Tag Archives: cost avoidance

An Inconvenient Reality For Environmental/Sustainability Professionals?

For years, those of us in the environmental/sustainability profession have sought credible ways and metrics for quantifying the economic value of our efforts, activities and programs.  A myriad of studies completed dating back to the late 1980s attempt to demonstrate “environmental value”.  Most of these studies have shown rather tenuous linkages or used meaningless metrics.

Interestingly, most of these studies link to equity markets – i.e., stock prices.  Maybe because stock prices grab headlines, are tied to compensation or are the target to which Boards and senior executive generally manage.

The problem is that environmental/sustainability matters don’t fit into this model, either because they tend not to be financially material, or they don’t develop economic certainty within the “current quarter” myopia of corporate management, financial markets and analysts.

A recent article on the topic was published in The International News.  The article includes an interview with Kevin Parker, CEO of Deutsche Asset Management (DeAM) on the subject of how capital markets currently view environmental/sustainability risks.  DeAM manages over US$775 billion in assets.

With simplicity, clarity and unquestionable credibility from the financial market viewpoint, Parker made key points in the article and interview:

  • Bond markets are poised to punish polluting companies in the aftermath of the Macondo oil spill and Fukushima nuclear crisis.
  • “The process of re-pricing carbon and environmental risk has begun, because these two events were catastrophic.”
  • By contrast, shorter-term equity and commodity markets have continued to chase high-carbon opportunities, including voracious emerging market demand for coal.
  • But investors in longer-term debt including bonds will increasingly avoid unsustainable companies … an inexorable trend that will push up their borrowing costs.
  • “What this boils down to be risk in capital markets, and capital markets know how to price risk once they understand it.”

Pension investment managers realized this years ago since they emphasize stability and a long-term investment horizon.

But there seems to be far less recognition of this by environmental/sustainability practitioners, as the amount of studies, white papers and pseudo-financial metrics is mounting, with continued emphasis on the equities side of capital markets.  Perhaps the driving forces for this are general economic pressures facing companies are pushing staff to find ways to justify their existence and cost, consultants are trying to come up with that elusive short-term ROI metric for the cost of their services to clients and much of the HSE/sustainability media are vying for limited attention on the part of their readership.

Given Parker’s comments – and the lackluster historical success of valuation of environmental/sustainability matters in the context of stock prices – perhaps it is time to redirect our efforts at finding relevant and credible metrics.

In limited circumstances, financial value of environmental/sustainability initiatives can manifest in material and short-term impacts.  Those instances give practitioners hope of riding those coattails.  But generally, the reality is a little inconvenient.

In Tampa, a Mining Company Shutdown Highlights Business Interruption Risk from Environmental Issues

In Tampa Bay, an all-to-real demonstration is playing out of the trickle-down economic impact of a company operation being shut down for environmental reasons.  The Tampa Bay Business Journal reported this story.

The Mosaic Co. is a publicly-traded company with over $6billion in annual revenue reported last fiscal year.  Mosaic mines phosphate ore.  The company has been mining in Polk County since 1995 and recently filed for an expansion of operations to access reserves in Hardee County.  These ore reserves represent about 10 years of active mining operations.

The Sierra Club, along with other NGOs challenged the issuance of a federal permit that would allow Mosaic to expand, alleging that the expanded operations would cause environmental damage to the headwaters of the Peace River and other streams that drain into the Charlotte Harbor estuary.

On July 30, in response to the challenge

U.S. District Judge Henry Lee Adams Jr. in Jacksonville issued a preliminary injunction against the expansion, saying the Army Corps had failed to adequately explore alternative plans that would cause less environmental damage to the area.

The article reports that, if the Mosaic expansion does not move forward, the economic impact would be dramatic.

At least 18 companies that do business with Mosaic would be out at minimum of $80 million in combined annual revenue, and about 400 of their employees would lose their jobs, in addition to the 221 Mosaic workers who would be laid off …

“If Mosaic is prohibited from further mining, it will mean that Bul-Hed Corporation would cease to exist sometime in the near future,” Ronnie Hedrick, president, said in a court filing.

Mosaic has estimated it would lose $250 million to $300 million in operating earnings in a worst-case scenario.  In its fiscal year ended May 31, Mosaic had earnings of $1.75 billion before interest, taxes, depreciation and amortization on net sales of $6.76 billion.

Business Interruption Planning

The company’s most recent 10-Q (Item 1A – Risk Factors), filed April 1, 2010, did  disclose this potential risk:

Expansion of our operations also is predicated upon securing the necessary environmental or other permits or approvals. Over the next several years, we and our subsidiaries will be continuing our efforts to obtain permits in support of our anticipated Florida mining operations at certain of our properties. In Florida, local community participation has become an important factor in the permitting process for mining companies, and various local counties and other parties in Florida have in the past and continue to file lawsuits challenging the issuance of some of the permits we require. In fiscal 2009 environmental groups for the first time filed a lawsuit in federal court against the U.S. Army Corps of Engineers with respect to its issuance of a federal wetlands permit and similar lawsuits could be brought in the future. A denial of, or delay in issuing, these permits or the issuance of permits with cost-prohibitive conditions could prevent us from mining at these properties and thereby have a material adverse effect on our business, financial condition or results of operations.

Even so, how should the company – and its business partners – respond to such a risk?  And did business partners understand, assess and plan for such a contingency?  In many discussions we have had with clients about potential shut downs, it is common for companies to plan production volume shifts across other operating locations to make up for the lost volume and continue operating.  In Mosaic’s case, however, the article states:

Although Mosaic has four other mines in Florida, their output would not offset the impact of a shutdown at South Fort Meade, the company said.

Even where a company has the physical capacity at other locations to make up for lost production at one plant, environmental restrictions may not allow timely production increases at others.  Wastewater and air permits typically contain conditions limiting production.  These limits can take various forms:

  • Direct limits.  For example, plant operating hours or volume; emissions limits for production equipment or material use; wastewater flow or contaminant concentration limits.
  • Indirect restrictions.  For example, fuel use or emissions limits on supporting equipment such as generators or boilers; wastewater treatment capacity/retention time for adequate treatment.

Suppliers, contractors and vendors may attempt to recover losses from Mosaic through the contractual obligations in place between the parties.  However, in this case, Mosaic has notified at least some of their business partners that this is a “force majeure” event – an extraordinary circumstance beyond their control – which releases Mosiac from contractual obligations.

Has your company evaluated/assessed the myriad business continuity risks associated with environmental matters in your supply chain?  And what contingency plans do you have in place to protect yourself?

“Surprised and Concerned” About Illegitimate Government-Sponsored CER Trading?

Environmental Leader has reported

that the Hungarian government sold 2 million previously used CERs, the market became tepid. Then when prices fell from more than 12 euro per credit to less than one euro, trading was suspended on two exchanges, Bluenext and Nord Pool.

The NYT provided more details of the transaction, stating

The credits appear to be part of massive blocks of CERs awarded to Eastern European states and Russia after the collapse of Soviet-era industry.  This created a loophole used by Hungary to reintroduce used CERs back into the market…

Carbon traders said countries like Hungary were exploiting the loophole to earn more money from the carbon trading system than they could by selling the credits that they had previously earned under the Kyoto system…

The traders said at least one other E.U. member state had acted similarly earlier this year.

The EU said they were “surprised and concerned” about the situation.  BusinessWeek quoted others who expressed more urgency about the matter:

“The supply and demand dynamics have been changed,” said Paul Kelly, chief executive officer of JPMorgan’s EcoSecurities unit. While the scope of the problem has yet to be determined, buyers are “questioning the authenticity” of what they are buying.

Unfortunately, this isn’t the only recent development that may cause market participants concern.  This is just the latest in a barrage of credibility and financial damage for GHG emissions trading, including:

  • Last year swindlers robbed governments of about 5 billion euros in revenues — about $6.8 billion — by selling carbon credits and disappearing before paying the required Value Added Tax on the transactions.
  • In January, swindlers used faked e-mail messages to obtain access codes for individual accounts on national registries that make up the bloc’s Emission Trading System, and then used the stolen codes to gain access to electronic certificates that represent quantities of greenhouse gases.
  • In Australia, recent fraud enforcement involved forcing a green power company, Global Green Plan, to purchase carbon credits it had promised to buy on behalf of customers, but never did.  The government is currently pursuing action against carbon capture company Prime Carbon over allegedly misleading claims made by the firm.
  • In Belgium, authorities have charged three Britons suspected of value added taxes (VAT) fraud on CO2 emissions permits.

In the U.S.,  the Regional Greenhouse Gas Initiative (RGGI), a group of Northeastern U.S. states that have a cap-and-trade program for utilities, faced its own demons.

  • The New Jersey government reallocated about $65 million in funds raised in the RGGI auction. The funds were intended for use in developing renewable energy projects, but instead are going to the state’s general fund, Reuters reports.
  • Last year, New York similarly took $90 million from its carbon fund.

So Now What?

Companies with a major stake in the GHG emissions game must conduct a detailed risk assessment of their GHG programs, solutions and exposures.  Given what has developed in the trading market in the past six months, it would be wide to carry out exposure identification, failure analyses, contingency planning and desktop exercises.

Such analyses and assessments may be critical for publicly traded companies in the United States due to SEC’s recent announcement and the newly effective EPA rule requiring reporting of greenhouse gas emissions from fossil fuel suppliers and industrial gas suppliers, direct greenhouse gas emitters and manufacturers of heavy-duty and off-road vehicles and engines.

Lawrence Heim, Director of The Elm Consulting Group International’s Atlanta office, said

Close to 10 years ago, I began posing the question ‘what if the GHG emissions trading market collapses?’  Assuming cohesive legally-enforceable emissions standards existed, the cost proposition presented by emissions trading in comparison to capital expenditures for pollution control equipment was quite attractive.  The impact of a material failure of the trading framework was significant.  This line of thought became incorporated into client risk assessments even back then.

In the US, we can look at the pollution control expenditures related to EPA’s New Source Review (NSR) enforcement initiative to provide insight into GHG control equipment costs.  Of course, NSR enforcement involves pollutants for which there are well-established and commercially-viable emissions control technologies.  We don’t have that luxury with carbon dioxide, which will likely translate into dramatically higher costs.

Further erosion of the viability of GHG emissions trading could have a significant impact on your company.  Please contact us if you would like to understand more about climate business risk assessments and potential risk mitigation options.

The World Economic Forum in Davos Releases Global Risk Report 2010

The Global Risk Network (GRN), an initiative under the World Economic Forum (WEF), released its Global Risk Report 2010 today.  The report is produced annually in conjunction with the WEF Conference in Davos and 2010 is the fifth year of the report.

This year, the report emphasizes the “interconnectivity” of global matters and the long-term view needed to identify and reduce major risks.  The report sets the stage by noting that

the increase in interconnections among risks means a higher level of systemic risk than ever before. Thus, there is a greater need for an integrated and more systemic approach to risk management and response by the public and private sectors alike.

In a contrast to previous years, today’s report underscored that a long-term view is critical to predicting major exposures.  Previous Global Risk Reports have not been as careful to clarify the timeline of the discussed exposures.  The report comments that:

the biggest risks facing the world today may be from slow failures or creeping risks. Because these failures and risks emerge over a long period of time, their potentially enormous impact and long-term implications can be vastly underestimated.

Further, the 2010 document seeks to provide more pragmatic guidance for companies to try to address the risks reviewed in the report.  A few points brought forward by GRN/WEC include:

Typically, risk is considered in terms of “impact and likelihood” based on internal consensus, often involving very little external or expert input [emphasis added].  Corporate risk assessments rarely consider a time frame beyond two to three years, or explicitly examine the long-term volatility introduced by risks to strategies with a five to 10 year execution horizon. Decision-making is further skewed by necessary focus on the reporting of short-term results and known or recent risks affecting the current period.

Further, research shows that relatively few companies effectively apply tools, such as scenario analysis, or effectively integrate risk data into long-term strategic planning.

…. institutions and governments collaborate to:

  • Take a long-term approach to global risk identification, analysis, tracking and mitigation
  • Use frameworks that reflect risk interconnections rather than silo approaches
  • Address the need for more robust data on key risks and trends to be collected and shared in a coordinated manner
  • Conduct cost-benefit analysis on risk solutions to improve fund allocation and better understand the long-term benefits of investment choices
  • Track emerging risks and educate leaders and the public about real, rather than perceived threats
  • Communicate clearly and consistently about the nature of threats and about strategies to manage and mitigate them
  • Understand the influence of behavioural aspects of risk perception

Our experience with various client HSE risk frameworks mirrors a number of GRN’s points.  Among our common observations:

  • HSE risk assessments frequently rely solely on internal senior management views.  Unfortunately, these views are not always consistent with operational reality in the field or trends outside the company.  To generate truly valuable information,  a risk assessment process should include senior management perspectives that are benchmarked against middle management directions, operations in the field and external emerging pressures.
  • Traditional financial and cost/benefit analyses do not adequately evaluate risk reduction benefits.  We find there are two primary reasons for this.  First, the complete array of relevant costs and benefits are not typically captured.   Second, the traditional view of short-term financial benefits tends to conspire with the internal “behavioural aspects of risk perception” to drive investment away from HSE risk assessment/management needs.  These findings lead to Elm’s development of our HSE risk reduction financial metric Return on Investment of Loss Avoidance (ROIa©).  Read more here.

The Global Risks report is produced by WEF’s Global Risk Network – a partnership of Citigroup, Marsh & McLennan Companies (MMC), Swiss Re, the Wharton School Risk Center and Zurich Financial Services.

More New of the Same Old

EPA announced two more major Clean Air Act enforcement settlements today that stemmed from the Agency’s long-standing industry New Source Review (NSR) enforcement initiatives.

Saint-Gobain Containers, Inc. of Muncie, Ind. agreed to install pollution control equipment at an estimated cost of $112 million to reduce emissions of NOx, SO2, and PM by approximately 6,000 tons each year. The settlement covers 15 plants in 13 states. This is the federal government’s first nationwide Clean Air Act settlement with a glass manufacturer that covers all of a company’s plants.  In addition, as part of the settlement, Saint-Gobain has agreed to pay a $2.25 million civil penalty.

Lafarge North America, Inc., based in Herndon, Va., and two of its subsidiaries agreed to install and implement control technologies at an expected cost of up to $170 million to reduce emissions of NOx by more than 9,000 tons each year and SO2 by more than 26,000 tons per year at their cement plants.  In addition, as part of the settlement, Lafarge has agreed to pay a $5 million civil penalty.

Companies potentially on EPA’s NSR radar screen should review their environmental audit programs to evaluate how critically the programs evaluate plant changes that could trigger this enforcement.  With the capital cost at stake, investing a small amount in a program review may generate a significant return in the event of NSR enforcement.

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.

Analysis Demonstrates Gap Between Risk Management and Environmental Exposures

According to Insurance JournalAon’s Global Risk Management Survey 2009 found that “environmental risk ranked lower as a concern in Europe than any other region – despite the introduction of the EU Environmental Liability Directive (ELD).”

Dr. Simon Johnson, Aon’s environmental director for UK and EMEA, pointed out:

The fact that environmental risk ranked 32nd as a concern in the survey is worrying because risk managers are seemingly lulled into a false sense of security, believing they have no exposure or their pollution strategies are under control.

He added:

Risk managers need to review the ELD and their operations in relation to their insurance programs as there will be gaps. US companies with European subsidiaries are becoming increasingly aware of their potential exposures and in turn we’ve seen a higher take up for environmental liability insurance.

Johnson stated that environmental insurance should be viewed as”preparing for the low frequency, high severity event [to] cover all the risks, damages and losses that could occur.”

On-going operational risk that are not “low frequency, high severity” may not be covered by insurance yet can still represent a significant financial exposure.   The company retains such financial risks.  Risk Managers may not be familiar with either the limitations of insurance coverage or the technical aspects of operations/environmental matters.

Environmental risk assessment processes, such as those used by Elm, are valuable in communicating to Risk Management leaders/departments in their terms, rather than technical EHS jargon.  This can lead to effective integration of risk management and EHS functions and risk reduction.  More information on environmental risk assessments can be found here, here and here.