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August 25, 2006
Trucost Joins Yale Professor to Devise Tool to Gauge Financial Cost of Environmental Impacts
by Bill Baue
Professor Robert Repetto and Trucost Researcher Dan Dias apply the TRUEVA methodology for measuring
externalities in financial terms to the US electric sector, which scores terribly.
SocialFunds.com --
In theory, business functions in society's best interest because it is a self-contained system that
amalgamates human and natural resources (work + raw materials) into products or services that
benefit customers while at the same time creating financial wealth that is dispersed to workers and
shareowners. Unfortunately, this is an alchemical myth that ignores the fact that companies do not
bear (or "internalize" in the business vernacular) all of the costs necessary do business--in other
words, the system has a leak in it. Specifically, many production processes necessarily degrade
the environment, yet companies typically shirk (or "externalize") this financial burden, leaving
society at large to foot the bill--for example through higher healthcare costs due to environmental
pollutants.
Companies have been able to avoid internalizing these externalities not only
because governments allow it, but also due to the lack of methods for calculating the financial
cost of externalities. This may no longer be the case. Bob Repetto, professor of economics and
sustainable development at Yale University, and Dan Dias, director of research at UK-based
environmental research firm Trucost, have
devised an empirical methodology for calculating the financial cost of externalities. Called True
Economic Value Added, or TRUEVA, the protocol measures companies' environmental externalities
against their ability to bear these costs through surplus revenues as expressed through economic
value added, or EVA.
TRUEVA follows in the footsteps of other recently-introduced environmental performance
metrics such as sdEffect and ADVANCE through a marketplace
orientation, using an accepted financial yardstick (EVA) to measure environmental impacts in
monetary terms.
"This approach lends itself to a bottom line assessment, which we believe
is more useful to investors and financial analysts focused on financial risk and return," Prof.
Repetto told SocialFunds.com. "TRUEVA is also useful as a management tool with which to assess the
overall performance of a business or business segment."
To illustrate this, Prof. Repetto
and Mr. Dias apply TRUEVA to the US electric utility sector. They estimate environmental damage
costs conservatively by looking only at air emissions of three greenhouse gases (GHGs)--carbon
dioxide (CO2), sulfur oxides (SO2), and nitrogen oxides (NOx)--while acknowledging that many other
externalities exist. Measured by EVA, most companies appear to be contributing to the economy.
However, when taking their environmental impacts into account by subtracting the cost of their
externalities, the picture changes dramatically.
"Remarkably, by this measure few electric
power companies were adding value to the economy," said Prof. Repetto. "The damages they imposed
exceeded their surpluses, often by a large margin."
The biggest externalizers were
American Electric Power (ticker: AEP) and Southern Company (SO), which imposed
net costs on society of $4.85 billion and $3.35 billion respectively in 2004, the year examined.
Interestingly, in April when the Senate
Committee on Energy & Natural Resources held a Climate Change Conference calling on energy companies to testify in
response to a white paper
suggesting new legislation to regulate emissions, the only two companies to oppose mandatory limits
on GHG emissions in favor of the Bush Administration's voluntary reductions approach were AEP and
Southern.
Exelon (EXC--one of the
companies to support mandatory limits) and PG&E (PCG) were among the handful of
companies generating positive TRUEVA scores ($225 million and $497 million, respectively)--meaning
their surplus revenues (or EVA) outweighed their externalizations.
Southern spokesperson
Mike Tyndall conveyed to SocialFunds.com that the company is not familiar with TRUEVA and did not
have enough time to assess the methodology and results to provide informed commentary. AEP
spokesperson Melissa McHenry echoed this lack of familiarity with TRUEVA, but called into question
some of the methodology's assumptions, such as the "arbitrary dollar value for the externalities."
"For example, it would be interesting to see how the author developed a $14 impact for a
ton of CO2 emissions since there is no current consensus on the cost or impact of a ton of CO2
emissions," Ms. McHenry told SocialFunds.com.
Prof. Repetto used the median value of
estimates for marginal damages from a meta-analysis (or
examination of multiple published studies) by Richard Tol, jointly
appointed at Hamburg (Germany), Vriej (Netherlands), and Carnegie Mellon (US) Universities.
Trucost uses marginal damage estimates because they represent externalization costs, whereas carbon
trading prices represent marginal abatement costs, according to Prof. Repetto.
"Also,
since SO2 and NOx are already significantly regulated, it seems that society has addressed the
externality of those emissions, so we are confused about their inclusion in an evaluation of the
future economic risk of emissions," Ms. McHenry said.
"The fact that SO2 and NOx are
regulated doesn't mean that these substances aren't being emitted and creating externalities,"
Prof. Repetto said. "All it means is that the company is not breaking the law."
Ms.
McHenry pointed to the multiple different initiatives AEP is
undertaking to address emissions. AEP started with an August 2004 report to shareowners. It
was the first US utility to join the Chicago Climate Exchange (CCX) committing it to reduce GHG emissions. It is
investing $4.1 billion through 2010 in environmental retrofits at its coal-fueled plants to
significantly reduce our emissions of NOx, SO2, and mercury. AEP also ranked highest of electric
utilities in a recent Ceres report
report
on climate change governance strategies.
Finally, Ms. McHenry pointed out that the
companies with the highest TRUEVA scores have significant nuclear operations, which do not emit the
substances under examination (Exelon is the largest nuclear producer in the
country.)
"What are the externalization costs of managing nuclear waste, or of addressing
the issue of nuclear weapons proliferation?" she asked.
Gil Friend, founding president and
CEO of environmental performance and sustainability metrics consultancy Natural Logic, similarly questions the decision to limit the
externalities covered. He notes the distinction between minimizing environmental impact while
maximizing profit on the one hand, and achieving true sustainability on the other.
"I'm
not sure that TRUEVA promotes progress toward true sustainability, as it only includes those
"externalities" whose impacts can be readily monetized--though enough to make a compelling case,"
Mr. Friend told SocialFunds.com. "It's worth remembering Albert Einstein's admonition that 'not
everything that matters can be measured, and not everything that can be measured matters.'"
"But whether or not TRUEVA promotes progress toward 'true sustainability,' it certainly seems
to promote progress toward financial markets taking 'true sustainability' into account," he added.
"And that's clearly a step in the right direction."
Others seem to agree.
"We are
just in the process of introducing this measure but there has been a good deal of initial interest,
not only from the socially responsible investing world but also from mainstream financial analysts
and portfolio managers," Prof. Repetto said.
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SRI World Group, Inc. All Rights Reserved.
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