Tag Archives: cap and trade

Details and Excerpts from the SEC’s Climate Risk Disclosure Interpretive Guidance

As we previously reported, the SEC issued their interpretive guidance concerning the need for publicly-traded companies to identify, assess and (if necessary) report climate-related business risks within existing SEC reports.  This interpretive guidance document was published in the Federal Register of February 8, 2010.

Elm has reviewed this publication and provides the following excerpts that we feel may be most critical to companies who are looking to address the requirements of the new Interpretive Guidance.    These excerpts may be slightly edited for length and clarity, but we have attempted to ensure that substantive information remains as in the publication.

The Commission has not quantified … a specific future time period that must be considered in assessing the impact of a known trend, event or uncertainty that is reasonably likely to occur. As with any other judgment required by Item 303, the necessary time period will depend on a registrant’s particular circumstances and the particular trend, event or uncertainty under consideration.

[Management] should not limit the information that management considers in making its determinations. Improvements in technology and communications in the last two decades have significantly increased the amount of financial and non-financial information that management has and should evaluate, as well as the speed with which management receives and is able to use information. While this should not necessarily result in increased MD&A disclosure, it does provide more information that may need to be considered in drafting MD&A disclosure. In identifying, discussing and analyzing known material trends and uncertainties, registrants are expected to consider all relevant information even if that information is not required to be disclosed, and, as with any other disclosure judgments, they should consider whether they have sufficient disclosure controls and procedures to process this information.

If management cannot make a determination concerning the known trend, demand, commitment, event or uncertainty likely to come to fruition, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.’’  Identifying and assessing known material trends and uncertainties generally will require registrants to consider a substantial amount of financial and non-financial information available to them, including information that itself may not be required to be disclosed.

Registrants should consider specific risks they face as a result of climate change legislation or regulation and avoid generic risk factor disclosure that could apply to any company.

Management must determine whether legislation or regulation, if enacted, is reasonably likely to have a material effect on the registrant, its financial condition or results of operations.

Examples of possible consequences of pending legislation and regulation related to climate change include:

  • Costs to purchase, or profits from sales of, allowances or credits under a ‘‘cap and trade’’ system;
  • Costs required to improve facilities and equipment to reduce emissions in order to comply with regulatory limits or to mitigate the financial consequences of a ‘‘cap and trade’’ regime; and
  • Changes to profit or loss arising from increased or decreased demand for goods and services produced by the registrant arising directly from legislation or regulation, and indirectly from changes in costs of goods sold.

We reiterate that climate change regulation is a rapidly developing area.  Registrants need to regularly assess their potential disclosure obligations given new developments.

Registrants also should consider, and disclose when material, the impact on their business of treaties or international accords relating to climate change.

Depending on the nature of a registrant’s business and its sensitivity to public opinion, a registrant may have to consider whether the public’s perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition resulting from reputational damage.

Significant physical effects of climate change, such as effects on the severity of weather (for example, floods or hurricanes), sea levels, the arability of farmland, and water availability and quality.

Possible consequences of severe weather could include:

  • For registrants with operations concentrated on coastlines, property damage and disruptions to operations, including manufacturing operations or the transport of manufactured products;
  • Indirect financial and operational impacts from disruptions to the operations of major customers or suppliers from severe weather, such as hurricanes or floods;

Clearly, SEC’s position is that such a risk identification and assessment framework be robust and extend far beyond a technical environmental scope.

These excerpts are presented for convenience and informational purposes only and should not be solely relied on in developing appropriate information/response to the SEC requirements.  Qualified expertise should be engaged to properly meet these requirements.

Dark Clouds on the Climate Horizon

In 2009, there was a general sense in the US that some regulatory and economic certainty would finally be established relative to greenhouse gases, and CO2 in particular.  The current administration made highly public moves and statements to that effect, which were mirrored by action in Congress and the Senate.  EPA issued its finding of endangerment.  And there was significant optimism that the COP15 Copenhagen meeting would bear fruit.

Fast forward to February 2010.  There has been quite a shift in direction and now there is arguably more business risk related to CO2/GHG than there was going into 2009.  Among recent highlights:

  • Nike formally announced that they are abandoning the use of carbon offsets and Renewable Energy Certificates (RECs), citing, among other concerns:

there is substantial scrutiny of the use of RECs, in particular related to whether they in fact help create new renewable power, or whether they are simply payment to a project that would have existed anyway. … Moving forward, however, our preference is to achieve climate neutrality through a combination of energy efficiency and the purchase of more direct forms of renewable energy, through on-site applications and other means.

  • The German Emissions Trading Authority (DEHSt) computer system was hacked and fraudulent European Union carbon allowance transactions were completed.  Read a report here.
  • Europol, the European law enforcement agency, reported on December 9, 2009 that

the European Union (EU) Emission Trading System (ETS) has been the victim of fraudulent traders in the past 18 months. This resulted in losses of approximately 5 billion euros for several national tax revenues.

As an immediate measure to prevent further losses France, the Netherlands, the UK and most recently Spain, have all changed their taxation rules on these transactions. After these measures were taken, the market volume in the aforementioned countries dropped by up to 90 percent.

  • The Copenhagen meeting failed to achieve the concrete results that had been expected.
  • The accuracy and veracity of data published by key climate scientists was called into question, creating the “Climategate” scandal.
  • The UK government published a report supporting a fixed price or auction reserve on carbon emissions over the current market-driven cap and trade.
  • National-level climate bills in the US are no longer getting the support they enjoyed in 2009.  Read more.
  • Arizona declined to participate in a regional GHG trading program, citing the difficult economy.

However, in contrast to the overarching trend, the US did see two important developments.  First, EPA promulgated its CO2 emissions reporting regulation in October 2009, which is effective calendar year 2010.  Second, SEC issued Interpretive Guidance on the inclusion of climate risks in financial disclosures.

There continues to be significant  uncertainty related to the financial value/risk of climate-related activities.  And that is not likely to change in the near future.

Debate Over Bolivia Carbon Project Spotlights Risks

The New York Times published an article highlighting questions surrounding a major forest preservation project in Bolivia sponsored by American Electric Power, BP and PacifiCorp, known the Noel Kempff Climate Action Project.

Greenpeace claims it found that from 1997 to 2009, the estimated reductions from the program had plummeted by 90 percent, to 5.8 million metric tons of carbon dioxide, down from 55 million tons. It also questioned the “additionality” of the program, which says that a specific forest area would not have been preserved without the program.

What is striking about this matter is not the debate of the project’s effectiveness (given the on-going controversy surrounding the use of forestry in climate risk management).  The surprise was a comment made by Glenn Hurowitz, a director of Avoided Deforestation Partners, a small nonprofit organization that claims to “advance the adoption of U.S. and international climate policies that include effective, transparent, and equitable market and non-market incentives to reduce tropical deforestation”:

In the proposed climate legislation, you can’t get credit for conservation or any other type of offsets until you’ve delivered the offsets. So inaccurate projections would not affect the issuance of credits.

This statement clearly demonstrates a critical business risk in using forestry for carbon management.

While “inaccurate projections” may not impact the issuance of credits, the sequestration calculations/projects have a significant impact on the upfront project support and financing.

It is reasonable to foresee that a failure of forestry to deliver on its projections will have a severely negative impact on the perception of forestry projects as a financially successful and viable carbon risk management tool.

As with any business investment, financial analyses are based on projections about what an investment will deliver in terms relevant to the investment.  In the case of forestry projects, calculations are completed to determine the amount of carbon that is projected to be absorbed and therefore generate the amount of credits/offsets.  These offsets create a financial return in terms of both cost avoidance and potentially revenue.  Financial analyses may be completed for different carbon management options and an investment is made in accordance with the option judged to be the “best” as defined by the criteria applied by the investor.

So what happens if the projections are inaccurate?  Sure, some offsets will likely be delivered by the project.  But will the investment deliver the anticipated return?  Will a shortfall trigger the need for pollution control investments and/or non-compliance penalties?

There continues to be a critical need to reduce risk in forestry-based carbon management investment.  As we have discussed before, it is advisable to take a deep dive into to uptake calculation methodologies, delivery milestones and scenario planning in advance of such investments.

Word Resources Institute Report: Financial Institutions Should Improve Environmental Risk Identification and Mitigation Efforts

Word Resources Institute (WRI) recently published a new issue brief titled Accounting for Risk.

This publication focused on the myriad issues confronting financial institutions (FIs) when determining and evaluating greenhouse gas (GHG) emission inventories and related risks.  The study concludes that there are a number of benefits to FIs for implementing well-thought out processes for assessing GHGs beyond their direct emissions.

Key risks discussed include:

  • GHG risk impact on new investment opportunities.  This risk may be most prevalent in the power generation sector.  WRI noted

Investments in carbon-intensive projects are no longer a safe bet. Companies, under pressure from shareholders, have been pulling support and cancelling plans to construct new coal plants.

  • Appropriate scope for emissions measurement. WRI contrasts two different scoping approaches – the Operational Control approach and the Equity Share approach.  To illustrate the potential differing results between the two, WRI provided an example.

In 2007, Citi reported its total environmental footprint (scope 1 and 2) at about 1.4 million metric tons of CO2, but estimated its share of CO2 emissions from financing just two thermal power plants to be almost 200 million metric tons of CO2 (~3.3 million metric tons on an annual basis based on a 60 year life). That’s a big difference, and, like Citigroup, most other financial institutions’ traditionally reported scope 1 and 2 emissions will be tiny when compared to their share of emissions from investments.

  • Comparability and reliability of emissions calculation methodologies.  Elm has commented several times on the issues of emissions calculation risks here, here and here.  In its report, WRI echoed our earlier comments and quoted Eliza Eubank, Assistant Vice President of Environmental and Social Risk at Citi:

“If everyone is finding their own way and designing their own methodology, then you really don’t know how to compare different numbers that different people are putting out there.” Without guidelines, deciding what and how to report, “can be a very dicey issue.”

In its summation, WRI stated:

To satisfy internal users (i.e., financial institutions) and external users (e.g., investors, clients, NGOs, regulators), more definitive and standardized [GHG inventory] guidance is needed.

Tiny Bug – Giant Financial Risk

Recently, we published discussions related to various risks associated with certain aspects of corporate carbon management programs – planning, calculations and reporting.  But we have had discussions with clients about other risks specifically posed by sequestration techniques.

Today, a Reuters report provides stark evidence of the reality of a disastrous threat to forestry sequestration: the tiny pine beetle. Infestations of the insect cause huge impacts:

In Colorado, aerial surveys show that from 1996 to 2008 Colorado lost almost 2.5 million acres (1 million hectares) of pine forest to the beetle outbreak, Wyoming 677,000 acres and South Dakota 354,000 acres.

Over the same period of time, the spruce beetle, which has also ravaged forests as far north as Alaska, took out 374,000 acres of spruce trees in Colorado and 340,000 in Wyoming.

That cumulative total of over 6 million acres (2.5 million hectares) is an area larger than Israel or South Africa’s Kruger National Park.

As the excerpt states, this is the impact over 12 years.  Commercially-viable forestry sequestion projects typically span 15 to 30 years.  The article stated that Colorado-based U.S. Forest Service scientist Mike Ryan is concerned that pine beetle destruction may lead to forests changing from carbon sinks to net emitters due to carbon releases from the increase in dead timber.

This would mean big problems for companies who have made investments or developed strategies that include forestry sequestration.

Geologic or subsurface seuqestration has also garnered attention.  But this brings an even wider range of exposures – third party damages.  Two scenarios include:

  • Equipment failures or human errors related to the technology for capturing, preparing and injecting CO2 emissions into the subsurface receptor
  • Releases from the receptor itself.

There are many instances of process equipment failures or human errors in industrial settings that have lead to catastrophic events.  Just earlier this week an unidentified chemical release at a household waste transfer station sent more than 100 people to the hospital and triggered a full HAZMAT response by emergency authorities.

What may be less known are instances and impacts of massive CO2 releases from natural “storage”.  Perhaps the most dramatic and relevant is the 1986 Lake Nyos disaster in Cameroon where 1700 people lost their lives.

As CO2 regulation moves forward in the US, thorough identification of risks and solutions becomes imperative.

AIG Shutters Climate Program, Creates Further Uncertainty for EHS and Risk Managers

Articles from the New York Times and Environmental News Network reported that last month, the world’s largest insurer – American International Group (AIG) – closed its climate change program.  AIG was until recently lauded as a leader in the financial services and insurance industry for its GHG activities.  According to NYT, AIG had

established new goals by inventorying its greenhouse gases and was collecting offsets for a year’s worth of emissions, developing insurance policies for renewable energy providers, and brainstorming for financial instruments that would assist innovators in the green movement.

With the closing of their climate program, the company is no longer calculating its emissions,  ceased efforts to reduce them and canceled its Be Green program,  NYT reported.

“Some people were concerned that if you took an advocacy position [on climate change], that might annoy — that’s a good word — clients,” the articles quoted Joseph Boren, the former CEO of AIG Environmental.

Both articles quoted Richard Thomas, former senior vice president of AIG, as saying that AIG’s decision about its climate change program  “will retard the development of some of the financial instruments to address some of the issues in climate change.” He pointed out that “AIG was a leader in that area, and now because of so much of what AIG did is in disrepute on the financial product side, I think that sends a chill through everyone.”

What does this mean?

Fundamentally, this demonstrates the unrelenting uncertainty of business risk related to climate management issues in the United States.  AIG’s actions are concurrent with federal GHG legislation having passed the House and awaiting Senate action, a President publicly committed to climate action, growing participation in the Climate Disclosure Project (CDP), successful completion of the first phase of RGGI and now Walmart’s supplier sustainability initiative.

Thomas’ statement and the NYT article indicate that some of AIG’s climate solutions were based on complex financial instruments rather than traditional insurance policy structures.  This itself presents an array of questions and possible concerns.  Certainly, the past year has shown the stark downside of AIG’s management of financial products; public and client concerns about the validity of such mechanisms may be justified.

Companies who had hoped to obtain insurance for various climate-related risks may not be able to do so, at least possibly not to the extent originally envisioned.  This places additional burden on companies to identify and assess their climate-related exposures themselves, develop internal management strategies on their own, and reduce reliance on potential insurance policies for financial risk mitigation.

Making plans for greenhouse gas emissions (GHG) trading?

Two articles in the June 26, 2009 edition of the Wall Street Journal highlighted two interesting items of potential concern to US companies who are planning their carbon or GHG strategies.   The articles (links posted below) discuss

-       new regulatory uncertainties of an emerging US GHG cap and trade mechanism.  A new round of technical backlash is arising from respected scientists around the world concerning the previously-touted scientific consensus on GHG emissions contribution to global climate change.

-       Financial institution concerns about the trading controls included in the current version of the American Clean Energy and Security Act.

There continues to be the need for US-companies to conduct a thorough business risk assessment of potential GHG trading plans and strategies.

http://online.wsj.com/article/SB124597505076157449.html

http://online.wsj.com/article/SB124597170994956985.html