Tuesday, March 31, 2009

The Road to Copenhagen (COP 15): Implications for Business

As business communities around the world are straining under the weight of this recession, in Bonn, UN Climate Change delegates continue to discuss possible frameworks for emissions reductions.

This is a pivotal year for climate change policy, in December, the UN Climate Change Conference in Copenhagen (COP 15) will convene and if they are successful they will forge a new international climate change treaty that will commit all signatory countries to broad reductions in domestic emissions. Ahead of COP 15, United Nations Framework Convention on Climate Change (UNFCCC) meetings are working out the details. See the Timetable for Action on Climate Change.

According to an article written by Ryan Schuchard, manager of environmental research and development at Business for Social Responsibility, this new climate policy will have a direct impact on how businesses operate, including raising the cost of energy, imposing new production process requirements, and changing competitive dynamics.

Understanding the issues associated with the new climate policy has important implications for businesses. Negotiators at the Copenhagen Conference will seek a global treaty for greenhouse (GHG) gas emissions, specifically solutions to the critical problem migrating sources of emissions to the places of least regulation (leakage). And under the notion of common but differentiated responsibilities, all countries will be held "responsible to protect the global climate, but taking into account their different historical contributions and relative capacity to act in requiring commitments."

A global treaty will shape domestic legislation which in turn has major implications for the business community. "[C]reating many layers of price and risk for companies that use, produce, or manage value chains that rely on carbon-intensive energy. Specifically, the treaty is expected to outline regulations and incentives related to not only reducing emissions, but adaptation, technology transfer, finance and international development, a global carbon market, and deforestation."

Although 183 countries have already indicated their willingness to support an updated version of the Kyoto protocol, for the first time the US is expected to participate under the guidance of President Obama.

Perhaps the most significant obstacle to American participation comes from China. American legislators will not ratify cap-and-trade legislation without guarantees that China will participate. "So far, however, China firmly opposes binding commitments, resists the need to act in advance of the U.S., and instead calls on developed countries like the U.S. to provide financial support and a transfer of technologies. Chinese leadership has taken this stance because it believes the country should be as unrestricted in industrializing as the U.S. was under the Industrial Revolution." Further complicating this debate, much of China’s emissions come from manufacturing goods headed to the West.

Business is sure to be affected as climate considerations are being factored into diverse policy arenas. From transportation to agricultural to national security, climate issues are an integral part of our wider economic and social dialogues.

According to an article entitled What Climate Change Policies Mean for Your Business, "policy is part of a general contract between business and society, and social groups may start to hold companies accountable via direct pressure. These actions, according to a recent Harvard paper (PDF), can range from events targeting single companies to strikes and riots deriving from social instability exacerbated by climate change.

The essence of climate policy is putting a price on carbon emissions, which means either regulation by taxes or cap-and-trade. However this also constitutes a regulatory risk as such a system would exposure business to the price of carbon.

Emissions targets can be achieved through direct regulation (a cap-and-trade system or a carbon tax) and various supporting policies. Supporting policies include standards like fuel efficiency. Standards define the requirements for end products and will eventually be applied to the production processes. Technology incentives, include "funding for R&D, the removal of barriers to enter new industries (particularly energy), and financial incentives such as tax credits to encourage companies to generate renewable energy on site."

Market mechanisms can also create positive incentives by taking advantage of the commodity aspect of carbon. The market can "promote activities being done at the lowest-cost locations where investments in activities that reduce carbon emissions are cheaper. With market mechanisms, companies can buy reductions when it is cheaper than “making” them."

The impact of these policies will differ depending on your industry and the country within which you operate. "These types of policies could also influence competitive dynamics. For example, incentives for renewables might lower entry barriers for ICT companies in the energy sector, while feed-in tariffs might enable consumer products companies to develop better cost positions over rivals. Also, with investor groups like the Carbon Disclosure Project demanding more information about companies’ self-appraisals of policy risk, those firms that are willing and able to disclose more have increasingly preferential access to capital."

Carbon taxes could also lead to "reduced availability of carbon-intensive inputs such as steel. Such a tax could also lower demand for products that create higher emissions during their use." Environmental leakage is another big issues, in addition to competition problems.

According to the Peterson Institute and World Resources Institute, the most vulnerable industries are those that have high energy intensity of production, low potential for efficiency improvement, little ability to switch to low-carbon energy sources, and high elasticity of demand. These include, in particular, energy utilities and heavy manufacturing sectors. [While] companies in industries that address adaptation problems, such as pharmaceuticals and biotechnology, stand to gain." Efficiency and renewable energy will be a lot more valuable especially for energy intensive industries.

In a recent interview, Ryan Schuchard predicted that "as the global market mechanisms form, we would expect probably some measures [border taxes or border tax adjustments]. He goes on to explain, "a border tax would be relevant if a country has a tax itself, as opposed to a cap-and-trade system, in which case, a border permit would be more likely. A border tax would probably be relevant for some of the heavy-emitting industries like aluminum, steel, maybe glass, paper products."

"[I]mports would likely be taxed or could be taxed if they were from a country that didn’t have adequate regulations by the view of the importing country... exports being taxed (by) the market that they would be exporting to. Specifically, you would see the most energy-intense or emissions-intense sectors getting likely caught there, and those would be things like aluminum, cement, steel, paper, glass, chemicals, iron -- these sorts of very intense industries. When countries like the U.S., Canada, China and other large countries have more serious taxes or caps on carbon, they would want to keep out or at least put constraints on imports. It’s both competitive and environmental reasons..."

"[N]o matter how you slice it, there’s increasingly pressure for the use and propagation of lower carbon fuel and energy. So being on the right side of that makes sense and that is true both in terms of the direct price on energy and carbon associated with the energy, as well as indirect effects, like how suppliers might be affected, about products that you’re selling. So in very many ways, indirectly and directly, there is increasingly a premium on using and propagating low carbon energy and fuels."

Despite the negative implications for some high energy intensity businesses, there are tremendous opportunities for low-carbon businesses. Many companies that generate renewable energy can expect to grow exponentially. Climate change legislation will drive efficiency innovation and provide opportunities for companies that can exploit novel technological applications.

Next: The Road To Copenhagen: Part 3, Positioning Your Business (Ahead of Legislation)

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