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Part 3 - Emerging Corporate Leadership - 1995
             3.1 Kyoto Protocol Implementation Local Policies
             3.2 Corporate Leadership and Action
             3.3 Carbon Markets

3.1 Kyoto Protocol Implementation Local Policies
Description
The 1997 Kyoto Protocol on Climate Change is an adjunct to the United Nations Framework Convention on Climate Change (UNFCCC), signed at the 1992 Rio Earth Summit. Since 1992 signature countries have met at a series of conferences to review progress in meeting the reduction targets. At the 4th conference in Kyoto, greenhouse gas emission reduction targets were set for all but a few signatory OECD countries. The Kyoto targets are required to be met in five-year commitment periods, the first one being 2008-2012.

Kyoto establishes an international regime that economically differentiates sources of energy and creates advantages for low and zero carbon energy sources. As emissions trading takes hold, high carbon fuels, like coal, will be disadvantaged and priced higher, while lower carbon fuels and technologies, like gas or renewable energies, will gain some advantage. Similarly funding arrangements within the Kyoto Protocol seek to advantage low carbon fuels and technologies and assist their introduction into developing countries.

Value at Stake
The greenhouse gas emissions limits contemplated in the Kyoto Protocol represent a significant reduction below what is considered a 'business as usual' scenario. If the market price of carbon reaches $10 - $15 per ton, or higher as some predict, the extent of downside risk that carbon constraints present for the future of many companies would be financially material. (See the section on Carbon Pricing.) This would raise serious questions about corporate competitiveness, particularly in emissions-intensive sectors.

Emissions trading schemes and other economic instruments are expected to have ramifications for production costs and commodity prices. On the other hand they can create new sources of income for businesses acting proactively to manage their carbon emissions.

Climate policies are expected to increase energy prices and the price of many energy-intensive primary goods. Companies will face new competitive pressures as operating and input costs increase. In some cases these cost increases can be passed on in the form of higher prices. In other cases if pricing power is limited, margins will be squeezed. In certain cases, specific assets will appreciate or depreciate in value based on how their competitive contribution is effected by climate policies.

A growing percentage of investment capital is managed using social responsibility criteria; climate change impacts will increasingly figure as one of these screening criteria. Mainstream investors are also seeking evidence that their portfolio companies are taking an intelligent risk management approach to climate change, as evidenced by specific policies, carbon management programs, and risk analyses (see section on Equity Markets).

Development and Trends
The main message for business is that the political momentum for greenhouse gas control is solid and the prospect of having to operate in a "carbon constrained world" is stronger than ever. As a result, further and deeper cuts in emissions are likely to be required in the coming decades, in order to curb the rising atmospheric greenhouse gas levels and limit the extent of global warming.

Carbon policies are in place in many countries and their stringency is set to increase as a result of the need for deeper cuts. Other countries may join the Kyoto regime as the pressures mount and the emissions trading system matures. All these developments act as a positive feed back loop adding to the overall momentum around Kyoto.

For some time now, much attention has focused on Russia and its decision about signing the Protocol. As long as the US remains a non-signatory, Russia holds control over whether or not the Protocol goes into effect. Without the US, the only way the Protocol will have countries with the majority of GHG emissions signed on and thereby come into effect, is if Russia signs.

In early December 2003, officials from different arms of the Russian government gave stunningly different interpretations of what the country might ultimately do regarding the Kyoto Protocol. While this added drama to the otherwise obscure goings on of a meeting of the international crowd responsible for moving Kyoto forward (COP 9 in Milan), it only added to the uncertainty about the final outcome in Moscow.

While this puts Russia in the spotlight, this shouldn't obscure the fact that many countries have already adopted public policies as if Kyoto were in force. Even while the Protocol remains in official limbo, the market is responding to those regulations and other initiatives.

Signatory countries are going forward with national and regional policies to deliver on their Kyoto commitments. What's been harder to project is what's happening in those jurisdictions that haven't signed Kyoto.

Australia and the United States are two countries that have not signed, but have seen considerable local actions on climate change, even in the absence of national commitments. Examples include California regulating the GHG emissions of vehicles, Oregon requiring the mitigation of a portion of GHG emissions from power plants, and the New South Wales state Premier, Bob Carr, building a coalition of states to introduce a national emissions trading system in Australia, in lieu of any initiative from the Australian Federal Government.

Implications
Global and local regulation of greenhouse gas emissions is underway. The pertinent questions to be asking are how and when, rather than whether or not this will influence business. In the absence of Kyoto, expect a confusing patchwork of rules and regulations that will madden even the most jaded and cynical global corporate manager.

While we'll talk more about the financial implications in subsequent sections, expect auditors to start asking questions about compliance costs and risks that could eventually lead to balance sheet liabilities and new reserves to deal with regulatory compliance costs.

3.2 Corporate Leadership and Action
Description
A significant number of companies that have identified climate change as a strategic business risk and/or opportunity are taking voluntary action. The response is not confined to any single sector or a single national economy but spans all sectors and is international.

Large multi-national corporations such as BP, DuPont, Toyota, Swiss Re as well as large national companies around the globe are taking concrete and tangible action in response to climate change and in doing so are creating substantial value for shareholders. Various international business forums such as the United Nations Environment Programme's Finance Initiative (UNEPFI) and the World Business Council for Sustainable Development (WBCSD) and their national counterparts around the world are responding to this emerging business challenge.

Value at Stake
Future competitive advantage is clearly at stake as leading companies are positioning to be able to adapt swiftly to changing economic circumstances driven by climate change. The value at stake can be negative such as an increase in fossil fuel energy prices and the imposition of carbon taxes and other regulations. Conversely demand for new products such as design and engineering skills, renewable energy and energy efficient technologies as well as other knowledge-based services can open up new growth opportunities as both adaptation and mitigation strategies are adopted.

Developments and Trends
The momentum around corporate action is building. Examples of individual corporate efforts include:

• DuPont - The company set a target of reducing greenhouse gas emissions 65% between 1990 and 2010, holding energy consumption flat over the same period, and deriving 10% of its global energy from renewables by 2010;
• BP - In 1998 BP set a target of reducing its GHGE by 10% based on a 1990 benchmark and by the end of 2001 had achieved a reduction of nearly 5% or about 4m tonnes of CO² equivalent, and believes it will be able to achieve the other 5% by 2003/04; and
• Swiss Re - As well as reducing its own GHG emissions, Swiss Re is providing risk reduction and financial services for emissions reduction projects, developing insurance based solutions to facilitate emissions trading, joint implementation and clean development mechanism projects as well as investigating participation in and asset management of sustainability funds focused on the GHG market.

Other corporate led efforts include:

• The UK Emissions Trading Scheme where 34 UK corporations including Shell, Rolls Royce, Barclays Bank, British Airways and Tescos - voluntarily assumed a legally binding obligation to reduce GHGE against 1998-2000 levels.
• Chicago Climate Exchange where 28 US corporations including Motorola, Baxter International, Ford and International Paper have committed to reducing GHGE by 2% below 1999 during 2002 and further reductions of 1% annually thereafter in return for accruing carbon credits both domestically and internationally.

• The United Nations Environment Programme Financial Initiatives is a unique grouping of 295 financial institutions dedicated to sustainable development and addressing climate change. Its members include Prudential in the UK, Dresdner Bank, Citigroup and Munich Re.
• The Business Environmental Leadership Council - 37 corporations including Boeing, Hewlett Packard, IBM, Intel and Whirlpool - supports the Kyoto Protocol as the "first step" and advocates that businesses adopt emission reduction targets and investment in new energy efficient technologies.

Implications
The impact of the actions of these "leadership companies" on the climate change debate cannot be over stated. These companies are having a significant impact on the public's expectations in relation to the role and capacity of the corporate sector to address the threat posed by climate change in four significant ways:

• They are proving that companies can meet big commitments more easily than expected
• They are debunking the myth that action on climate change always negatively impacts the bottom line
• They are developing systems and technologies that will enable other companies to act more quickly and efficiently; and
• They are breaking up the policy logjam by weakening the "just say 'no'" position.

Companies in denial or which fail to respond to climate change run the risk of "missing the boat" once critical mass of public opinion and other factors is reached. Those companies that are positioned due to their foresight will take advantage of the new operating environment. Others will quickly follow. The laggards will find themselves in a potentially fatal position unable to adapt quickly enough to the new reality and unable to compete with those companies which took early, decisive strategic action on climate change by integrating the risks and the opportunities into their business plans.

3.3 Carbon Markets
Description
The Kyoto Protocol and many of the national schemes to implement it either contemplate or employ a "cap and trade" approach that limits GHG emissions and enables emitters to create tradable allowances if they reduce their emissions below the cap. The underlying rationale for this is economic efficiency for those that can reduce their GHG emissions with the least expense to do so even if they go well beyond their own limit.

The public trading of such allowances or credits has been one of the most unique and controversial aspects of the climate policy debate. Some of the key issues include asking what should qualify to create such a credit? How would they be standardized and audited? And across what jurisdiction should trading be allowed?

A formal market for carbon would reduce the overall cost of reducing emissions, create opportunities for those entities with the ability to generate emissions below the market cost, and create a powerful financial incentive to develop the cheapest and most cost effective means of reducing emissions.

A number of trades have occurred already. These have largely been private transactions structured between a buyer and seller of emission reductions rather than buyers and sellers each trading standardized financial instruments in a single public, liquid market.

Value at Stake
Markets for greenhouse gas allowances (initially carbon credits) would provide several benefits:
- setting a price for carbon credits, and
- generating additional cash flow for efforts leading to reductions in GHG emissions.

Such a market would give companies attempting to lower their GHG emissions new opportunities to do so at a lower cost, creating value. Likewise, those companies that could reduce GHG emissions at below market price could pocket the difference.

They key dimension of value here is obviously price. Recent trades in carbon have been in the range of US$3.50 to US$5.75 per tonne.

Developments and Trends
The world of carbon trading is moving beyond the realm of structured private trades and into national and regional exchange trading. The UK established the first national exchange market for carbon credits in 2002 as a part of program to cap emissions.

In July 2003, the EU market did the same. The EU carbon-trading scheme will be operational in 2005, with over 10,000 industrial facilities in the expanded 25 countries facing caps with trading. It covers power and heat generation, oil refineries, ferrous metals, pulp and paper, and building materials sectors in its initial form. This scheme only covers Co2emissions within the EU. A separate proposal under EU consideration will address credits stemming from European investments in the developing world that reduce GHG emissions under the Clean Development Mechanism (CDM).

One aspect of the EU scheme that has many market participants excited is that the expansion of the EU means much greater potential for volume in trading and will include many opportunities to reduce GHG emissions at a relatively low cost in the Central and Easter European countries joining the EU.

In other regions, market participants are working out many of the mechanics and standards in advance of implementing cap and trade policies. For example, in Australia, the New South Wales state government has taken the initiative to organize a formal market for carbon allowances despite the national government's failure to ratify Kyoto. In the US, the Chicago Board of Trade has established Chicago Climate Exchange; a formal market for trading carbon allowances independent of any government jurisdiction. In Japan, there are two voluntary pilot schemes underway to gain experience with the national registry of GHG emissions and trading.

Implications
Both buyers and sellers of GHG allowances are preparing for significant trading. It will undoubtedly provide a significant "knock on" effect in those regions adopting cap and trade and most likely globally whether or not Kyoto is adopted, by giving actions that reduce greenhouse gas emissions an economic value. This will create significant business opportunities for companies that can reduce emissions at a low cost.

Go to Part 4 - Market Pressure Mounts - 2000
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