It's not easy being green

Last year, companies could still dismiss the idea of reporting about climate change and other more speculative environmental risks as something too insubstantial to bring to investors’ attention. This reporting season, the conversation has shifted dramatically. Not only are companies expected to address how their business affects the environment, but the best are committing to concrete action and reporting on these commitments publicly.

American Electric Power (AEP), the largest user of coal in the western hemisphere, has been widely praised for the candor of its environmental reporting. ‘We could make our sustainability report what I call greenwash, with all the birds and trees we saved, but what people really care about is whether we recognize we have issues,’ says Dennis Welch, AEP’s senior vice president for environment, safety and health. ‘And more importantly, what are we doing about those issues?’

The Nobel Peace Prize for Al Gore’s work on climate change, record-setting heat waves and hurricanes and a raft of increasingly credible legislation have all brought environmental issues like global warming to companies’ attention, says Jeffrey Smith, head of the environmental practice group at Cravath, Swaine & Moore.
Mindy Lubber, president of Ceres, notes that the widespread devastation of property by Hurricane Katrina showed businesses that ‘the financial impacts of climate change can be as real a financial risk as inflation and inventory backlogs.’

Another notable development is the types of companies coming to grips with environmental risk. Conversations about climate change are not just being aired in the boardrooms of the usual suspects – energy producers, auto makers, chemical companies and heavy manufacturers – but are taking place across corporate America. Lubber notes that Bank of America has in place a $20 billion climate change program and Citigroup a $50 billion one.

‘The order of magnitude of the climate change problem is greater than any we’ve seen,’ says Lubber. ‘It’s going to call for a major disruption of our energy and transportation systems over the next decade or two, all of which requires ramping up now.’

Assigning ownership – achieving results
When AEP committed to environmental improvements last year, the board passed a resolution holding management accountable for sustainability. ‘As we go into year two of our reporting, they’re looking at what we achieved versus what we said we’d achieve,’ says Welch. AEP has identified improvement metrics tied to specific risks; for each environmental risk identified in the sustainability report, an individual officer is held accountable for meeting objectives.

For instance, last year AEP committed to becoming carbon neutral throughout its fleet of 6,000-7,000 vehicles and aircraft, buying or creating carbon offsets when necessary, says Welch. This goal was accomplished by late fall 2007. On the other hand, AEP has fallen short of its goal of spending an additional $1 million on forestry in 2007. ‘We made the decision we’re not going to pay exorbitant amounts of money for property to plant trees to offset emissions until the ethanol market calms down,’ he says.

Todd Arbogast, director of sustainable business for Dell, also embraces environmental disclosure. He points out that Dell reports on the impact of its facilities and operations; on greenhouse gas emissions by region, by impact, and by source; and on expected reduction initiatives. These disclosures are made within Dell’s own sustainability report as well as through the Carbon Disclosure Project.

What makes useful disclosure?
Although some companies are taking the lead, the question remains: just what types of environmental risks should companies disclose? Lubber says that most companies are adept at reporting litigation risks, but they’re far less forthcoming about regulatory and physical risks. She believes that the increasing likelihood of new fuel economy standards in the next three to four years is a regulatory risk that cries out to be explained to investors, especially given that it takes companies seven to eight years to develop whole new fleets.

Physical risks may be less apparent, although these risks were memorably highlighted by Hurricane Katrina’s decimation of oilrigs off the Louisiana coast. Another imminent risk is the melting of permafrost and the impact that will have on oil pipelines, according to Miranda Anderson, vice president for investor analysis at David Gardiner & Associates, an energy and climate consulting firm based in Washington, DC. When formerly frozen ground becomes swampy, pipelines are no longer supported. Anderson points out that estimated costs for bolstering and repairing those pipelines run $2 million per mile. ‘Those are the kinds of physical risks that investors need to know that companies are evaluating,’ she emphasizes.

Which regulatory risks a company discloses depends on its operations as well as where these operations are based. Companies with subsidiaries in countries that have signed the Kyoto Protocol need to address these commitments, says Beth Young, senior research assistant at the Corporate Library. Similarly, companies with operations in California might discuss the California Climate Action Registry.

‘The regulatory noose is tightening,’ observes Smith, noting that companies facing capital expenditures to comply with new laws should start informing investors how much these expenditures might be. What’s more, earlier this fall, investors, led by Ceres, petitioned the SEC to clarify that climate risk is material and therefore worthy of disclosure.

Russell Read, chief investment officer for the $250 billion California Public Employees’ Retirement System (CalPERS), describes the changing landscape this way: ‘Five or ten years ago, the greenhouse gas footprint was simply not material to investors. Five or ten years from now, investors and regulators will be placing values on companies based on what their footprints are,’ he says. ‘It’s inconceivable that a greenhouse gas footprint will not become material in the valuation of these companies.’

Building a reporting template
Thus far, most environmental reporting in the US has been purely voluntary. Ceres’ global reporting initiative, established in 1997, gives companies one template for disclosing environmental and other corporate behaviors.

Another important touchstone is the Global Framework for Climate Risk Disclosure, which was created by investors and released in 2006. This framework examines four basic components of reporting: 1) historical emissions data; 2) strategic management of climate risks and emission reduction plans; 3) physical risks posed by climate change; and 4) a quantitative assessment of regulatory risks.

Another increasingly important gauge is the Carbon Disclosure Project (CDP). Currently 1,300 companies globally report through the CDP and 300 of these participants are based in the US, according to CDP CEO Paul Dickinson. He notes that the CDP questionnaire elicits data for four categories of environmental risk: physical, regulatory, consumer attitudes and technological innovation. Within the past year, CDP participation in the US climbed dramatically with 56 percent of companies in the S&P 500 now reporting, relative to just 47 percent a year earlier.

One important benefit of voluntary CDP disclosure is the ability to benchmark a company both inside and outside its industry. Arbogast emphasizes that the CDP lets Dell’s management team and board compare progress and commitment to its peers. 

The variety of templates points to a growing problem: it’s not yet clear how best to calculate emissions data. Read, for instance, encourages companies to view greenhouse gas emissions in terms of efficiency. Ideally, he suggests, a company might measure how many tons of carbon it emits per thousand dollars of sales or profits. However, these metrics will only have real value, he emphasizes, once everyone performs calculations the same way. ‘Right now,’ says Read, ‘we have voluntary disclosures that show good faith but are problematic because they’re not standardized.’

Even without standard measures, many experts believe that the impulse to disclose is a worthy one. ‘If companies are very factual in their disclosure and careful to express uncertainty where there is uncertainty, I don’t think they can go wrong,’ says Young.

Jennifer Woofter, CEO of Strategic Sustainability Consulting, based in Silver Spring, MD, agrees, calling transparency ‘a risk mitigation technique.’ She continues: ‘It’s hard to scare people these days. The reluctance to talk about environmental exposure is what creates fear.’

That said, it is possible to disclose environmental risk in a way that leaves a company looking foolish later. Smith cautions against ‘putting yourself in an embarrassing position by getting too specific too early.’ He believes that introducing purely speculative numbers – or worse, numbers that don’t add up to a true and accurate picture of your environmental situation – might even create liability for a company somewhere down the road.

‘You don’t want to establish a track record of fake math that’s hard to crawl back from and later looks like an accounting restatement,’ says Smith. Instead of swinging ahead of the ball, Smith advocates waiting, watching and swinging true.

Sustainability reports and beyond
Sustainability reports – standalone documents that address everything from a company’s environmental record to its engagement with the community – are increasingly popular places for disclosing climate change and other more speculative environmental risks.

Jonathan Halperin, director of research and advocacy at the Washington, DC-based consulting firm SustainAbility, says that clear metrics are critical for getting investors and other stakeholders to take these reports seriously. To date, companies have excelled at describing initiatives but have fallen short when identifying whether they’ve met targets.

Michael Gerrard, partner at Arnold & Porter and editor of Global Climate Change and US Law, notes that ‘there’s a lower threshold for disclosing things in a sustainability report than in financial statement disclosure.’ Lubber and Young both agree that ‘the gold standard’ for environmental disclosure is a discussion of climate change in the 10K and annual report.

Some aspects of disclosure are particularly well-suited to the MD&A. Say a company’s carbon footprint grows because it’s acquired a new operation. The company would want to put such a change in context for investors so that it isn’t punished for growth. Read, for instance, underscores that investors aren’t looking at raw emissions data so much as a company’s ‘trajectory’ in tackling climate change and other daunting environmental challenges.

Both Young and Halperin praise internet-based discussions of environmental risk because they lend themselves to regular updating. ‘You can’t just publish something in a report and be done,’ says Halperin. ‘The real question is how do you go from once-a-year reporting to quarterly, monthly, daily and then real time?’

Making it meaningful
‘The push has been more disclosure, more disclosure, more disclosure. The unintended consequence? A carpet-bombing effect,’ says Woofter. She hopes that companies will begin distinguishing their core issues from the welter of sustainability issues, and help investors make important distinctions.

Young points out that one of the major differences between climate change and other environmental risks is that ‘climate change has the potential to shake up business models.’ Consequently, she argues that ‘boards need to be looking at these issues and assessing them in a company-specific way.’

As an example, Anderson notes that investors want to know what high energy consumers are doing to hedge against growing energy costs. And Lubber points out that beverage manufacturers and others whose products rely intensively on water ‘know the kinds of predictions they’re seeing on water shortages now and in the future.’ She continues: ‘Not factoring that into your business plan is crazy. This is a strategic core operating issue.’

Although Smith believes that corporate boards increasingly ‘get’ the issue of climate change, he finds them ‘justifiably skeptical’ about some of the ways this looming potential disaster will actually affect their particular companies. ‘They’re saying, We understand this is a societal issue, but what does this matter to our business? And a lot of the answers to that question haven’t fully been developed yet.’

When a company can boil down the complex environmental issues that the planet’s facing into a set of concrete problems that it might address, then opportunities also begin to emerge. Arbogast, for instance, notes that the fact that the cost of energy increased 56 percent over the past five years presents a clear opportunity for adding value. Last year Dell responded by launching a product with 80 percent less energy consumption than its predecessor.

What lies ahead
Almost everyone anticipates that 2008 will be a watershed year because of the presidential election. ‘Next year we’ll have a new president, a new Senate, and a new House, and maybe a radically new slate on which to write a climate change agenda,’ says Smith.

When trying to envision what shape federal legislation might ultimately assume, Smith advises companies to look toward state initiatives. He notes that the Superfund Act resembles one of its predecessors, the New Jersey Spill Act, and that the likelihood is high that federal climate change legislation will be modeled after some of the state initiatives currently being enacted. ‘There are literally hundreds of regional, state and local initiatives out there. Some are purely political and don’t have any teeth,’ says Smith, ‘but many of them are very practical and are great templates on which to base federal legislation.’

Companies themselves are also providing shining examples of how to disclose environmental risk responsibly. Although finding a way to discuss risks that could profoundly alter a company’s operating model isn’t easy, it’s what business leaders must do. Welch believes that a productive dialogue will begin when ‘the majority of companies see that you can talk about environmental risks and it’s not going to bring you to your knees.’

‘When you’re being honest and you develop trust, you’ll come to a solution,’ concludes Welch. ‘We’re not going to solve all the issues in a decade, but we’ve got to start moving.’