnership (USCAP)—businesses including GE, Alcoa, DuPont, and PG&E—announced their call for federal standards on greenhouse gas emissions in January 2007, the Wall Street Journal castigated these “jolly green giants” for acting in their own self-interest in promoting a regulatory program “designed to financially reward companies that reduce CO2 emissions, and punish those that don’t.” But seeking advantage is what companies do. Any company that can foresee business opportunities in influencing carbon-emissions regulation is practicing what is expected of business managers—capitalism.

Indeed, any company that sits on the sidelines as the policy is formulated is recklessly playing the bystander to a significant shift in its market environment. Carbon-emissions regulation will burden certain companies, industries, and sectors more than others, and, likewise, will deliver advantage unevenly. The regulatory policy will set the rules of the game that affect how that burden will fall and how the advantage will be delivered. It’s time to plot how you’ll respond.

At a minimum, all companies should know their carbon footprint—where their emissions are coming from and in what amounts (this may include understanding suppliers’ footprints, too). At the next level, they can take steps to reduce emissions and calculate the costs per ton to make those reductions. The most advanced companies can parlay that experience into an advisory role with governments, gaining a seat at the table when regulations are designed. BP and Shell, for example, became savvy carbon-emissions traders in advance of any requirements, allowing them to become advisers to policymakers in the European Union.

Companies that hope to participate in policymaking need to know the answers to two questions: First, what’s on the table (what are the regulatory issues at stake)? And second, where is the table (where are standards being developed)?

What’s on the table? To shape policy to your advantage, you must start by monitoring pending regulations and understanding how they may affect your business objectives. That requires being knowledgeable about the relevant language and issues. Here’s a quiz:

  • Do you understand how cap-and-trade programs work or how carbon taxes might be applied? Do you know which of the possible programs under discussion would best serve your company’s interests?
  • Do you have good intelligence on how carbon-emissions permits will be allocated, whether there will be economy-wide or sector-based standards, whether deeper reductions will be expected from upstream or from downstream industries, whether there will be a “safety valve” above which emission prices will not go, and what emissions will be counted (direct, indirect, or both)?
  • Do you know the difference between renewable energy credits, verified emission reductions, certified emission reductions, emission reduction units, and European Union allowances? Do you know how to make deals under the Clean Development Mechanism and the Joint Implementation?

If your company doesn’t know the answers, you’re probably ill-prepared to participate in policy development and already missing out on the fast-growing carbon-trading market—one that roughly tripled from $11 billion globally in 2005 to $30 billion in 2006.

Where is the table? Climate-related standards are being set at the state, national, and international levels. Which will become the dominant standard? Answering that question tells you which table to sit at but requires making a calculated guess among an array of possibilities.

For example, a company in the New England region of the United States might focus on shaping local policy in the near term and become involved in the Regional Greenhouse Gas Initiative in the Northeast and Mid-Atlantic United States. On the West Coast, a company could lobby the California Air Resources Board as it develops mandatory emissions-reporting rules. Or a U.S. company could lobby in the 47 states that, according to a July 2007 report, had begun to inventory emissions, developed renewal portfolio standards, and climate action plans, or committed to a cap-and-trade system. Thinking more broadly, the firm could lobby at the federal level on one of the more than 100 climate-related bills making their way toward a vote. On the international level, and thinking in the longer term, a company could engage with the United Nations Framework Convention on Climate Change as it debates what rules will be established after the Kyoto treaty expires in 2012.

Establishing a presence at each of these tables would require tremendous resources. An efficient alternative is to join one of the many industry or activist groups or trade associations that are weighing in on these myriad negotiations, such as the Chicago Climate Exchange, USCAP, the Pew Center’s Business Environmental Leadership Council, the Global Roundtable on Climate Change, or the World Business Council for Sustainable Development. Participation in such organizations can keep you informed about policy development and give you the tools to help you shape it.

Andrew J. Hoffman (ajhoff@umich.edu) is the Holcim (US) Professor of Sustainable Enterprise and the associate director of the Erb Institute at the University of Michigan in Ann Arbor. He is a co-author, with John Woody, of the forthcoming book Climate Change: What’s Your Business Strategy? (Harvard Business School Press, 2008).

Reputation: When Being Green Backfires

by Auden Schendler

In the past two years, companies have battled to outdo one another in their high-profile purchases of certificates symbolizing “green” electricity produced by wind, solar power, and other carbon-free, climate-friendly means. The problem is that the buying spree, meant to burnish companies’ green credentials, may end up tarnishing them.

Consider this: In January 2006, Whole Foods announced the purchase of renewable energy certificates (RECs) representing the production of 458,000-megawatt hours’ (MWh) worth of green electricity but was soon trumped by Wells Fargo, which bought 550,000 worth. Then Pepsi surged ahead of last April with an unprecedented 1.1 million MWh REC purchase. The companies trumpeted their purchases with claims that they “offset” or, in effect, neutralized some of their carbon emissions. I made similar claims when my own company purchased RECs.

Anytime there’s a feeding frenzy, you have to ask, What’s so tasty? Why are businesses falling over one another to buy these pieces of paper? Printed by producers of energy each time they generate clean electricity—and then sold to hungry buyers—the certificates merely symbolize green energy. (For more, see the box “How Do Renewable Energy Certificates Work?”)

How Do Renewable Energy Certificates Work?

When a wind turbine or solar panel generates a megawatt-hour of electricity (a little more than an American home uses each month, on average), that clean, carbon-emission-free electricity flows into …

Most businesses will say they’re buying RECs because they care about the environment and climate change. Fair enough. But for many, buying RECs is a relatively inexpensive way to make a powerful brand-positioning statement. In one stroke, a business can don the environmental mantle, seemingly legitimately and at an affordable price, without having to directly and expensively do anything to reduce carbon emissions. Certainly, corporate reputations have been enhanced by large REC purchases.

The danger in buying RECs is that the mainstream press has begun to challenge claims about their environmental value. Articles have appeared in publications including BusinessWeek and the Financial Times pointing out that most RECs don’t actually offset emissions, and the skepticism is spreading across the Internet. Indeed, most RECs don’t result in the creation of clean electricity, which would have been generated anyway, whether or not a REC was printed. As consumers become increasingly savvy about evaluating companies’ environmental claims, businesses that tout REC purchases may expose themselves to charges of greenwashing.

A report released in 2006 by an environmental organization called Clean Air-Cool Planet was among the first to rigorously examine the environmental impact of RECs. The report found that while most RECs don’t lead to carbon-emissions reductions, a minority do, by directly helping to finance, say, the construction of a new wind farm. Companies that buy RECs and want to avoid charges of greenwashing should seek out these higher-quality and more costly certificates, whose purchase directly and demonstrably helps reduce carbon emissions.

RECs, supporters argue, create a market mechanism that spurs the development of new wind, solar, and other green-electricity plants. As demand for RECs grows, their prices will rise, encouraging developers to build more renewable power facilities that can generate income through increasingly profitable sales of the certificates. Unfortunately, because there has been such a surplus of cheap RECs—and no easy way to distinguish between high- and low-quality offerings—the market mechanism has remained stalled for the most part. If companies, mindful of their reputations, reject inferior RECs and begin demanding quality ones, that could jump-start the production of renewable electricity and actually reduce carbon emissions. Corporate scrutiny and activism might even foster the development of a badly needed tool that could clean up the entire REC industry in one masterstroke: a third-party gold standard for REC quality.

Auden Schendler (aschendler@aspensnowmass.com) is the executive director of community and environmental responsibility at Aspen Skiing in Colorado.

Conversation: Alyson Slater, Global Reporting Initiative’s Director of Strategy, On How Disclosing Emissions Benefits Companies

Carbon-emissions reporting is a laborious undertaking that publicly exposes potentially serious liabilities and risks facing your business—and it’s voluntary. So why do it? We explored that question with Alyson Slater, the director of the strategy at Global Reporting Initiative, an Amsterdam-based organization that has developed the most widely used framework of reporting principles, guidance, and standard disclosures on environmental, social, and economic performance.

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