Yet there are substantial behavioral, institutional, and financial barriers. As I’ve discussed in this blog post, there may well be free lunches available, but they are hidden away behind misaligned incentives, inertia, and market barriers. Consumers are often unaware of the potential cost savings, cannot afford the upfront costs, or fear that home efficiency upgrades will not add much to the market value of a home. For renters, new construction, and commercial property, the people who pay energy bills are often not the same people as those who design buildings or invest in efficiency. At our university, capital budgets for buildings and operating costs come from two separate pockets that don’t necessarily communicate. In the corporate world, few have traditionally paid much attention to potential energy savings because nobody was paid to do so.

Demand response systems raise some particular issues relating to fears regarding privacy and corporate intrusiveness. The Economist article highlights a survey by Parks Associates, a Texas-based market-research company, that indicates that only 15-20% of US consumers would be willing to sign up for DR programs that enable utilities to control their thermostats. Yet the survey also shows that over 80% of households would pay up to $100 for cost-saving equipment if it chopped at least 10% off their monthly electricity bills. Utilities, however, are still in the business of selling electrons, and incentives for energy efficiency, such as California-style rate decoupling, is only making slow progress toward adoption in other states.

Real-time feedback to customers on the price and quantity of electricity they are using can help cut consumption, and new devices can give an analysis by appliance, illustrating the savings from cutting usage or running appliances on lower-cost night-time power. Google announced last year that it’s developing software package called Powermeter to provide real time information about home energy usage by communicating with household devices. But few appliances are ready for smart meters, standards don’t yet exist for Google or other smart meter devices (Google just released the API in early March 2010), and systems will cost several hundred dollars per home. Moreover, as The Economist points out, trying to run a home using this information could become a complex and time-consuming job.         

The next stage in smart buildings is to move from real time information to direct control of power consumption, from devices to heating, and cooling. Companies such as PassivSystems are developing intelligent home controls using multiple sensors, but they are expensive and would still require a lot more programming regarding preferences and trade-offs between cost, convenience, and comfort than your average consumer might be willing to take on. And as the surveys indicate, consumers are wary about ceding control of their homes to computer algorithms. Commercial and industrial buildings are likely to be more lucrative markets than residential in the early stages of this new market, because of the larger scale of opportunities for saving energy, not just in HVAC and lighting but in industrial processes that have some flexibility in load and timing, such as water treatment. Nevertheless, target markets are fragmented by sector and solutions frequently need to be customized.

In my MBA class on Business and Climate Change, several student groups are working with regional companies interested in demand response and smart grid. From my conversations with firms active in the area, a major problem is finding the right channel to potential customers. Facilities managers tend toward a conservative outlook and generally lack the funding and also the authority to implement systemic controls that affect operations. As with other areas of clean energy, the gadgets are cool but the implementation requires overcoming a host of organizational hurdles.

On January 27, 2010 the SEC voted to issue interpretive guidance on disclosure requirements of climate risks in SEC filings. The SEC stressed that the interpretive releases do not create new legal requirements but are intended to provide clarity and enhance consistency on existing requirements. Nonetheless, the issuance of guidance indicates the growing focus of the SEC on climate change disclosure and the need for companies to expand and improve their environmental disclosure.

Till now the SEC had not called for any specific disclosures regarding climate change nor provided interpretative guidance regarding the application of existing disclosure requirements for “material risks” to climate change-related matters. The SEC sent a signal that it was preparing for future action when in a briefing released July of 2009 it included “Environmental, Climate Change and Sustainability Disclosure” on the list of possible refinements of the disclosure regime for the Investor Advisory Committee.

As the SEC explains in its release, existing regulations require a company to disclose information related to risk factors and call for management discussion and analysis. The new guidance on those rules emphasizes that when assessing potential risks, companies should consider the impact of existing climate change legislation and regulation, international accords or treaties on climate change, indirect consequences of regulation or business trends, for example new risks for the company created by legal, technical, political and scientific developments, and the physical impacts of climate change. This appears to be an impressively comprehensive assessment of investor risk associated with climate change.

Ceres proclaimed this action to be the “the first economy-wide climate risk disclosure requirement in the world”. The guidance follows a petition sent to the SEC in 2007 by a group of investors, state agencies and environmental advocates, led by Ceres, urging the SEC to issue guidance on climate-related impacts. Ceres has long pursued a strategy of exerting leverage on companies by institutionalizing information disclosure of value to investors. Ceres initiated the Global Reporting Initiative and, more recently, the Investor Network on Climate Risk. The Carbon Disclosure Project (CDP) mechanism has become the most prominent mechanism for corporate carbon disclosure, though the value of the information to investors is unclear.    

Moreover, CDP-style data has not been integrated into formal SEC reports. According to two major studies released last year by Ceres, Environmental Defense Fund (EDF) and the Center for Energy and Environmental Security (CEES) climate-related disclosure “continues to be weak or altogether nonexistent in SEC filings of global companies with the most at stake in preparing for a low-carbon global economy.” The SEC initiative responds to repeated investor requests for formal guidance on the climate-related disclosure companies should be providing in securities filings.

SEC Commissioner Elisse Walter commented that the decision “is designed to improve the quality of disclosures filed by U.S. public companies for the benefit of investors.”. She mentioned that she does not consider “that public companies today are doing the best job they possible can do with respect to their current mandated disclosures.” The SEC guidance thus represents an endorsement for more stringent and meaningful carbon disclosure, and moves it beyond a voluntary “social responsibility” type of activity into the regulatory realm.

Some critics have argued that the guidance will not lead to meaningful change in corporate reporting. Zac Bissonnette from DailyFinance writes that “the absolute best thing that will come of this policy is that some public companies will add a few lines of boilerplate that no one reads to the risk factors section of the 10-Ks they file with the SEC.” Others argue that some of the terms used are unclear. As an example, the guidance states that “when assessing potential disclosure obligations, a company should consider whether the impact of certain existing laws and regulations regarding climate change is material.” Jane Wells of CNBC questions “what constitutes material”. Julie Gorte, a senior VP for sustainable investing at mutual fund company Pax World Management LLC, suggested that corporate officers would still have considerable discretion in deciding what constitutes a “material risk” that must be shared with investors.

The guidance is likely, however, to prompt companies to increase climate disclosure or face the threat of legal action for failure to disclose required information in light of the 1933 Act. In his blog, John Shideler makes the case that “the SEC’s action should prompt more companies to collect, analyze and report on climate change information. Companies that do not do so face added risks of litigation or regulatory action if future developments show that management failed to disclose material financial impacts linked to climate change.”

Even though this SEC initiative provides “guidance” rather than create new legal requirements, its impact could be very far reaching. SEC enforcement and legal challenges will gradually clarify the detail and form in which companies have to assess and disclose climate-related risks in their filings and improve their climate related disclosure.

By David L. Levy

(This is an updated version of an earlier posting)

President Obama’s decision to speak at the COP-15 climate summit in Copenhagen in December 2009 cannot have been easy. Obama surely did not want to invest his shrinking political capital in backing the doomed international conference, but at the same time wanted to reassert US leadership after decades of denial and obstruction have cost it dearly in international credibility and influence. President Obama announced his decision to attend Copenhagen just as I was leaving the city after attending a conference on business education and climate change. Perhaps the President was inspired by our effort at Copenhagen Business School to infuse climate change into the business school curriculum, but I surmise that he had other strategic calculations.

Copenhagen was rebranded from a somewhat sleepy European capital to Hopenhagen,  the shiny new star on the global climate stage, showing off its clean tech sector with Vestas ads on every metro train. The conference I attended was, of course, also timed to cash in on the climate cachet of the city. I met a staff person from Copenhagen Capacity, whose organization is trying to attract clean tech investment to the region, and hoping for a boost from the media-grabbing climate conference. The city’s green credentials do not just rest on high tech renewables but on decidedly low-tech bicycles – Copenhagen is the biking capital of the Western world, with nearly 40% of commuters, many dressed in suits, pedaling to work through cold and rain. Whether they are motivated by environmental enthusiasm or the 200% tax on cars is hard to say.

Unfortunately, the Copenhagen brand is looking tarnished and, as the talks collapsed, many observers quickly renamed it Brokenhagen. The estimated 40,000 delegates, observers, and assorted groupies who descended on Copenhagen were unable to produce a binding treaty, despite the cost of more than $62 million borne by the Danish government, according to the Guardian in a special 10-page Copenhagen supplement. The Guardian noted that the delegates would emit more than 40,000 tons of CO2 during their travels and travails, which now looks like a rather bleak investment from a climate perspective. At least it must have been boom times for the retail carbon offset business.

Despite last minute by Obama and Chinese premier Wen Jiabao, the conference only generated a vague declaration of principles the Copenhagen Accord, which sets a goal of limiting global temperature rise to 2°C and recognizes that all nations need to work to that goal. A key part of the draft, a pledge to cut carbon emissions by 50% by 2050, was removed at the last minute, apparently under pressure from China. Yet even this watered down accord didn’t win broad endorsement (Click here for a Dr. Seuss-style satirical summary from the BBC).         

The Copenhagen debacle has been endlessly dissected and analyzed. Many blame the Chinese for thwarting an agreement, while some blame the US for lack of leadership and bullying developing countries. Both countries are wary of multilateral agreements that might infringe on sovereignty. The main stumbling block was the distribution of economic costs and benefits, with the axis of contention being the divide between rich and poor countries. Developing countries demanded emissions cuts in the industrialized world of around 40% below 1990 levels by 2020, while the “offers” were in the 15-25% range with various baselines (not to mention flexibility from offsets). Developing countries also argued that any new regime maintain the Kyoto principle that only industrialized Annex I countries have legally binding emissions targets, while the US and Europe demanded that a new agreement include binding and verifiable targets for the larger developing countries, especially China and India. China’s total GHG emissions edged past the US in 2008, to reach 6.1 GTonsC02e. Developing countries also demanded up to $200 billion a year in aid designated for mitigation and adaptation. Industrialized countries did finally promise short term funding of $30 billion over the next three years, mainly for adaptation in vulnerable developing countries, as well as longer term funding of around $100 billion a year from 2020.

Observers are not optimistic about the prospects for completing a binding treaty at COP-16 in Mexico at the end of this year. Most countries are filing their GHG targets by the Jan. 31 2010 deadline, though some are vague ranges. The problem is that country negotiators more closely resemble corporate managers concerned with “competitiveness” than adverse impacts from climate change. Moreover, the financial crisis has weakened national treasuries and resource constraints are stark. Fundamentally, collective action is very difficult when there are so many actors with divergent interests.

What might happen in the absence of a binding global deal? The failure to achieve a binding treaty could well send a negative signal that stalls momentum on climate action. The prospect of a strong global emissions agreement has provided the political and economic context for the beehive of climate activity in recent years, from carbon footprinting to voluntary offsets, from Walmart’s supply chain initiative to BP’s investments in renewables. According to the Financial Times, “The private sector investment needed to tackle climate change will not be made without a binding international deal on carbon emissions.” Lars Josefsson, chief executive of Vattenfall, a Swedish power company, and chairman of Combat Climate Change, a group of 60 large companies that includes BP, GE, and Unilever, stated that: “The necessary investments will only be made when you have a binding treaty and legislation. Of the money required to implement a deal, the vast majority – about 80% – will come from the private sector. That can only come when there is a stable legal framework….It is very important to get business more engaged, because they have the knowledge of the market economy and how investment decisions are made.” Wulf Bernotat, CEO of the power company Eon, has made it clear that accelerating emission reductions requires a strong global framework.

The more optimistic camp argues that the climate bandwagon will lumber on regardless. Just as a weak Kyoto, without the US or China, was not the primary motivator for a host of corporate, NGO and governmental initiatives, so a non-binding Copenhagen declaration of good intentions will have little relevance. Mat Hoffmann at the University of Toronto is researching how decentralized local initiatives can evolve into effective forms of governance even in the absence of global authority (see his blog). Climate change science remains a key driver; NASA just announced that 2000-2009 was the hottest decade on record. Action will continue to bubble up from a host of organizations, and business will pursue low-carbon investments because they recognize the longer term strategic dynamic and will be seeking profitable new markets and efficiencies. Concerns about the rise of China in clean energy technologies appear to be driving a new dynamic of competitive investments and incentives, as states strive for national competitiveness in the rapidly growing cleantech economy.

One positive sign is that the stalemate at Copenhagen did not appear to dent the value of cleantech shares. The chart below shows the value of PBD, a clean energy ETF from Powershares (in blue) over the last two years, through Jan. 12. 2010. It clearly tracks the NASDAQ closely (red line) but is also influenced by the price of oil (yellow line). The collapse of talks in Copenhagen at the end of December had no noticeable impact.

In the US, climate regulation is moving forward even without a national cap-and-trade system. The EPA has mandated that suppliers of fossil fuels, manufacturers of vehicles and facilities that emit 25,000 metric tons or more per year of CO2e are required to collect data and submit annual reports to EPA. The new rule, effective in 2010, will apply to nearly more than 12,000 facilities which account for about 85% of US emissions. The EPA also ruled in December 2009 that greenhouse gases pose a threat to human health, which enables the agency to use the Clean Air Act to regulate GHG emissions directly without legislation. This “endangerment finding” eases the path to stronger regulatory control of emissions from autos, power plants, buildings, appliances and factories. Finally,in late January, the Securities and Exchange Commission announced that publicly held companies should warn investors of any potential effects from climate change on their bottom lines.

Increasingly, business is realizing the dangers of the proliferation of multiple regulations, and standards emanating from various regions and states, and is lobbying for simple, transparent, predictable, and coordinated frameworks. General concern with the cost of carbon regulation has been replaced by fears of the compliance costs and uncertainties of trying to cope with a chaotic and fragmented climate regime. Energy intense business sectors are particularly concerned at the prospect of EPA regulation of GHGs – they would much prefer the flexibility and low carbon prices of a cap-and-trade regime. The Financial Times reported that large US-based companies are warning “that they will face a heavy regulatory burden should US Congress fail to pass climate change legislation,” as EPA and individual states develop a patchwork of regulations and measures. Peter Molinaro, head of government affairs at Dow Chemical, the largest US chemicals group, told the Financial Times that the proliferation of such initiatives would present “an enormous administrative burden” for companies that operate across different regimes. “Manufacturers are having enough trouble in this country competing with foreign companies,” Mr Molinaro said. “We’d be adding administrative and cost burden where we shouldn’t.”

The concerns regarding patchwork regulations are even more acute at the international level: Alison Taylor, vice-president of sustainability for the Americas at Siemens, the German engineering group, said businesses needed to know the price of carbon for planning reasons. “How do you have one price of carbon if you’ve got four or five different regimes?” she said. These concerns have played an important part in building corporate support for an international agreement and driving the recent defections from the US Chamber of Commerce. A string of high-profile companies including Coca Cola, GE, Microsoft, Cisco, DuPont, Johnson Controls and Nike tried to make the case at Copenhagen for a global agreement. But the business community is still far from reaching a consensus view, and the Chamber of Commerce and National Association of Manufacturers remain opposed to pending US climate legislation. Until mainstream business organizations become more coherent in their support, the prospects for meaningful national regulation in the US or for an international treaty remain dim.

The headline 2020 emission reduction target has been raised slightly to 20% from 17% (from a 2005, pre-recession baseline, but still only 7 percent below 1990 levels), but most analysts think that this improvement is largely offset by the elimination of regulatory controls on methane emissions from natural gas facilities and other sources. Instead, voluntary efforts to control methane emissions can be used as offsets, which will provide a relatively cheap and plentiful domestic source of offsets, at least till 2020 when regulations are meant to kick in. The overall offset cap remains at 2 billion tons per year, equivalent to 30% of all U.S. GHG emissions,  and the cap on international offsets has been lowered from 50% to 25%.

Methane accounts for around one-third of the human contribution to global warming and, according to Andrew Revkin and Clifford Krauss in the New York Times last week, “some three trillion cubic feet of methane leak into the air every year, with Russia and the United States the leading sources…This amount has the warming power of emissions from over half the coal plants in the United States.” Unless controlled, these emissions could grow rapidly as gas production is expected to soar nearly 50% in the US in the next 20 years, according to the Department of Energy, will thousands of miles of new pipelines being laid. Some recent studies by EPA suggest that emissions from oil wells and other sources might actually be far higher than previously thought. In fact, global atmospheric methane levels have resumed a sharp upward trend in the last couple of years (see graph and discussion of possible reasons). Yet under industry pressure, the EPA has excluded oil and gas well methane emissions from the mandatory GHG reporting requirements that start in 2010.  

The carbon arithmetic here is very troubling, to put it mildly. For compliance purposes, offsets are interchangeable with allowances on the carbon market. It is critical, therefore, that offsets reflect real GHG reductions from the fixed 2005 baseline. If we suddenly discover that methane emissions are much higher than previously thought, and give offsets to companies that reduce them, we are not cutting emissions below the baseline. The case is particularly clear for new wells and gas facilities constructed since 2005. Moreover, because it is relatively cheap to control these emissions, the price of carbon allowances will be low, reducing the incentive for investments in low-carbon technologies and products (see Carbon Markets to Serve the Planet).

The mechanisms for defining offsets have not yet been spelled out in detail in the 800+ pages of the Senate bill. International offsets from sources such as the Clean Development Mechanism (CDM) are generally NOT real reductions from a baseline. This point cannot be emphasized strongly enough. Even in the best circumstances, offsets are reductions below “business as usual”. A new facility that beats some average “performance standard” can claim credits that feed into the offset market, but still generate incremental new emissions compared.

The Kerry-Boxer bill keeps the price collar on the price on carbon, one of the better features of Waxman-Markey, as it reduces the uncertainty that plagues potential investors in low-carbon technologies. Nevertheless, the starting floor price of $11/ton, even with a 5% annual escalator (which is only 2-3% in real terms), is far too low to have any real impact on carbon emissions for at least 15 years. For industries with a very long time horizon, of course, the expectation of a higher price in the future will have some effect.

Perhaps the most important change in Kerry-Boxer is that it retains EPA’s authority to regulate GHG emissions, which was superceded in the Waxman-Markey version. This is critical, because in the absence of an adequate carbon price signal, EPA officials know that they must move more directly to regulate emissions from major sources, particularly automobiles, buildings, and power generation.

Carbon comes in many forms: depending on how the atoms are arranged, carbon can be a tough brilliant diamond, a rigid bucky-ball, a super-strong nanotube, soft graphite, or a lump of coal. These forms have very different properties and uses – diamonds are not the best fuel for generating electric power. Similarly, carbon measurement and disclosure comes in various shapes and sizes, from the Carbon Disclosure Project to product-level carbon footprints to Enterprise Carbon Management Systems. Yet the various modes of carbon measurement have very different goals and intended audiences, causing considerable confusion amongst firms and potential users of carbon information. This is going to impede the adoption of carbon information systems that are most crucial, those designed to manage and reduce emissions.

The Carbon Disclosure Project (CDP), a non-profit UK-based organization, launched its 2009 report in late September with great fanfare. The report is impressive in many ways. It’s based on a detailed questionnaire sent to companies that includes topics such as greenhouse gas (GHG) emissions, risks and opportunities to the reporting company, programs to address corporate emissions, and the assignment of managerial responsibility. With seven years of data, CDP claims to hold the largest database of primary corporate climate change information in the world.

CDP’s strategy has been to leverage the influence of institutional investors to pressure companies to voluntarily disclose their carbon-related activities, on the premise that this information is important in assessing asset values and predicting financial performance. The CDP has now signed up 475 investors with a total $55 trillion under management. CDP states that over 2,000 organizations in 66 countries around the world now measure and disclose their greenhouse gas emissions and climate change strategies through CDP. The headline 2009 report focuses on the “Global 500”, the 500 largest corporations in the FTSE Global Equity Index Series, which in June 2009 had a combined market capitalization of US$15.5 trillion. CDP achieved an 82% response rate for this group. These are impressive numbers indeed.

The CDP has certainly helped to spread familiarity and acceptance for carbon reporting and disclosure in the corporate world. Yet it is questionable how much CDP has actually contributed to emissions reductions. First, the investors who sign up do not undertake any commitment themselves (unlike the similar but smaller CERES INCR project). As Charles Morand writes in his Alt Energy Stocks blog post “Climate Change & Corporate Disclosure: Should Investors Care?”:

in 2008, worldwide investments in “sustainable energy” totaled $155 billion. That’s about 0.28% of the $55 trillion in assets under management represented by CDP signatories. A mere 1% commitment annually, or $550 billion for 2008, would substantially accelerate the de-carbonization of our energy supply.

Second, and more important, CDP does not generate data that is useful for reporting companies to measure and manage their GHG emissions at the facility, process, or product level. Neither is it adequate for compliance with EPA’s new rules for mandatory carbon reporting, or for carbon trading under ETS, RGGI, or a future national US system. These require carbon information systems, analogous to cost and management accounting systems, designed specifically for these purposes. But the goal of CDP is primarily to pressure corporations to wake up to climate change and pay attention to carbon. It’s simply not designed as a carbon management tool. True, CDP has been evolving under the guidance of the accounting firm PricewaterhouseCoopers, but the problems are structural. Charles Morand points out that “The problem with the CDP is that it’s really an activist organization parading as an investor group.

As with the Global Reporting Initiative (GRI), CDP is designed for a dual purpose: to assess and rank corporate social performance, and simultaneously to institutionalize the disclosure of social and environmental information useful for investors. I’ve recently been involved in academic studies of GRI and CDP (click links to download papers) and after interviewing many of the stakeholders involved, the message is clear. The information is simply not very useful, at least in its current form, for the reporting companies, for investors, and even for environmental NGOs. The reporting systems are put together by awkward coalitions of companies, NGOs, and professional accountants and consultants. As a result of the compromises made along the way, they tend to be too broad and vague. For example, the CDP section on risks and opportunities simply asks companies to write some text in response. There is no format for strategic appraisal in any systematic sense.

There is a rapidly growing market for corporate carbon management systems that attempt to cover multiple purposes. The London-based consulting company Verdantix recently released a proprietary report on carbon management software from vendors such as CarbonView, Carbon Hub, ESS, Greenstone Carbon Management, Hara, IHS, PE International, SAP and SAS. The report notes that “Many Board members would be horrified at the low quality and poor verification of carbon emissions data that is released into the public domain through channels like the Carbon Disclosure Project.” A recent spate of acquisitions demonstrates the spike of interest in this area: SAP bought Clear Standards in May 2009, while EnerNOC bought eQuilibrium Solutions in June. (Update 1.20.10: see NYT article on Groom Energy report).

These software packages aggregate emissions data from multiple sources across a company and integrate carbon price projections for planning purposes. But these systems are very immature compared with financial and management accounting systems, or Enterprise Resource Management systems for logistics and inventory control. While carbon management software systems might be useful for generating data needed for compliance purposes and for CDP-style public reports, they will not realize their potential for management control of carbon till they are better integrated with traditional corporate software systems. Verdantix provides examples of very high rates of return from implementing carbon management, but many companies will likely find the short-term gains to be as elusive as those from Total Quality Management; there are considerable hurdles to system-wide implementation, from confusion and data problems to inertia and even resistance.

One important driver for carbon management and reporting systems is the trend toward product labeling. While already well underway among major European retailers such as Tesco, Walmart jolted its 100,000 strong supplier base with an initiative announced in June to provide a label for every product on its shelves with environmental impact information (see the New York Times and the Wall Street Journal). Walmart will soon be sending an initial survey to all its suppliers with questions regarding their sustainability practices. This project requires that Walmart’s suppliers develop accurate estimates at the SKU level not just of the greenhouse gas emissions, but also of water consumption, air pollution, and other measures for all the inputs required to source, manufacture and ship their goods. As Stephen Stokes of AMR Research wrote in an earlier Climate Inc. post, Sticker Shock, this could prove hugely expensive, divert funds from investments in cutting carbon, and still not provide the information necessary for managing carbon effectively. Moreover, consumers seem either indifferent or confused by the various labels out there.

If CDP is geared toward aggregating carbon information at the corporate level, product labeling aims to allocate these emissions to individual products. Most carbon data has been generated with external audiences in mind, consumers, NGOs, and regulatory agencies. There has not been nearly enough attention to the needs of management for intermediate level information that is designed to help manage carbon and reduce costs at the facilities and process level. Whether enterprise carbon management systems can really serve these multiple needs remains to be seen.

The world faces twin energy-related threats: not having adequate and secure supplies of energy at affordable prices, and the environmental harm caused by consuming too much of it. Companies are central to paving the way towards a low-carbon society because a large portion of carbon inputs and GHG emissions stems from industrial production. As a consequence, stakeholders increasingly require companies to disclose their strategies for addressing climate change. In particular, actors in financial markets are investigating the implications of climate change on the competitive position of companies and on risks to shareholder value. However, business responses to climate and carbon issues have been characterized as ambiguous, and external assessments of corporate efforts have been contradictory, even when analyzing the same firms. Furthermore, for many companies, emissions from their own operations are dwarfed by emissions that occur upstream or downstream in the value chain, e.g. those connected to energy provision or product usage, which are often not covered in voluntary GHG emission reports.

The literature on Industrial Ecology has termed this perspective ‘life cycle thinking’ of material and energy flows. In order to increase the reliability of life cycle-wide carbon assessments and to determine performance differences between companies, indicators are required that concisely measure a company’s performance with respect to carbon. These indicators can be used for analysis and reporting purposes, which aim to increase the transparency of corporate carbon performance assessments.

However, the key question: How to construct comprehensive and systematic carbon performance indicators? In a paper published in the Journal of Industrial Ecology we suggest an answer to this question. We distinguish between two dimensions: on one axis, whether an indicator measures a firm’s physical carbon flow performance or the monetary value of these flows; on the other axis, whether an indicator assesses the carbon performance in a static of dynamic manner. This two-by-two matrix gives four distinct indicators.

The first indicator, carbon intensity, relates to a company’s physical carbon performance in a static manner. It describes the extent to which a company’s business activities are based on carbon usage for a defined scope and year. A firm’s carbon intensity is measured by the ratio between a company’s carbon usage in absolute terms (e.g., the total greenhouse gas emissions of the fiscal year 2005) and a related business metric (e.g., the sales of the same year).

The second indicator, carbon dependency, describes the change in a company’s physical carbon intensity over time – as such this indicator displays a dynamic component. For this purpose, certain steps need to be undertaken: first, a time period has to be determined. Second, the future carbon intensity has to be estimated, for example, based on specific scenarios and models (e.g., the total greenhouse gas emissions and the sales in 2015). Third, a specific carbon intensity (e.g., 2005) is put into relation to a future one (e.g., 2015). Based on this information, the carbon dependency describes the degree to which a company is able to reduce its carbon intensity over time (e.g., between 2005 and 2015). As result, a highly carbon dependent company has difficulty reducing its carbon intensity over a given time period.

The third indicator, carbon exposure, brings the monetary dimension into the picture. For this purpose, the prices for a firm’s carbon inputs (i.e., fossil fuels) as well carbon outputs (i.e., for greenhouse gas emissions, if emission trading schemes or taxation exist) are taken into account. Like the carbon intensity indicator, the carbon exposure assesses the static performance; it, therefore, determines the monetary implications of the business activities due to carbon usage for a defined scope and fiscal year (e.g., 2005). Through the use of prices (for the same year), the carbon inputs and outputs can be combined in one monetary figure. The result describes how much carbon matters for a firm from a cost point of view.

The fourth indicator, carbon risk, describes the change in a company’s monetary carbon performance within a given time period. Similar to the carbon dependency indicator, a firm’s carbon risk measures the relative performance change from the status quo to a future carbon exposure. In order to obtain this future carbon exposure, the results of the estimated carbon dependency can be utilized, complemented by forecasts regarding future price conditions for fossil fuels and carbon emissions (as, e.g., provided by EIA reports).  With these estimates, the risk feature of the indicator becomes vivid: especially when taking into account a future price for greenhouse gas emissions (e.g., $30 per ton of CO2) that are likely under a future international climate regime or national climate policies and the potential increase of fossil fuel prices (due to increasing resource scarcity), the real monetary risks lurking behind carbon become transparent. The indicator does not address potential risks (or opportunities) associated with new technologies or loss of market share for carbon intense products; it reflects increasing costs incurred by a company in paying for fuels and credits.

These indicators shed light on the physical and monetary dimensions of a company’s current and future activities with respect to carbon inputs and outputs. Based on this kind of information stakeholders are enabled to assess a company’s stake in climate change and its efforts towards better managing carbon usage: policy makers can use such information to formulate and evaluate policies, while financial markets obtain insights regarding the performance of companies with respect to carbon and corresponding financial effects. Furthermore, companies themselves can use the indicators for benchmarking purposes with competitions as well as with respect to own performance improvements over time.

The full paper is available here and the citation is: Hoffmann, V.H., Busch, T. (2008): Corporate Carbon Performance Indicators: Carbon Intensity, Dependency, Exposure, and Risk. Journal of Industrial Ecology 12 (4), 505-520.

Governor Deval Patrick of Massachusetts announced September 1st nearly $1 million in  grants for educational programs that will enhance training for the state’s burgeoning clean energy industry. This is good news for climate change, for Massachusetts, and particularly for me, because a group I’m leading at the University of Massachusetts, Boston was awarded $187,000 for a program entitled Business and Professional Education for the Clean Energy Economy. The project will be coordinated through the Center for Sustainable Enterprise and Regional Competitiveness (SERC) in the College of Management at the University. While other grants focus on vocational training and “green and blue” collar jobs, such as installation and maintenance of renewables and efficiency, our program builds higher education capacity for the rapidly expanding “green and white” collar job opportunities in a low-carbon economy.

The transition to a low carbon economy will entail radical technological and market change that promises to transform entire industries. There is an urgent need for a major education initiative to prepare for and manage the impending transition. Clean energy jobs have been growing at a rate of 9.1% in the US over the past decade, compared with only 3.7% for traditional jobs, according to a report issued this June by The Pew Charitable Trusts. Pew identifies five categories of the clean energy economy: (1) Clean Energy; (2) Energy Efficiency; (3) Environmentally Friendly Production; (4) Conservation and Pollution Mitigation; and (5) Training and Support. Although 65 percent of today’s clean energy economy jobs are in the category of Conservation and Pollution Mitigation (mostly recycling and wastewater treatment) but three other categories – Clean Energy, Energy Efficiency and Environmentally Friendly Production – are growing at a much faster pace.

Some of the sectors, such as windows, insulation, and water treatment, are not exactly what comes to mind when we think about clean tech, more old-economy than high-tech solar. But the growth in green job opportunities will extend well beyond renewables into electronics, software, financial services, and education (see this comprehensive list of reports on green jobs in the US.). Organizations of every type will be seeking “green and white” collar professionals with appropriate expertise. In fact, two new studies on the green labor market argue that an important prerequisite for employees in the new economy is general education in sustainability concepts and climate in particular.

My research with Dr. David Terkla revealed that in the Boston region there are large numbers of software and electronics firms capable of providing the sensors and controls for power management and energy efficiency, for smart buildings or connecting renewables to the grid. Most of these companies don’t currently identify themselves with clean tech. A recent Marketwatch story pointed to energy services and controls, often part of much larger companies, as important beneficiaries of the clean energy economy. Honeywell’s Automation and Control Solutions division, for example, which accounts for 38% of revenue and 32% of operating profits, provides environmental controls for buildings.

The clean energy economy will generate a large number of managerial and administrative jobs in non-energy sectors. A majority of large businesses in the US and Europe already produce annual sustainability and social responsibility reports, and are extending this to the climate issue. The proposed EPA guidelines on mandatory carbon reporting in the US, the advent of carbon trading, and voluntary carbon management and disclosure will affect almost every business. The need to track, manage, and report carbon across the value chain will create new demands on corporate management and open up large new markets for service firms, particularly consulting, legal, software, and accounting. eQuilibrium Solutions Inc., a Boston area software firm specializing in carbon and energy efficiency management software was just bought out by EnerNOC, indicating the buzz of activity in this field. Meanwhile, financial firms are becoming more directly engaged in carbon trading, financing clean energy, and assessing the impact of carbon risk on assets and loan portfolios.

Environmental skills and knowledge are increasingly valued in the employment market. In a recent survey titled “The Engaged Organization: Corporate Employee Environmental Education Survey and Case Study Findings” by the National Environmental Education Foundation, 65% of businesses surveyed said they value environmental and sustainability knowledge in job candidates and 78% said that that value will appreciate as a hiring factor in the next five years. Carbon footprinting, emissions reduction, and energy efficiency were key areas identified. Clean energy-related jobs also have better conditions than those in other sectors. A recent survey of 1200 clean energy professionals indicated that they enjoyed higher salaries and more job security than workers in other sectors.

The employment impact of a transition to a low-carbon economy will reach beyond business to affect government and non-profit organizations. Policymakers and planners will increasingly need to be familiar with market-based and regulatory mechanisms for addressing greenhouse gas emissions from transportation, power, industry, and buildings. Demand is growing rapidly for environmental and climate-related education at all levels and for the teachers with the expertise to deliver these programs. Despite the current budgetary environment, this is one area where our university will be looking to hire in the next few years.

The initiative at the University of Massachusetts, Boston, will provide the workforce with the skills and knowledge needed to play more effective roles as professionals, policymakers, and business managers. The College of Management will collaborate with the Department of Environmental, Earth, and Ocean Sciences to develop new interdisciplinary degree and certificate programs at the graduate and undergraduate levels that build on existing campus strengths in the science, business, politics, economics, and policy dimensions of clean energy and climate change. We will also extend and develop existing programs to bring a sharper focus on clean energy and the workforce skills demanded in a low-carbon energy efficient economy. The core programs are being designed for professionals seeking focused, compact, and low-cost career development, and will be valuable for mid-career professionals as well for degree students seeking a unique qualification.

I’m proud to lead this initiative to UMass-Boston, a public university capable of delivering high quality, accessible, and cost effective education to a wide range of traditional and non-traditional students. The university has a strong commitment to diversity, serving disadvantaged communities, and promoting regional economic development. The certificate programs are part of a broader environmental and clean energy education initiative at UMass-Boston, including the development of a Professional Science Masters program, which will support a cluster of clean energy capabilities in the state that will increase the competitiveness of the region, increasing investment and employment with clean energy firms and related service sectors.

The Uncertain Policy Environment

With negotiations currently under way for a successor to the Kyoto Protocol, progress is slow and business faces considerable uncertainty. Although the US under the new Obama administration has shown commitment to reaching an agreement at Copenhagen in December 2009, there are many unresolved issues on the table. These include the level of the emission reduction targets for the US and other industrialized countries; the introduction of emission reduction targets for emerging economies such as Brazil, China and India; the future shape of emission trading schemes and the relationship between them; and the transfer of money and technology to less-developed countries. The credit crisis and current economic recession have also affected the current setting for business and climate change in various ways, shifting the terms of the debate and highlighting tensions at the business-climate change interface.

The economic recession

The economic recession has reduced economic activity, especially industrial production, leading to lower greenhouse gas emissions and making it easier for companies and governments to reach their GHG targets. The Netherlands, for example, recently reported that it expected to be able to meet its Kyoto target in 2011. At the same time, this has reduced prices for carbon permits and other tradable emissions rights, lowering incentives for longer term investments in low-carbon technologies. Still, prices have been recovering recently within the European Trading Scheme (ETS) and trading activity for carbon permits has increased by more than 50% in the first quarter of 2009 (compared to the last one of 2008). Overall, however, the emissions market is not yet mature and the outcomes of the negotiations for the post-2012 regime will decide its future shape and viability. Current carbon prices are rather volatile and too low to provide sufficient incentives to change behavior in a more climate-friendly direction.

The economic slowdown has put downward pressure on oil prices, making the search for alternatives less attractive. One silver lining is that it has lowered investments in tar sands, which are energy-intense in extraction and processing. More problematic has been the loss of incentives to develop renewables, which has been reinforced by the credit crisis and the difficulty in raising venture capital. In the US, for example, clean tech venture capital investment fell from $1 billion in the last three months of 2008 to $154 million in the first quarter of 2009. Companies in Europe report similar problems; the Dutch company Econcern, for example, has gone bankrupt and the Danish wind company Vestas announced a lay off of 10% of its workforce.

There has also been a sharp decline in interest in biofuels. Corn-based ethanol had been growing rapidly in the US, supported by heavy subsidies, while sugar-based ethanol in Brazil had also been booming prior to the recession. The US ethanol industry has now gone from boom to bust and even the strong Brazilian producers have been severely hurt, leading to bankruptcies and a wave of consolidation.

The high oil price was one of the drivers of sales of hybrid vehicles and smaller, more fuel-efficient cars in the US, as gasoline prices peaked above $4 per gallon. Car sales overall have dropped due to the economic recession, despite a temporary boost in the US (and other countries, particularly Germany) from the ‘cash for clunkers’ program, although hybrids have suffered surprisingly little compared with the overall market. Hybrid sales are being stimulated by preferential tax measures. In the Netherlands, for example, hybrids receive favourable tax treatment, especially for leased vehicles, which influences corporate purchases. In the first eight months of 2008, sales via leasing of Toyota Prius cars in the Netherlands increased by 550% compared to the same period in 2007 (for the Honda Civic hybrid, the figure was slightly over 300%). In 2009, the Honda Civic hybrid became the country’s most leased car.

Green Bailouts

The fiscal measures adopted by governments in the face of the 2008 financial collapse were painted various shades of green. Table 1 gives an overview of the ‘green’ share in the bail-outs by ten countries and the European Union as estimated by HSBC in early August 2009.

The table shows that South Korea stands out for the high percentage of its green bail-out, followed by the EU and China, whereas Italy and Spain have the lowest share. The green label needs to be treated cautiously, however, as definitions are vague. Moreover, these are only promises of funds; in the US, some targeted recipients, such as the wind energy sector, have seen no money so far.

Innovating for climate change

In view of the importance of transport, fuels and energy use for the economy, key sectors for reducing emissions are automobiles, oil, and electric power. These are prime targets of policy measures and also provide good illustrations of the trade-offs we face in moving towards a low-carbon economy. A key strategic issue facing managers is whether their businesses should focus on exploiting existing know-how and technologies or on developing new products and markets that represent a departure from the current energy infrastructure.

In most cases, there is not just one best ‘solution’. For example, if companies want to invest in renewables they still have various options, ranging from more mature to much less well-developed technologies. Most mature are hydropower, biomass co-firing, wind, solar thermal and geothermal technologies, which in the best circumstances are approaching cost-competitiveness with conventional sources. Offshore wind and solar PV are emerging technologies that are not yet cost-competitive. And there are renewable technologies that are still in the R&D phase – e.g. specific forms of solar power, ocean energy and advanced biofuels – which completely lack market penetration and largely depend on public subsidies for further development.

The specific balance of risks and returns differs by company but also depends on the sector and its level of technological dynamism. This can be illustrated by pointing at the difference in R&D patterns between power generation and the automotive industry. R&D intensity in power generation has been notoriously low, due the fact that innovation involves massive capital investments combined with limited opportunities for product differentiation. Car companies, on the other hand, operate in a much more dynamic technological environment and therefore face greater pressure to develop alternative drive-train technologies, such as hybrids, electric and fuel cell vehicles.

In addition to technology, new market development needs to be considered. Companies can develop niche markets that allow companies more opportunity to experiment, or undertake incremental changes and transitional technologies. The auto industry illustrates both approaches. The fuel cell vehicle has long been viewed as the ultimate winner because it followed the route of niche development. Since the 1960s, fuel cells have been used for power in several market niches, such as space travel and the US army and navy. However, they have demonstrated the typical problems of niche development as well: it has been difficult to move beyond the niche into mainstream markets due to cost and scaling issues, and the resources needed to move across niche markets. Transition technologies, on the other hand, may become dominant themselves and then become barriers to further change. A case in point is the success of hybrid cars such as the Toyota Prius, which might have serious consequences for the further development of pure electric or fuel cell vehicles.

An example of a technology that allows companies to extend existing technologies and know how is carbon capture and storage (CCS), popular among oil, coal and electricity companies. CCS gives carbon-intensive companies the opportunity to show proactivity on climate change, while concurrently continuing their core business activities – this has also been a source of criticism. Transition technologies also play a role in the oil & gas industry, where gas can replace coal in power generation, and liquefied gas can substitute for gasoline in transportation.

Climate change is a problem demanding solutions that extend beyond the reach of any single company. How far are companies willing to go in collaborating with others? This is a tough question, especially when there are also competitive dimensions to the relationship. Various types of cooperation can be noted. One is by several competitors together with smaller niche players that own a specific technology, as has happened often in the car industry (e.g. Ford and Daimler with Ballard for fuel cells). A drawback of this structure is that companies share the technology with a close competitor. Cooperation with companies from other sectors avoids this problem: Dow Chemical and General Motor’s joint work on the development of fuel cells, each for a different purpose, is a good example.

In some cases more systemic, infrastructure-related collaborations are required. For example, to commercialise the fuel cell vehicle, the auto industry needs the chemical and oil industries to supply the hydrogen and distribution system necessary to attract prospective customers. This necessitates major breakthroughs which could actually threaten the fossil-fuel suppliers. As the car industry cannot supply the hydrogen itself, it faces a major chicken-and-egg problem: oil companies will not scale up their hydrogen activities until car companies come with more affordable fuel cell vehicles, while car companies will only launch such models if there is a hydrogen infrastructure. A somewhat comparable problem exists regarding plug-in hybrids or electric cars, which need electricity networks capable of meeting peak power demand. Two partnerships – between Toyota and EDF and between Daimler and RWE – were announced last year, both with the aim to develop a recharging infrastructure in selected locations. For more widespread use, there must also be a sufficient number of charging points and places to exchange batteries, requiring cooperation with local authorities and electricity grid operators. In the Netherlands, such a partnership was recently formed with the goal of ten thousand charging points in public spaces in the coming years.

These systemic issues require determined policy efforts to break the deadlock and escape the current “carbon lock-in”. These policy initiatives needs to take into account not just the technological options but also competitive, strategic, and market considerations. The key challenge for the coming year is to develop a comprehensive approach that simultaneously addresses the economic slowdown and the climate crisis.

Sources and Further Reading

Dyerson, R. & Pilkington, A. (2005). Gales of creative destruction and the opportunistic incumbent: The case of electric vehicles in California. Technology Analysis & Strategic Management, 17(4), 391-408.

Harvey, F. (2009). Healthy rebound for clean energy. Financial Times, 18 August.

Hekkert, M. & Van den Hoed, R. (2004). Competing technologies and the struggle towards a new dominant design. The emergence of the hybrid vehicle at the expense of the fuel cell vehicle? Greener Management International, 47(Autumn), 29-43.

Kolk, A. & Pinkse, J. (2008). A perspective on multinational enterprises and climate change. Learning from an ‘inconvenient truth’?. Journal of International Business Studies, 39(8), 1359-1378.

Neuhoff, K. (2005). Large-scale deployment of renewables for electricity generation. Oxford Review of Economic Policy, 21(1), 88-110.

Raven, R. (2007). Niche accumulation and hybridisation strategies in transition processes towards a sustainable energy system: an assessment of differences and pitfalls. Energy Policy, 35, 2390-2400.

Romm, J. (2006). The car and fuel of the future. Energy Policy, 34, 2609-2614.

Sandén, B.A. & Azar, C. (2005). Near-term technology policies for long-term climate targets – economy wide versus technology specific approaches. Energy Policy, 33, 1557-1576.

Unruh, G.C. (2000). Understanding carbon lock-in. Energy Policy, 28, 817-830.

Managing crises in complex systems

Just when the world was beginning to wake up to the climate change crisis, with a flood of new evidence on the accelerating meltdown of glaciers and polar ice caps, the financial crisis struck. Paul Gilding has termed this convergence of twin crises “The Great Disruption.” At first glance, the twin meltdowns, financial and climatic, appear to be very different problems requiring very different responses. The financial crisis presents as a relatively short-term crisis that resulted from a combination of housing and financial asset bubbles, poor regulation, excessive leverage, and distorted incentives. The climate crisis, by contrast, is driven by the seemingly inexorable rise in human emissions of greenhouse gases, a longer-term problem with a more defined physical structure. The financial crisis calls for fiscal and monetary policy responses combined with new financial regulation. The climate crisis is spawning a wave of regulatory and market responses, from caps on emissions to subsidies for low-carbon energy.

Despite their apparent differences, however, the climate and financial crises are both manifestations of a common problem – the difficulty in predicting and controlling complex dynamic systems riddled with feedback loops, time lags, and non-linear relationships. Though it’s tempting to point the finger of blame (and there is plenty of blame to go around), both systems are susceptible to fundamental, structural problems of governance. Most notably, we rarely recognize that we are careening over a cliff until we are well past the precipice. Moreover, once we recognize that we are spiraling down in a vicious circle, recovery is far from easy.

Complex systems, such as the climate and the economy, have many interconnected parts that interact in intricate and sometimes poorly understood ways (for a primer on complexity, download my book chapter here). They tend to be unstable and unpredictable, though they also exhibit patterned, cyclical behavior. The current recession, while more severe than most since the 1930s, is following an oft repeated trajectory of boom and bust, of overshoot and collapse in asset prices. In a similar way, but on a much longer time scale, the earth’s climate has cycled from ice ages to relatively warm inter-glacials about every one-hundred thousand years. The search for historical parallels can be useful due to this regularity. As Mark Twain famously said, history does not repeat itself, but it rhymes. Systems move in familiar patterns, but never exactly retrace the same path. A host of complex non-linear interactions mean that small differences in starting conditions can lead to very different outcomes. Though hurricanes take familiar tracks in the North Atlantic, we can never be quite sure how strong one might grow or what city it might hit. The current recession could turn out to be a brief dip or herald the onset of second major depression. Occasionally, complex systems can exhibit dramatic collapse, a result of self-reinforcing feedback loops that transform a minor event into a systemic crisis. We are used to the “normal” business cycle where output, investment, employment, asset prices, and confidence interact to create growth or recession dynamics. In the current recession, however, the sudden recognition that vast pools of complex derivatives based on risky mortgage and credit card debt might be worthless led to panic, frozen credit markets, and bank insolvencies. In a similar way, many scientists fear that human emissions of greenhouse gases could lead to a runaway warming effect due to several mechanisms. For example, polar regions tend to warm more rapidly, leading to loss of polar ice and more absorption of solar radiation. Moreover, warming is likely to lead to faster release of carbon dioxide from forests and vegetation. The vast Russian and Canadian tundra regions are thawing, while recent studies demonstrate that the Amazon will become significantly drier, accelerating the shrinking of the rain forest.

In the June McKinsey Quarterly, Michele Zanini reminds us that the severity of these unpredictable disasters, from earthquakes to stock market crashes, actually follows a predictable power law; there is a clear statistical relationship between the frequency and magnitude of the collapse. The so-called butterfly effect is not always at work; sometimes small events may cascade into a major storm, but more typically self-balancing feedback loops help to restabilize the system. Hurricanes dissipate thermal energy, the fuel for storms. Recessions lower interest rates and prices, stimulating investment and consumption. Occasionally, however, the changes that cascade through a system can push it past a tipping point and lock it into a new “phase state”, with a markedly different set of patterns of cycles. As Keynes famously argued, the economy was stuck in a deflationary cycle in the Great Depression and would not naturally bounce back as wages and prices fell. In a similar way, the climate can transition into ice ages lasting tens of thousands of years, in which ice sheets miles thick covered the British Isles and large portions of North America, or hot periods such as the Jurassic era, which lasted millions of years.

It is, then, not surprising that complex dynamic systems are inherently difficult to manage. Controlling the economy has been likened to attempting to steer a car by looking in the rear-view mirror. We can only see where we have been, not where we are heading. And the mirror is often foggy. Data are available after a time lag and may be distorted or offer conflicting interpretations. While the warning signs might seem obvious with hindsight, distinguishing the signal of a financial crisis from the noise of usual variability is difficult in the early stages. Moreover, the recognition of crisis conditions necessitating extraordinary policy measures is a time-consuming social and political process. Nick Kristoff has argued that evolution has predisposed us to worry about immediate tangible threats from tigers and snakes rather than longer term concerns based on analysis and calculation. As a result, prescient prophets of doom are destined to be ignored and we prefer, instead, to assume that what worked (or appeared to work) yesterday will continue to work tomorrow. There are also social and competitive pressures for this. We exhibit herd behavior in markets and crowds, relaxed and optimistic if others are, but vulnerable to panic contagion. As Citigroup chief executive Chuck Prince famously said in mid-2007: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Facing up to the climate crisis is much harder than recognizing the financial crisis. It is unfolding on a time scale of decades rather than months. Unlike the economy, where unemployment, bankruptcies and foreclosures provide more tangible and immediate evidence, the human imprint on the climate is hard to discern for the casual observer. Changes in carbon dioxide levels are invisible, the melting polar ice sheets and tundra are far away, and the oceans are, for now, soaking up much of the excess heat (though we may have reached nature’s overdraft limit).

Even for climate scientists, sophisticated statistical analysis is needed to demonstrate the human impact of greenhouse gases on global temperatures, and we are only just beginning to discern evidence of a link between hurricane intensity and climate change. Moreover, this is our first climate crisis as a sentient civilization. We have experience and institutions to help measure and deal with hurricanes and financial crises, but these are sorely lacking on the climate front.

We do, of course, attempt to peer into the future for both climate and the economy using modeling techniques, but the picture is generally even foggier than that in the rear view mirror. Models are, by definition, simple representations of a far more complex reality. They attempt to capture the major elements of a system and can perform quite well for short-term forecasting under relatively stable conditions. Economic forecasts hold up in reasonable fashion over several months or quarters, as long as there are no sudden shifts in consumer or investor sentiment. Weather forecasts, which rely on very well defined physical relationships between humidity, temperature, air pressure, and other factors, can be quite accurate for three or four days into the future, a bit better than a guess for up to ten days, but have little utility beyond that.

Weather forecasting illustrates an interesting paradox of complex systems; in principle, the weather is a deterministic system based on the well-known physics of atmospheric interactions, so that from a given set of starting conditions, the system ought to unfold in a predictable way. Yet even the most sophisticated weather models that use powerful supercomputers cannot capture the precise initial conditions at every point on earth; they usually work with a spatial resolution of several kilometers and don’t even have accurate data for all these “grid boxes”. Small errors in initial conditions are amplified across the millions of calculations that simulate the dynamic interaction of these atmospheric boxes every few minutes. For climate forecasting, the problems are similar, though different in scale. We are more interested in the average temperature and rainfall in fifty years time at a regional level than whether it will be cold and raining in Boston next Tuesday. But over a timescale of decades, the climate will exhibit more structural shifts with uncertain feedback effects; we don’t know how rapidly polar ice will melt, how fast rainforests will shrink, what might happen to cloud cover, or whether giant ocean currents like the Gulf Stream might slow or even shut down.

Even once the existence of a crisis is widely recognized, the steps required to address it are far from clear and simple. The economy and the climate have huge inertia and respond slowly and somewhat unpredictably to intervention, with the potential for unwelcome side effects. Action on the financial crisis was delayed while debates played out over fiscal versus monetary intervention, and bank nationalization versus recapitalization. Paul Krugman and Niall Ferguson have been recently feuding over the potential impact of large governmental deficits on inflation and interest rates; while Krugman supports aggressive intervention, for Ferguson and the deficit hawks, large scale government deficits will spook the bond markets, raise interest rates, and choke off any recovery. In any event, available policy options are only partial, limited tools; the government does not directly control business investment or consumer confidence. Large parts of the “gray” financial markets, such as hedge funds, non-bank finance, and credit default swaps issued by insurance companies lie beyond the reach of existing regulatory structures.

In a similar way, action on climate has been delayed while various parties argue over the best course of action – cap-and-trade versus carbon taxes versus direct traditional command and control regulation; nuclear power versus renewable energy. Mitigation policies can have unwanted side effects; raising vehicle fuel efficiency lowers the cost of fuel per mile, and so might encourage more driving. Electric vehicles might be charged on coal-intensive power in the US mid-West. Valuable carbon credits help to make air conditioning plants in China appear more profitable, accelerating production of these power hungry appliances. Policy tools tend to use indirect levers, such as the carbon price, which is likely to so low in the US as to have little effect on corporate or consumer behavior (see: Carbon Markets to Serve the Planet). Large sources of emissions lie mostly beyond the reach of current policy; emissions from developing countries, deforestation, international air travel and sea shipping have been out of bounds, till now at least. Moreover, carbon is only one piece of the climate system; we lack the technical tools to directly address other elements, such as melting ice caps, thawing tundra, or ocean currents.

Arguments about how to tackle crises are partly technical, reflecting different understandings of the workings of complex systems. But these differences are also deeply political, reflecting how we think the crisis, and proposals for intervention and change, will affect us in our particular geographic and economic location. It’s easy to claim that “we are all in the same boat”, but the truth is that some of us are in luxury yachts and some are in leaky dinghies. Bankers holding bad loans and homeowners facing foreclosure might want very different forms of government assistance; meanwhile, the majority of the tax-paying and still-employed public are wary of large scale public bail-outs. On climate change, the fiercest proponents of action on climate change are the low-lying countries likely to be swamped by rising sea levels, while the countries who strongly oppose action possess substantial coal and oil reserves. Rich industrialized countries might consider it reasonable to pay 1-2% of GDP to cut their emissions, but developing countries want access to cheap fossil fuels to drive their own industrial transformations.

Managing through a crisis in a complex dynamic system is clearly no easy task. To adapt the steering metaphor, the apt image might be steering a car with fogged up windows, using a greasy steering wheel that’s only loosely coupled to just one of the wheels. Oh, and there are four people in the car arguing about how we got here, where we are heading, and which way to turn the wheel.

A managerial and behavioral lens on low-cost carbon reductions

I’m writing this response to Jürgen Weiss and Mark Sarro’s excellent guest contribution while looking out of my antiquated and rusting steel casement windows in Brookline, Mass. These single pane windows, which date to the1951 construction of the house, are wintertime energy hogs – they are drafty, provide no insulation, and get covered in icy condensation. Why haven’t we replaced them? I teach in a business school and am outspoken on climate change, so the decision to replace the windows ought to be easy -  with my business school suit on, I should see the financial benefits, and with my environmentalist hat, I would feel good about reducing emissions.

But the math does not look so good when I run some numbers. Oil heat costs us around $2000 a year, and new windows might save up to $400 a year (though we have huge south-facing windows, which help keep the house comfortable in winter, at least when the sun shines, and insulated blinds for night-time). Yet it would cost around $20,000 to replace the windows with energy efficient ones. The 2% return on investment is a little better than money market funds are paying right now, but wouldn’t be attractive to an average investor (let alone a hedge fund!) It represents a 50 year payback, while most businesses look for 3-5 year payback. Even if we had the $20,000 lying around, who knows how long we’ll be in the house, or whether new windows would add much to the sale price. And this is a big expense, so my wife would have to be onboard. Ironically, my low-tech energy management system (the blinds!) helps lower the bills and reduces the incentive to invest in new windows.

The point of this embarrassing personal saga is to reinforce Jurgen and Mark’s argument that we need to be cautious of negative-cost carbon abatement. The good news is that about one-third of needed emissions reductions appear to have positive ROI, according to the McKinsey Marginal Abatement Cost (MAC). The bad news is that about one-third of needed emissions reductions appear to have positive ROI – yet the necessary investments are not happening. The costs may be higher than engineering estimates suggest and there are a host of market, institutional, and psychological barriers (and McKinsey themselves now puts more stress on these hurdles). The same logic applies to emission reductions that the curve suggests will occur with a carbon price of, say, $50 a ton – in reality, it might take a much higher carbon price to overcome these hurdles and secure the reductions.

Jurgen and Mark frame the problem in classic economic terms of scarcity: There Is No Such Thing As A Free Lunch. If there were free MAC lunches lying around, it is axiomatic for economists that someone would already have eaten them. My own Harvard Business School training in organization and management leads to a different perspective, however. There may well be free lunches available, but they are locked up or hidden away behind misaligned incentives, inertia, and market barriers. This business school perspective leads to a more optimistic conclusion than the economists’ dismal view.

Most companies, for example, have traditionally paid little attention to potential energy savings because nobody was paid to do so. Once companies assign managerial responsibility for the task, measure the savings, and evaluate performance accordingly, they start finding a lot of low-hanging fruit (see, for example, work by the Pew Center and The Climate Group (download large pdf file). Many of the barriers are more complex, and require restructuring markets and institutions – California is famous for paying utilities to save energy, not sell it. Utilities are also finding that they can nudge consumers in the right direction with non-price signals, such as comparisons with their neighbor’s bills. The booming field of behavioral economics points to all sorts of low-cost ways of shifting behavior. There are also a host of start up companies trying to exploit the potential savings and overcome market barriers by providing customers with turnkey efficiency projects packaged with financing, and then generating a revenue stream out of the lower energy bills.

Of course, these solutions are not cost free – they involve managerial time, some capital, and transaction costs. Some of the barriers are complex and would require large scale institutional restructuring, requiring government-business collaboration. But one person’s transaction costs are another’s business opportunity (the transaction costs of carbon markets will keep financial firms smiling). The key point here is that there are creative organizational and managerial approaches to unlock the doors to low-cost or even negative-cost carbon reductions. The carbon price is, by itself, an inefficient and ineffective tool – the price would have to be at a politically infeasible level to achieve the desired goal. But we don’t have to rely just on the carbon price or on command and control; a multi-pronged attack is needed.