Keep Carbon Futures Fluid
Go with the flow: Select the best mix of options to turn carbon-related risk into financial opportunity.
By Karla Hignite
Regardless of actions that may be taken by the current U.S. Congress—or even the next one—some form of regulatory compliance will emerge over the next several years that applies to greenhouse gas emissions, asserts Jeff Burks, director of sustainability and climate strategy, for Energy Strategies. This, says Burks, will start to monetize the strategic and tactical climate change-related risk that higher education institutions face. His firm, focused on energy management consulting, is working with colleges and universities and other public- and private-sector clients throughout North America to quantify their financial exposure. The goal: to develop and implement cost-effective initiatives to reduce emissions and capture opportunities posed by climate change.
While federal legislation remains a possibility, regulation by the U.S. Environmental Protection Agency (EPA) will occur under authority granted to regulate greenhouse gases as pollutants under the Clean Air Act, and state-imposed standards may apply, notes Burks. “It's not a matter of if, but of when and how.”
Joseph Grasso, associate dean for finance, administration, and corporate relations at Cornell University, Ithaca, New York, points to other developments indicating that greater scrutiny of environmental performance is forthcoming. For example, in May 2010, the National Association of Insurance Commissioners began requiring any insurer with more than $500 million in premiums to disclose its climate risks to regulators, shareholders, and the public. Even earlier this year, the U.S. Securities and Exchange Commission issued guidance in January that publicly-traded companies must disclose climate-related effects on their business operations, notes Grasso, who also serves as chair of NACUBO's Sustainability Advisory Panel.
“The SEC approval of these disclosure rules,” he adds, “marks a widespread recognition of the costs, risks, and opportunities climate change brings to U.S. corporate finance and investment decision making. One implication for college and university investment committees and advisers is that they can now incorporate a firm's exposure to climate change, when making investment and asset allocation decisions.”
Meanwhile, the Financial Accounting Standards Board and the International Accounting Standards Board only recently began focusing on accounting issues related to emissions trading and allowances. (See sidebar, “NACUBO Resources,” for further information.) However, their rulings will likely produce new guidelines on how to value cap-and-trade tools such as renewable energy credits, the purchase of carbon offsets, the production and sale of clean excess energy, and any derivative products being used to trade carbon allowances, notes Grasso. Also likely to be included, he says, will be guidance about the timing of profit and loss from trades and asset and liability recognition. “At some point, colleges and universities will incur a future obligation for carbon emissions that we will have to record as liabilities.” Yet, Grasso believes that institutions producing a surplus of clean and renewable energy will also be able to recognize new revenues and assets.
In preparing its climate action plan under the American College and University Presidents' Climate Commitment (ACUPCC), Cornell began assigning a cost to its carbon output. From its initial greenhouse gas inventory, university leaders learned that Cornell emits the equivalent of 319,000 metric tons of carbon per year. “From that, we created a baseline of energy use, made energy price forecasts, and assigned a cost of $28 per metric ton of carbon for the next decade,” explains Grasso. Using present-value analysis, a midrange estimate of Cornell's compliance-related costs totaled approximately $150 million over a 30-year period, resulting in annual costs of between $5 million and $10 million on a $2 billion Cornell budget, says Grasso. Not budget busting, but no drop in the bucket, either.
“While present market values for carbon have decreased since we conducted our initial assessment,” says Grasso, “the fact remains that the price of carbon will continue to fluctuate and will certainly rise again once requirements are established and enforced.” He notes that elements of Cornell's climate action plan were recently used as cost-saving measures to trim the university's operating budget.
Risk by Association
Even if colleges and universities do not have a direct compliance obligation under forthcoming regulation, somewhere along the supply chain their vendors will feel the impact, says Nick Travis, principal of Energy Strategies. “Incremental costs of complying with climate change regulation will work their way through the economy to end consumers.” For instance, a cost of carbon will be embedded in the price of fuels universities and colleges purchase, in electricity purchases from the grid, and in the cost of airline tickets, explains Travis. In essence, these indirect costs may be associated with any supply-chain service or product in which fossil-based fuels are either a feedstock or involve energy as a major input in the production process, adds Burks.
“The extent to which higher commodity prices for things like iron, steel, cement, paper and pulp, and plastics can be passed on to consumers will depend on a number of market and economic factors, but the costs will be real and will pose a significant indirect financial liability for institutions,” warns Burks. “Based on our work with 11 colleges and universities, the potential cost exposure could be in the tens to the hundreds of millions of dollars for an institution.”
While there is a general awareness among college and university leaders of this “risk by association” through their investment and supplier relationships, a lack of information exists on which to base informed decisions about the impact of those risks, says James Salo, vice president of strategy and research for Trucost Inc. The research firm works with organizations, investors, and governments to quantify the environmental impacts of their business activities with regard to greenhouse gas emissions, water use, waste streams, and various pollutants. Since its founding in 2000, Trucost has compiled comprehensive data on more than 4,500 companies, which have been used to develop Newsweek's green rankings of the 500 largest publicly-traded companies based in the United States. (The second annual ranking, to be published in the October 25 issue of Newsweek, will also include the 100 largest publicly-traded global corporations across 15 industry sectors.)
Beyond assessing environmental impacts, explains Salo, the company's research is aimed at helping clients determine and reduce areas of potential environmental and financial costs. This is done by identifying areas in which to increase efficiencies and reduce liabilities associated with regulatory compliance, and noting penalties that might one day apply under proposed cap-and-trade legislation, explains Salo. These tools have recently been developing for higher education institutions to help inform important decision-making and institution-reporting practices. In recent years, institutions have made some progress through ACUPCC and other formal commitments and tools that have required institutions to collect and assess data about their energy consumption, space use, and other environmental measures, notes Salo. “While institutions have primarily focused on the greenhouse gas impacts stemming from their direct operations,” he says, “an institution's carbon footprint is also affected by the suppliers of goods and services and the way its endowments are invested.”
For institutions that undertake a comprehensive assessment of impacts across all areas—operations, supply chain, and investments—the types and levels of risk will certainly vary by institution, says Salo. “What's important is for colleges and universities to measure and assess both operating and upstream institutional activities before allocating resources to areas that may have little payoff,” he argues. “While many institutions have scrutinized business travel as an area to trim greenhouse gas emissions, in actuality this may be a drop in the bucket compared to what can be achieved by enhancing supply-chain efficiencies.”
Trucost is currently working with Michigan State University (MSU), East Lansing, on a pilot project to review the carbon impacts of the university's largest suppliers and its top food purchases. Kathryn Lindahl first heard about the company during Salo's presentation to NACUBO's Sustainability Advisory Panel last January. She was immediately impressed by the level of reporting detail and the company's ability to hone in on smaller subsets of vendors, in addition to taking a comprehensive look at an organization's entire spend. “While I began to further understand the importance of assessing MSU's supply chain, I wasn't at first convinced that the firm fully understood some of the red flag issues for many higher education institutions with regard to supplier relationships,” admits Lindahl, MSU's assistant vice president for finance and operations and vice chair of the advisory panel.
One of her chief concerns related to the fact that a large research university like MSU relies on a huge network of providers large and small to keep the campus running. “I was particularly sensitive to the possibility that our vendors might view this as a threat—that perhaps MSU might take the pilot project's findings and discontinue our purchasing relationships,” says Lindahl. “We wanted to assure vendors that this was not our intent at all. As much as anything, this was a learning activity for MSU to better understand the impact of our own operations and an opportunity for us to learn together and prepare for a future when we all will likely be required to report emissions and comply with state and federal restrictions.” Accordingly, she ensured that MSU purchasing managers spent ample time in advance of the study talking with suppliers to tell them about the survey and the project's purpose.
“Fundamentally, this is about developing an awareness of efficiencies and exposures,” says Salo. “It does not mean you will have to change the systems or the relationships you have in place. On the other hand, where you find you have business partners that are not managing their environmental impacts in the most responsible or efficient manner, this analysis provides a basis for educating those companies in ways that promote activities that are ultimately good for them and for your institution.”
It's never easy to move forward in the midst of ambiguity, and there is still plenty of ambiguity about whether or to what extent higher education institutions may be held responsible for the environmental impacts of their vendors, says Lindahl. Yet, the possibility of this, she says, presents a whole different perspective to managing institution operations. The value in assessing your supply chain during this interim stage is that it allows a nonthreatening environment in which to meet in the middle to better understand the effects on both sides, she adds.
“Some of our smaller suppliers, in particular, are unlikely to have engaged in any kind of environmental assessment of their business activities,” says Lindahl. “We see this as a huge opportunity to provide education and knowledge to them and to help them understand what will likely be a financial cost for their emissions within a more regulated environment in the near future.”
Lindahl is also hopeful that MSU's investment in this pilot project will benefit higher education as a whole. “Perhaps as more institutions come on board to assess their supply chains, we can, as an industry, begin to compile data and criteria specific to higher education that will produce a useful benchmarking tool, much like the comparative data Trucost has amassed for private sector industries.”
First Things First
Perhaps even more basic than risks associated with outside suppliers and regulatory compliance are the expense and risk associated with technology upgrades needed to reduce an institution's carbon footprint (see sidebar, “Technology and Operational Risk.”) Leaders at Smith College, Northampton, Massachusetts, are addressing this right now, taking a methodical—albeit aggressive—approach toward the institution's carbon-reduction goals. According to Ruth Constantine, vice president for finance and administration, signing the ACUPCC in November 2007 was an easy decision for Smith's president. The college's commitment to sustainability and carbon neutrality fit beautifully with what the institution had already identified as one of four priority directions within its current strategic plan.
Conducting the necessary research and collecting the data to develop Smith's sustainability and climate action management plan helped the institution pull together separate initiatives already taking place among faculty, staff, and students. It also confirmed what campus leaders already knew: that outside the college's pursuit of central plant efficiencies, the greatest potential for reducing Smith's carbon footprint is through improving the thermal envelope of its existing infrastructure. With more building space per student than many comparable institutions, Smith's greatest carbon impacts are the result of its mission as a residential college, says Constantine. Heating, cooling, and lighting of the college's 111 buildings—some dating from the 19th century—account for 85 percent of the institution's total greenhouse gas emissions.
Having spent the better part of a year gathering data and evaluating the energy efficiency of each type of campus building, college leaders now have a much greater understanding about how to begin systematically reducing emissions, says Constantine. “You can't bypass this critical first step of research and assessment,” she adds. “All of our work to this point, including significant faculty and student research, has helped us understand what is realistic and which options are best to pursue based on today's technologies and our greatest potential for savings.” With a climate action blueprint in hand, Smith leaders will push forward this fall to refine the timeline for implementing specific priority actions and investments. “Even once you have a plan, you haven't necessarily answered all the when's and how to's to make sure you are investing in the right things at the best times,” says Constantine.
Smith has already achieved significant declines in its emissions during the past decade, with its 2009 emissions trailing those of 1990 by more than 10 percent. The single largest contributor to those reductions is the introduction of a cogeneration plant that went online in October 2008. Eventually the 3.5-megawatt natural gas-fired turbine will generate about two thirds of Smith's electrical power needs. The system also supplies steam to the college's central heating system. Estimates suggest that this system alone will cut energy costs by about $650,000 annually while increasing the efficiency of energy used from 45 percent (through previous conventional burning of fossil fuels) to 70 percent or greater.
Assumptions that biofuels will likely be cost competitive within the next decade and that investments in renewable energy are likely to have much quicker paybacks are reflected on Smith's list of options to monitor. In particular, biofuels with heating value properties comparable to heating oil that could be used in the college's cogeneration plant could become available in the near term to further reduce Smith's greenhouse gas emissions. Yet, other factors must be considered in evaluating the viability of alternatives, according to Smith's climate action plan. For instance, wood chip combustion may not be the best option because this source would require new infrastructure and operating space. Likewise, the way to accurately calculate the true environmental cost of certain biofuels is currently under debate. The clearing of land to grow alternative fuel sources might not only release sequestered carbon but could also raise the potential for increasing world hunger as more land is removed from food production.
“Our plan recognizes that over time we will see new developments in technologies and a maturity in renewable and alternative energy options and offset markets, but for right now, we believe our best efforts are to focus on reducing emissions through better efficiency of our existing infrastructure,” says Constantine.
Pursuing the Practical and the Positive
It is that opportunistic mind-set that gets to the heart of climate-related risk management, asserts Burks. Institutions that have undergone internal assessments to understand their own carbon footprint and potential financial exposure are positioned to take a more strategic approach with their capital investments and efforts to mitigate greenhouse gas emissions. This allows for more-informed decision making.
Prior to partnering with Energy Strategies, Cornell had already achieved significant greenhouse gas reductions through a variety of initiatives, including its lake source cooling project. By employing a local asset—the nearby cold waters of Cayuga Lake—the university was able to retire an aging chiller system, thereby reducing by 87 percent the electrical energy required for its cooling operations. University leaders have now adopted a portfolio approach to mitigation efforts to help assess the best timing of particular investments going forward and to provide trustees with a projected return on investment for each strategy on its own or in combination with other measures. “This new decision-making model,” says Grasso, “depicts a menu of creative and feasible options with the potential for positive returns. It aligns with Cornell's academic mission and will allow for ongoing learning and adjustment.” (See Figure 1: Cornell Greenhouse Gas Reduction "Wedges" and Figure 2: A Portfolio Approach to Mitigation Efforts for an illustration of the model.)
Recently, Lindahl turned to Energy Strategies to see how the consulting firm might help MSU integrate its various initiatives into a single model to better understand how each alternative would affect overall efforts to reduce emissions in balance with other priority objectives and while assuring capital stewardship. “If we invest $10 million more into natural gas versus coal, how would that impact our greenhouse gas emissions and our debt load, and would that reduce our labor costs?” asks Lindahl. “This is the kind of tool we need to engage trustees in discussions and decision making with regard to the university's environmental objectives.”
According to Travis, the company's first step takes clients through developing a baseline, business-as-usual scenario that assumes no changes to current practices. “We can estimate,” he says, “the financial exposure to climate change regulation given projected growth for the institution and varying scenarios with respect to advances in technology and legislative policy—along with the range of costs that might be assigned to carbon in the future.”
Under a business-as-usual scenario, the dollars an institution would have to spend as a passive participant in an economy—even one where carbon is not constrained—represent real dollars that could be used elsewhere within the enterprise and to better achieve the institution's priorities, adds Travis.
By hypothesizing an alternate set of decisions that can be taken to cut emissions, leaders can see how they might better deploy scarce financial resources to further the institution's mission and goals, explains Travis. “In every case, we've been able to identify actionable initiatives that can be implemented over a 10-year horizon that accomplish very significant reductions in greenhouse gas emissions while offering an attractive payback—before assigning a cost to carbon.”
No Carbon Left Behind
Although in many regards it makes sense to speak about climate change in terms of risk, business officers can arguably view their mitigation efforts in a more positive light. “I think we need to see our efforts to reduce our environmental impact as an opportunity rather than as a limit on our activities,” says Constantine. “Institution leaders care about doing the right thing, and the reality for all of us is that we are living in an era of constrained resources. We don't want to spend more on buildings and energy than we absolutely must. In Smith's case, far from viewing our move toward carbon neutrality as a limitation, we see this goal as opening the door to new possibilities so that by more efficient use of our resources, we will have more to invest in core education activities.”
With its main focus on seizing opportunities for financial savings and emission reductions through investments in conservation and energy efficiency, Smith does not consider compliance risk of future regulatory change as a primary motivating factor, says Constantine. That said, the college is monitoring offset markets and cap-and-trade legislation. “We know we can only minimize, not completely eliminate, emissions and that at some point we will need to achieve the balance of carbon neutrality through offsets or other means.”
Neither is MSU standing by idly. The university's assessment of the carbon impacts of its supply chain isn't the only example of the university's willingness to advance its own understanding while broadening the knowledge base of the industry as a whole. MSU is one of seven U.S. higher education institutions that have joined the Chicago Climate Exchange, currently North America's only market-based system for trading greenhouse gas emissions. Launched in 2003, CCX administers offset projects around the globe for its 450-plus members worldwide, which represent all sectors of the global economy and include more than 70 percent of the Dow Jones Industrials. Combined, CCX members represent 600 million metric tons of carbon. Although voluntary, CCX membership is legally binding. Participation requires creating a baseline greenhouse gas inventory and adhering to independent third-party verification by the Financial Industry Regulatory Authority to chart progress toward step-down emissions targets. If a member reduces emissions below its target, the member earns allowances that it can trade or bank to use in the future. Members that exceed their targets are obliged to purchase allowances or offsets.
With several MSU faculty engaged as CCX researchers helping to establish urban forestry offset protocols, membership in the exchange also provides the university with an opportunity to educate its entire campus community on the topic of climate change and inserts a level of reporting transparency that keeps the university honest, says Lindahl. “That doesn't mean this is easy or painless,” she adds. As with all major research institutions, the ramp-up in construction and renovations required to build the research base in essence can end up cancelling the efficiency gains made elsewhere on campus, notes Lindahl. “This is a real problem, but one that institutions are going to have to figure out.” Last year MSU had to pay $200,000 for offsets, which it purchased from Delta Group in support of Michigan farmers. “This is an example of why we engaged Energy Strategies—to help us model how we can better spend that $200,000 to result in reduced emissions and greater efficiencies on campus,” says Lindahl.
As for MSU's membership in CCX, university leaders view it as another opportunity to gain knowledge and to practice what it means to have to pay for emissions, says Lindahl. “We believe this is the direction in which the world is headed and we want to get in front of that learning curve. Knowing that you must report emissions and pay a price if you don't meet your target provides real incentive for finding ways to do things differently,” she adds.
Choose Your Future
Travis agrees that price signals can reinforce behavior modification. “Leaders should not forget that much can be accomplished with small adjustments in human behavior and institutional culture, and these should not be left out of an institution's strategy development.” This includes discussions among institution stakeholders about the potential for emissions-related regulation in order to help everyone begin to understand the impacts to their own budgets of conducting business as usual.
Cornell recently established a space management committee to develop plans for enhancing use of existing facilities. The university is considering charging some occupants for portions of the institution's 15 million square feet of space, allocating the cost of utilities to university departments based on their use of space, says Grasso. Extensive metering and monitoring of buildings to generate real-time consumption information is also helping to modify behavior, he adds.
The fact remains that institutional financial exposure to carbon-related risk—both direct and indirect—will pose a major challenge for colleges and universities going forward, especially for those not actively engaged in curbing emissions today, argues Grasso. “During these difficult economic times, there is a very strong business case for higher education to act now to manage the risks of climate change, to ensure that we're investing in the best options at the right times to lower our risk and maximize our returns,” he adds. “The seriousness of the risk posed by future climate change policies argues for these issues to be factored into an institution's overall enterprise risk management planning.”
Important for every institution to bear in mind is its unique set of assets, strengths, and weaknesses, notes Travis. A university that is dependent on either a coal-centric utility for electricity or a coal-fired central plant to provide steam and hot water must consider how to leverage the investments already made in those fuel sources and infrastructure assets even as it migrates toward other cleaner, low-carbon options. “What we all can do is determine the best ways to invest in new approaches while deploying current assets as productively as possible,” he adds. “There is no single solution for the best or most-direct path to carbon neutrality, but each institution can begin to chart a cost-effective course.”
A range of possibilities already exists for curbing carbon-related risk, and more options will emerge affording solid financial return on emissions-reducing investments. In an environment where business as usual could mean going out of business, higher education leaders can instead choose a proactive path by starting today to prepare their institutions for a future carbon-constrained world.
KARLA HIGNITE, Universal City, Texas, is a contributing editor for Business Officer.