Carbon risk management

Understanding the impact of a trend towards low carbon economies on management thinking should be considered on three levels – compliance, operational and strategic.

Compliance

A growing number of countries e.g. UK, Australia, France, South Africa and the United States have implemented, or are in the process of implementing, legislation governing the measurement and reporting of carbon. In most cases this goes further to monetising carbon through the purchase of allowances, cap and trade systems or taxation.

Compliance risks include the usual fines and penalties for non compliance and inaccurate reporting. In the case of the UK’s Carbon Reduction Commitment (CRC) Efficiency Programme there are both civil and criminal penalties. There are, however, two additional key risk areas that need to be managed – reputational risk and a new source of cost. In most cases the reports are publicly available and corporate perceptions will be affected by their relative carbon profiles. In the UK this goes a step further through the publication of a league table which will also influence the value of the allowance returned to CRC participants. The financial risks originate out of the additional administrative burden, the need for new tools such carbon management software and the costs associated with taxes or the purchase of allowances.

Companies need to have the processes, tools and administration in place to be able to measure and manage their carbon emissions with a similar level of rigour applied to their financial accounting, including auditability, evidence packs, etc. They also need to go beyond the pure mechanics of compliance and have the management capabilities in place to identify and manage carbon reduction opportunities to lower these risks and costs.

Operational

Even in the absence of legislation there is already evidence of operational impacts resulting from voluntary actions. For example, in response to perceived consumer demand issues, retailers are increasingly requiring their suppliers to disclose the carbon impact of their products. This is also happening in B2B relationships, especially in the ICT space, where the carbon impact of outsourcing or implementation of new ICT solutions are commonly required as part of RFP processes. As a result management is now needing to consider both the demand and supply side impacts of carbon on its business. An inability to provide this information and demonstrate differentiation in this area is increasingly becoming a competitive risk.

This goes even further and almost all management areas are touched:

• Finance needs to consider the potential direct and indirect financial impacts; consider the accounting treatment of a new poorly defined P&L and Balance sheet item and add another element to due diligence and outsourcing processes.

• Sustainability mangers need to have the capability to analyse emissions, model and manage reduction projects, and report against multiple voluntary and regulatory schemes.

• Marketing needs to consider the impact of carbon emissions on the brand and how to communicate its position on carbon related issues and performance.

• HR needs to consider employee perceptions and expectations and manage appropriate internal and external communication to ensure retention and recruitment.

Strategic

Of the three key areas the strategic impact of low carbon economies on corporates is arguably the most critical but most neglected aspect. Management needs to proactively step back and consider the potential impact of climate change and regulation to their sectors and businesses. This is most obviously required in the long term planning of capital and plant expenditures where management is forced to consider scenarios 20 to 40 years out. However, the impact will be far wider than this. For example, how will demand be impacted by changes in population demographics and migration, demand cycles, buyer behaviours? Will supply chain economics be disrupted through the monetisation of carbon and the effect of cap and trade or carbon tax schemes? Investment decisions and market valuations will increasingly price in analysts perception of risk exposure to carbon related issues and the perceived ability of businesses to adapt to the resultant change in their strategic circumstances.

Every sector will be touched and it doesn’t take much thought to model potential scenarios and impacts, but surprisingly few businesses are doing so.

In summary, carbon represents a new management challenge and risk to business leaders. As with any new challenge the first step is to understand one’s exposure – in the case of carbon this means measuring carbon emissions across the enterprise and establishing a baseline. From this baseline compliance exposure and liability can be addressed and carbon management processes and reduction activities can be initiated to address operational risks. In addition, management also needs to consider the adaptive strategies required in future low carbon economies and a world experiencing various degrees of climate change.

Matthew de Villiers, Chief Executive Officer, Greenstone Carbon Management

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