Some have advocated placing a simple tax on carbon emissions as opposed to the complexity of a carbon market. In recent years, Wall Street market manipulation scandals and the failure of products such as sub-prime mortgage-backed derivative securities have tarnished the idea of a competitive market to achieve policy goals. Taxes, at least for the foreseeable future, are not politically feasible and don't assure policy results. For example, a tax on gasoline would probably need to be several dollars per gallon to motivate consumers to change consumption habits enough to reduce carbon emissions 10 or 20 percent over the next decade. Moreover, taxes stifle innovation; they are paid grudgingly and no one is motivated to find a lower-cost method of achieving the same policy goal. Finally, without a cap on emissions, which does exist in the cap-and-trade marketplace, there is no assurance that the policy goals will be achieved.
Considering these points, both businesses and political leaders have favored the market approach, and, given its track record of success in reducing other pollutants over time, it is likely to remain the policy option of choice in the United States as regulations evolve in states and ultimately at the federal level. Moreover, carbon markets have already gone global and will soon be linked. These markets and the products that serve them, such as offsets, will soon connect economic interests in the forests of Brazil with energy producers in California, driving costs even lower as the market, innovation, and competition expands. The total value of these efforts is growing exponentially, even ahead of a coordinated global system of regulations. In 2007, regulated market trades were valued at around $64 billion. Even the voluntary market that year topped $300 million, more than three times the market value of the previous year.
It's also likely that markets will grow faster in the next five years as the U.S. and global markets follow the course being set by California (and its partners in the Western Climate Initiative, as described in Appendix C), setting rules that allow an installation to meet up to half its obligations from offsets and other creative carbon management tools traded on the open market. Keep an eye on the development of those rules over future commitment periods at WesternClimateInitiative.org. As Ben Franklin said, we all belong to one of three classes: those that are immovable, those that are movable, and those that move. Nothing could be more true in terms of managing carbon.
To underscore the point that innovation comes from capping emissions and allowing businesses to find the most cost-effective means of compliance, following are several examples of both winners and losers in the race to reduce carbon footprints.
Winners: Those Who Managed Their Carbon Footprints
Sun Microsystems found numerous ways to shrink its carbon footprint, and then even more clever ways to manage it. The software giant cut overall Scope 1 and 2 emissions by about four percent in the second year after it began measuring, which may not seem like much, but a steady four percent per year decline will keep the company well ahead of regulators. Sun also cut energy use by more than 50 million BTUs—adding money to the bottom line—with measures such as HVAC upgrades, lighting retrofits, building "tune-ups," and installing variable speed drives on motors. Sun then focused on two parts of its footprint for management strategies, business travel and air freight shipping of its products.
From 2007 to 2008, Sun was able to cut business travel two percent—again, not a big number, but impressive considering that business-as-usual would have seen that figure rise by double digits. The company also boasts that some 3,000 employees in the United States signed up for mass transit programs to cover their daily commutes. Finally, in FY2009, Sun addressed the largest, most obvious, and measurable source of carbon in its supply chain: air shipments. The company reduced the weight of products and improved logistics so that products travel shorter routes from manufacturing to end-users. The result? Sun cut emissions from that source by a third in one year.
As companies look to carbon markets for hedging strategies, the markets themselves will become very profitable. Climex provides an online trading platform for carbon credits of all kinds in Europe and will soon be expanding to the United States The new "stock exchange" will give risk managers options when they seek the lowest cost ton of carbon, offset, or seek to hedge with derivatives.
Companies that help clients manage carbon liabilities with strategies and offset products, along with companies that keep these markets trustworthy, will do very well in coming years. Two examples are Camco, a strategy and offset product company, and APX, which acts as a clearinghouse for buyers/sellers of these products, ensuring proper recording and clearing of transactions so that money changes hands properly and carbon credits are "retired" (used only once for compliance with regulatory schemes).
Losers: Those Who Failed to Manage Their Carbon Footprints
The obvious losers in this category are energy companies that can't do much to reduce their carbon footprints and don't have many cost-effective strategies to deal with such a large shoe size. A stark example exists in California, for example, where the Los Angeles Department of Water and Power (LADWP) relies on long-term contracts for coal-fired generation of more than a third of its power, while other large utilities in the state have already switched to cleaner sources such as natural gas, nuclear, and hydro. LADWP will be forced to buy allowances or offsets for its liability while the other utilities may have excess credits to sell because of advance carbon planning. Ameren, Reliant, and Mirant are other examples of mostly coal-fired generators that operate in largely unregulated and highly competitive markets, giving them few ways to pass along carbon costs (as utilities in highly regulated regions can do) or to pay for hedging strategies (also very costly when the carbon footprint is so enormous).
A less obvious loser in this category is a company such as WM Barr, whose products will be impacted by both carbon and general air pollution concerns. Like the utilities that rely on coal-fired generation, there isn't much this company can do, dependent as it is for revenues on products like paints, thinners, and industrial solvents that have a high content of volatile organic compounds (VOCs) not easily replaced by other constituents. In California, which usually precedes national and international regulation, high-VOC-content products will be reduced or eliminated over time, starting in 2012, and will carry a much higher price because of inherent and unmanageable costs of carbon and toxins.
A World Bank study depicts nations and regions (figure 5.1 below) that can't manage their carbon footprints and will become carbon "losers." "Impact vulnerability" refers to climate change hazards, such as increased storms, droughts, floods, and sea-level rise. "Source vulnerability" refers to a region's access to fossil fuels and the potential size of short-term economic impacts when carbon has a global price. Source vulnerability makes countries less likely to commit to new carbon regulation/pricing, while impact vulnerability makes countries more likely to commit to carbon regulation. Companies with economic ties to source vulnerability are less likely to deal with carbon costs and present greater future risk. Based on the World Bank's assessment, the best places to invest—in carbon terms—are likely to be those with some combination of low impact vulnerability and high source vulnerability.
Managing your carbon footprint requires the same ingenuity as cutting the carbon in the first place. As Fred Krupp and C. Boyden Gray demonstrated several decades ago, even unlikely allies can find common ground and solve complex problems. Because carbon emissions are a waste product—and no company wants to be inefficient—innovation is not a political issue, and managing a carbon footprint provides ways to create new, profitable products and services.
If you have cracked the Carbon Code up to this point you have the right to feel proud—you know more than 99 percent of investors and managers on the planet—but you're not done yet. How will evolving rules and markets change the way a company is positioned on the carbon scale? Will a company that successfully took the first steps have the resilience to remain ahead of the pack? The only way to know for sure if your strategy is a long- or short-term bet is to estimate your "carbon resilience."
Excerpted from Cracking the Carbon Code: The Key to Sustainable Profits in the New Economy by Terry Tamminen. Copyright © 2010 by the author and reprinted by permission of Palgrave Macmillan, a division of Macmillan Publishers Limited.