Friday, November 28, 2014

Sustainability at a Profit

NAIROBI – How profitable are the world’s major industrial and agricultural sectors? According to a new report by the London-based consultancy Trucost, when one accounts for these sectors’ costs to third parties in the form of environmental and other damages, the answer is “not very.”

Many sectors seem lucrative when conventional economic calculations are used. For example, pre-tax profit margins for iron, steel, and cement production, and for crude-oil and natural-gas extraction, range from roughly 7% to nearly 20%.

But, after factoring in externalities, the global cement sector has average pre-tax losses of 67%, and crude-oil and natural-gas extraction barely break even. Indeed, Trucost’s report estimates that the top 100 environmental externalities worldwide – including greenhouse-gas emissions, natural-resource depletion, deforestation, climate change, and air pollution-related health problems – cost the global economy roughly $4.7 trillion annually.

But such losses are rarely captured in the balance sheets of the companies concerned. Rather, they are passed on to taxpayers, the poor, and, in the form of a degraded planet, future generations.

Among the sectors with the highest impact in this regard are coal-burning power plants in East Asia and North America, with externalities totaling $453 billion and $317 billion, respectively – higher than the value of the electricity that they produce. Cattle ranching and farming in Latin America is the third most damaging sector, with losses linked to deforestation of $354 billion – more than 20 times the value of the sector’s annual output of $17 billion. Calculations for water-intensive industries, such as corn, rice, or wheat farming in dry regions like North Africa and Southeast Asia, and for energy-intensive sectors, including cement production and iron and steel milling, are similarly sobering.

Although the developing world is generating a significant proportion of these costs, the goods that result are consumed worldwide. Thus, addressing externalities should be regarded as a global challenge, to be addressed jointly by governments, producers, and consumers.

At last year’s Rio+20 summit in Brazil, leaders of governments, businesses, and NGOs agreed to a range of measures that will expose the costs of major economic sectors’ activities to an increasingly engaged public. At the same time, countries are working to devise a new, comprehensive wealth indicator that extends beyond GDP to account for some of these externalities.

Moreover, several countries, with support from the United Nations Environment Program and the Global Reporting Initiative, have launched programs to boost corporate sustainability reporting. Such reporting will provide pension funds and other investors – as well as ratings agencies – with a better understanding of companies’ long-term risk factors.

Given rising natural-resource scarcity and the escalating risk of supply-chain disruption owing to extreme weather events linked to climate change, companies can no longer afford to ignore their activities’ externalities. Forward-thinking business leaders already recognize that, in the twenty-first century, competitiveness will hinge largely on using natural resources more efficiently and cutting carbon emissions.

In addition to the obvious benefits, this approach will bring reputational advantages, as consumers – whether through education or first-hand experience – become increasingly aware of the environmental and social impact of the goods and services that they purchase. The drought in the United States in 2012 is estimated to have caused soybean and corn losses of around $20 billion with costs to consumers rising more than $50 billion as a result of higher grain and oilseed prices. Companies that adhere to unsustainable, damaging practices – and continue to pass on the associated costs to consumers – may find that their customers start shopping elsewhere.

Externalizing the impact of production – whether in power generation or agriculture – was perhaps easier when the global population was only a few billion; and, with most people living in countries with undeveloped economies, the supply of natural resources seemed unlimited. But, with natural-resource stocks dwindling, economies developing at breakneck pace, and the global population set to exceed nine billion by 2050, the need to decouple economic growth from resource consumption and move toward a low-carbon, resource-efficient green economy has become acute.

From the depletion of fish stocks to the inexorable buildup of greenhouse gases in the atmosphere, there is no shortage of evidence that current systems are unsustainable, and that corporations – which account for two-thirds of the global economy and use the vast majority of the planet’s resources – must transform the way they do business. The Trucost assessment brings into sharp focus why.

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    1. CommentedLundi Sun

      Thank you for your article. The issue I see is in "the how to transform" - misaligned incentive structures and as noted non existent or underdeveloped markets to price the true cost of externalities all contribute. At least starting at the local level progress can be made and at the supra national level we have examples such as the banning of CFCs that point the way. Having said that a key driver is continued population growth which is one of the core foundations upon which many of our problems rest.......

    2. CommentedDallas Weaver, Ph.D.

      With no market for "externalities", all the speculation about their value is just speculation. Life cycle analysis (LCA) doesn't sum into a single value for dollar accounting (water, energy, CO2, NH3, NO2, PO4, etc. are apples and oranges).

      The resources necessary for the future of man (sustainability) are energy combined with innovation and human creativity. All other "resources" can be made from those. For example, given energy you can make H2 and NH3 from water and air and then use the H2 and NH3 to grow bacteria to make fish food, which then crates your fish fillets for dinner (all steps have been proven).

      Using fast reactor technology, like traveling wave reactors, the U238 (depleted uranium) already mined and sitting above ground in storage areas in the US can be converted into a 700 or so year energy supply, which producing far less radioactive waste than our existing nuclear reactors.

      "Sustainability" is a very slippery concept that seems to be more political and emotional than useful.

      With known detrimental taxes like payroll taxes in most countries, you could do revenue neutral tax shifts from these know detrimental taxes to less detrimental taxes on things like oil and carbon (a tax on oil/carbon does less economic damage/$ of tax than payroll taxes) and obtain an economic stimulus. The decrease in externalities would be a free byproduct and there is no need to know the value of the externalities.

    3. CommentedProcyon Mukherjee

      Environment externalities that account for the bulk of the natural cost of capital is almost completely missing in the price of commodities that is passed through to the consumer. Our pitch for sustainability should not undermine the stark realization that the world's populace is currently not in a position to bear these costs of externalities as a pass-through in the market clearing mechanism of price. The vicious cycle would start to raise the end-use prices, which would counter-act on whatever recovery we see today, thus further dampening the prospects of demand.

      By being unconventional in our economic calculations, surely we should not want to project the demise of so many vital industries that provide sustainability to the people to barely live on this planet by virtue of being employed.

    4. Commentedradek tanski

      Not much can be done with criticism that offers no solutions.
      Much more important than environmental externalities are the growth expectations of the population. When compared against each other, no-one that counts will willingly sacrifice their own growth and cut themselves out of the evolutionary chain, for the sake of the environment. Those that do won't count in the next generation... Humanity ceased being sustainable when it started changing its own environment hand over fist to its own specifications (farming), which resulted in unprecedented growth and expansion. Technology is all about crafting tools and techniques to accelerate this growth process, so that in turn a greater population can be supported, after all who won't have babies when they are rich. Sustainability is nothing but an impossible ideal. One which more forward thinking peoples hope will be solved by technology and moving off world. In the meantime the race is on to be in the best position before the environment does start making growth impossible or even negative. The real sustainability question to ask, is who has the power to overcome basic reproduction instinct, when children are considered a more important asset than the world.

        CommentedPatrick Lietz

        I could not agree more. In fact, I think that we are already very close to reaching the point of zero growth, and that the second order effects of these resource restraints are at the heart of our financial difficulties. Yearly growth rates of more than 2% are probably not returning any time soon

    5. CommentedProcyon Mukherjee

      The Trucost report makes a scathing attack on our existing beliefs that the current value of firms reflect all the associated costs versus their revenue generating potential; in reality if one factors all the environment costs embedded in externalities then the impact ratios are several hundred times in the case of wheat and rice farming or Cement, Iron & Steel, which means the current revenue generating model captures only a fraction of the true natural cost of capital including the environment impacts. It was an eye opener that Water pollution costs are dominated by the impact of eutrophication from phosphate and nitrate fertilizers or that the GHG emissions alone constitute several Trillion dollars of costs even a fraction of which have not been factored in the value model.

      All this leaves a sobering thought that put to impairment tests if all natural costs are factored in, the value of the firms in question (including the agricultural) would erode their entire equity that have been accrued over long decades of hard work and investments in physical and natural capital. Our views to factor costs should not be based on the narrow prism of future losses which would denigrate the very basis of existence of these firms.

    6. CommentedZsolt Hermann

      Our whole life, individual or national is based on a simple self-calculation at every idea or action:
      "maximum benefit with minimal cost".
      This is based on our inherent human nature that is self-centered and egoistic.
      This is how we are born, it is nobody's fault or sin.
      But we are obliged to recognize it, this separates humans from animals that we are capable of critical self assessment and we are capable of changing ourselves through a positive environment.
      Until any solution, method addresses the root problem, everything else is going to fail.
      The world cannot be changed before the human being, its basic operating software is changed.
      And the way of changing human nature is through education, through positive motivation teaching people that actually working for the well being of the whole, the individual is better off, since in today's global, integral, interdependent state, when everybody is sitting on the same boat, the individual and the collective is one and the same.