Coping with a changing patchwork of climate regulation is an element of business risk that leading companies have identified and are tackling

By Andrew Merrie

For many companies, uncertainty about climate and emissions regulatory structures and the diversity of regulatory institutions is a clear business risk. The stakes are high when it can take two to three years to establish and implement a regulatory mechanism at company level.

It can take even longer for European companies, as they face different subsidies structures for renewables within and outside the EU.

Bill Spence, vice-president with responsibility for carbon emissions at Shell, says the current patchwork of regulations is a major risk to the company’s efforts to tackle climate change and the source of very high transaction costs. Shell’s policy engagement strategy focuses on ensuring regulatory harmonisation at the international level.

Consumer incentives for energy efficiency also vary between companies, as do environmental targets and objectives between industries.

Regulatory patchwork

This issue of an uneven playing field was passionately raised by analysts from Business Europe at Copenhagen. They are worried that the emissions trading regime and carbon price already in place in Europe will add costs to companies in Europe and dent their competitiveness in international markets.

This is also an issue in the US, where both national and sub-national regulatory differences, diverse incentive structures and the general unpredictability associated with the climate change bill create a complex and messy playing field. Such inequalities create perverse incentives and facilitate gaming of the system.

The US wind industry is a clear example of this, where extremely generous federal tax equity incentives led to a market where continued growth will be in doubt once the subsidies are removed.

This relates to the harmonisation advocated so strongly by Spence and his team at Shell. Intelligent regulation consistently applied to a sector and a geographical location will reduce the likelihood of an unfair competitive environment that benefits one particular sector or region.

Spence advises companies to support the process and remain constructive. He stresses it is in a company’s interest to make it known what is required in the policy framework to allow companies to deliver their products with lower carbon. He says that by avoiding the process, companies are hoping the regulator comes to the “right” decision without being properly informed. Participation in the process is essential, Spence argues.

National legislation and global standards

At present the regulatory landscape around climate change is fragmented and uneven but there is no doubt that much new regulation is on the horizon.

Nick Robins, head of HSBC’s climate change centre of excellence, says the move to a lower carbon world is inevitable and irreversible. He believes that companies sitting on their hands risk becoming prey for regulators and rivals. Climate experts agree that there are a number of emerging regulatory developments that companies should monitor closely.

• At an international level, companies need to keep an eye on any progress that is made at the next UNFCCC touch point in Bonn in May-June and COP16 in Mexico in November.
• There is a prospect of major regulatory change in the US. Climate legislation is currently proceeding through the US Senate, and may pass this year. The Environment Protection Agency has ruled that greenhouse gases endanger human health. And new standards on car efficiency and energy efficiency are emerging.
• Large institutional investors such as pension funds are increasingly focusing on disclosure and reporting of carbon footprints. HSBC’s climate change centre of excellence says developments in this direction are rapid and companies need to keep abreast of the changing disclosure and reporting landscape.
• The European emissions trading scheme has just moved into its third phase and will continue to evolve. A carbon tax has been proposed by French president Nicolas Sarkozy. A significant push in the UK for carbon reduction will bring the sectors in the UK not covered by the ETS into a cap-and-trade scheme.
• Among developing country initiatives, India is about to launch a multibillion-dollar market in energy efficiency and China is proposing a cap-and-trade scheme.
• A key voluntary effort and initiative that was largely overlooked at Copenhagen was the work of the Major Economies Forum on Technology and Climate. Its new technology action plan offers a roadmap for continuous improvement in the absence of a global climate deal. Experts at Copenhagen highlighted this as a key development that companies should investigate further as part of their climate change strategy development.

Engaging consumers

Introducing more sustainably produced products can mean higher sourcing and production costs. Testing consumer willingness to pay a premium also commands resources.

In addressing this risk, Pacific Gas & Electric is finding ways to pull people in through a cleverly designed “climate smart” programme that forms part of the firm’s commitment to environmental stewardship. This is a voluntary programme where customers who want to be carbon-neutral can calculate the carbon contribution of their power then pay a separate, tax-deductible amount to PG&E. The company then invests the money in funding greenhouse gas emissions reductions projects. And so PG&E can monitor the responsiveness of its customers to initiatives to address climate change.

There is no doubt that climate change will affect raw materials production and reliable access to natural resources. Regulation and pressures on resource use will develop – from NGOs, communities and governments.

Robins says it is important that these potential downsides of climate change be incorporated into the day-to-day business of companies.

He also argues that climate change will increasingly come to directly impact companies’ bottom lines. The cost of climate risk via insurance cost and the hedging costs of soft commodities are two such examples. Robins says companies should develop strategies to protect employees and other assets that will be adversely affected in the future.

The insurance industry is taking climate risks increasingly seriously. The Munich Climate Insurance Initiative, a broad coalition of insurance companies, announced in Copenhagen that a minimum of $10bn would be required to manage the extra risks associated with climate change.

Clearly the costs associated with tackling climate regulation may also be significant. The companies that keep abreast of the relevant rules and obligations will be well placed to develop competitive advantage.