Supplement, October 2000 Why Kyoto counts Years of international negotiations are on the verge of presenting global industry with perhaps its biggest challenge of the new century. Some businesses are already moving to address their carbon emissions. Mark Nicholls explains why The current furore over the price of petrol shows only too clearly that the global economy is still very much wedded to fossil fuels. As truckers lead newly-formed coalitions lobbying hard for cheaper fuel, the temperature of the global warming debate has perceptibly cooled. But whereas the car-driving public can easily forget the bigger, environmental picture when prices soar at the petrol pump, the evidence of climate change is becoming ever more compelling. High fuel prices may cost votes, but how long can policymakers ignore the issue when evidence of global warming is accumulating by the day? National and international efforts to curb emissions of greenhouse gases (GHGs) - which are understood to cause global warming - are, of course, intensely political. Democratic governments must ultimately respond to the demands of their electorates, and balance these against longer-term environmental policies. And what is difficult at the national level is rarely any easier internationally. The progress of the Kyoto Protocol gives many observers cause for concern. Reaching agreement in 1997 that the industrialised world would cut its GHG emissions to 5.2% below 1990 levels by 2008-2012 was an enormous achievement. But this effort will have to be repeated, even surpassed, to bring about the treaty's ratification. And the danger of the negotiations collapsing, or grinding to a halt, cannot be ignored. But whatever the vicissitudes of public opinion, and despite the often perilous state of the Kyoto negotiating process, world leaders - in business as well as politics - realise that emissions of GHGs will have to be radically reduced to avoid a potential climatic catastrophe. Whether as a result of Kyoto, or a successor international treaty, or simply under national or regional schemes, companies will in future have to exist with restrictions on their output of carbon. The first Kyoto compliance period (when emissions reductions will be assessed) doesn't begin until 2008. But governments are already putting policies in place to meet their goals. Some, like the UK, have announced targets that exceed their Kyoto commitments. It will fall on industry, of course, to make the lion's share of the reductions - and the more-forward looking companies are beginning to set internal targets, and plan for a carbon-constrained future. These firms have decided not to wait on the outcome of these tortuous international negotiations. Senior executives at companies such as US chemicals and pharmaceuticals giant, DuPont, oil companies BP and Royal/Dutch Shell, Canada's Ontario Power Generation, and Tokyo Electric Power have given the go-ahead to take actions now that they believe will help their companies deals with future emissions restrictions - and take advantage of market opportunities - and each week brings news of further initiatives and more corporate converts. Although they are not yet subject to binding agreements, these companies believe that action now will either reduce the cost of complying with targets when they arrive (that is, from 2008 under Kyoto, or earlier under some domestic schemes) or, by learning-by-doing, help them better face the challenge. At the end of the day, these companies - and their slower-moving contemporaries - will simply have to emit less. But transforming a company from a heavy carbon-emitter to a GHG-lite firm is akin to turning a super-tanker around. In the meantime, companies will have to buy the right to pollute - from firms that beat their own targets via emissions trading, or from investing in external emissions reducing projects - until such time as new investment and new technologies can be brought to bear on their own emissions profiles. Trading should make compliance with emissions reductions targets more cost-effective. Trading schemes ensure the environmental objective - the overall emissions limit - is met, while allowing companies flexibility in formulating emissions reductions strategies. For example, some firms could capitalise on aggressive, early reductions by selling credits to others who may find it economically rational to buy credits and defer investment in cleaner technology. Kyoto fully embraces this idea. It proposes an international market in emissions permits from 2008, linked to mechanisms whereby companies can invest in emissions-reducing projects to earn carbon credits (in theory, from this year). Without these mechanisms, business would have thrown up its hands in horror at the cost of compliance - and the Protocol would most likely have been suffocated at birth. Already, a nascent market in Kyoto emissions permits has sprung up. Brokers, consultants, bankers and exchanges are rushing to carve out a niche in a market that, some predict could dwarf the biggest commodity markets. Some estimate that the market could be worth $50 billion/year by 2008. But while GHG emissions present a market opportunity for intermediaries and consultants, it is set to be one of the greatest challenges facing large companies over the coming decades. Even the first step for emitting companies - establishing what their GHG emissions 'footprint' is - is a far from straightforward task. A number of initiatives - such as the GHG Protocol from the World Business Council for Sustainable Development - set out to help companies assess and report their emissions. The next stage will be to get to grips with these new markets, new financial tools, and new hedging strategies. Learning how to use new instruments and new risk management strategies requires considerable investment. Both BP and Shell have established internal emissions trading schemes, not only to help identify and exploit emissions reductions opportunities within their operations (which usually generate cost-savings themselves), but also to prepare themselves for national and international trading schemes. It is in this spirit that the growing number of inter-company emissions trades have taken place. Most, such as the recent trade between a German utility Hamburgische ElectricitatsWerke and Canadian power company TransAlta, have been small transactions. But while they have had little impact on firms' emissions profiles, they each represent leaps in understanding of how such trades should be structured, priced, accounted for, and legally underpinned. Furthermore, early action by companies to manage their emissions will pay dividends. Because the policy-framework for emissions reductions is still fluid, companies can buy carbon credits at a fraction of their likely cost in a few years. Undoubtedly, companies are in an unenviable position: attempting to take strategic decisions in a fluid policy and regulatory environment. But as Kyoto has accepted the precautionary principle with regard to climate change, business would be advised to follow suite. Whether Kyoto succeeds or fails remains to be seen. But what is clear is that emitting companies would be foolish to ignore what is an accelerating global trend towards action to limit GHGs. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE