ACCOUNTING FOR S NATURAL CAPITAL DRIVING THE TRANSITION TO A RESOURCE-EFFICIENT GREEN ECONOMY Asia s rapid economic growth during recent decades has been accompanied by serious depletion of the region s natural resources and severe pollution impacts. Intensifying natural resource constraints and pollution related health impacts, fuelled by population growth and increasing consumption patterns, now threaten the region s continued growth and stability. Imminent threats to resource-intensive business models derive from volatile commodity markets, polluter pays environmental costs, supply disruptions and shortages. But where there is risk, there is opportunity. Natural capital, the extension of the economic concept of capital to goods and services provided by the environment, provides important financial context to reverse unsustainable growth trajectories and drive the transition to a resource-efficient green economy. By integrating economic and natural capital indicators, Governments can factor the economic cost of natural resource degradation and pollution impacts in decision making. In this way, natural resource efficiency and optimization can be viewed strategically as a central growth strategy. Companies that integrate financial and natural capital metrics will also benefit from improved strategic visibility of their natural resource dependencies and pollution impacts, providing critical insights to get ahead in evolution of sustainable global markets. Here we explore how natural capital accounting can help policy makers and business leaders to decouple growth from unsustainable natural resource and pollution impacts through a combination of regulatory drivers, corporate action and accounting mechanisms. WHAT IS NATURAL CAPITAL ACCOUNTING? The natural resource and pollution impacts of companies lead to environmental and social costs which are rarely factored into decision making or paid for by companies, for example water shortages due to irrigation in water constrained regions, flooding or biodiversity loss following deforestation, and healthcare costs triggered by pollution impacts. Natural capital accounting places a monetary value on the natural resource and pollution impacts of companies, providing a tool to integrate environmental considerations in traditional financial decision making. In this way companies and policy makers can develop strategies to decouple growth from unsustainable environmental impacts. For example Trucost s natural capital valuation of air pollution estimates the local cost of air pollution impacts on human health, crop and forest yields (Figure 1); Trucost s natural capital valuation of water estimates the cost of water use on the local population by considering, among other factors, local water availability; and Trucost s natural capital valuation of land use estimates the cost of local environmental services provided by land that are lost when land is converted to agricultural or industrial use. Detailed explanations of Trucost s natural capital accounting methodologies are provided in Natural Capital at Risk: The Top 100 Externalities of Business.
FIGURE 1: NATURAL CAPITAL ACCOUNTING (AIR POLLUTION) VOCs CO NOx NH3 HEALTH PM10 CROPS VALUATION TIMBER SO2 CORROSION ACIDIFICATION COSTS PER TON 1. POLICY DRIVERS In Asia, the unpaid natural capital costs of business totalled 3.7 trillion in 2010, representing 50% of unpaid natural capital costs globally (Table 1). Economic policies that allow these costs to remain external to company balance sheets create perverse market incentives for unsustainable business. TABLE 1: GLOBAL NATURAL CAPITAL COSTS BY REGION REGION NATURAL CAPITAL COST (TRILLION) PROPORTION OF GLOBAL NATURAL CAPITAL COSTS 3.70 50% AFRICA 1.00 14% NORTH AMERICA 0.85 12% EUROPE 0.85 12% SOUTH AMERICA 0.73 10% OCEANIA 0.11 1% GLOBAL FISHERIES 0.08 1% 7.32 100% REGULATORY DRIVERS The main sources of natural capital costs generated by Asia s business community were greenhouse gas emissions, largely driven by energy intensive iron, steel and cement manufacturing as well as coal power generation; water use by agricultural sectors including wheat, rice and cotton farming; and land use due to land conversion for agricultural use such as rice farming, palm oil cultivation and cattle ranching (Table 2). 2 TABLE 2: S NATURAL CAPITAL COSTS NATURAL CAPITAL IMPACT () NATURAL CAPITAL COST (TRILLION) PROPORTION OF REGIONAL NATURAL CAPITAL COSTS GREENHOUSE GAS EMISSIONS 1.40 38% 1.15 31% 0.75 20% AIR POLLUTION 0.21 6% LAND AND POLLUTION 0.18 5% 0.01-3.70 100%
1.1 PRICING STRATEGIES GREENHOUSE GAS EMISSIONS Several countries in Asia are already establishing policies to internalize the environmental and social costs of greenhouse gas emissions on company balance sheets, including China and South Korea. Natural capital accounting can help policy makers to identify appropriate pricing strategies for regulatory costs that reflect the unpaid market costs of greenhouse gas emissions, including human health impacts, reduced crop yields, flooding, acidification of oceans, and loss of biodiversity. Incorrect pricing of water is a critical issue for Asia given the high prevalence of water intensive agricultural sectors in the economy, in particular in the more water scarce Southern, Western and Central regions. Asia produces 72% of global cotton, resulting in the export of vulnerable public water resources at little or no cost by local private beneficiaries to their global consumers. Trucost s natural capital cost of water factors local water availability, helping policy makers to correct inaccurate water pricing that incentivises water intensive business in water scarce regions, and drive the adoption of more water efficient practices where it counts. Policy makers can protect critical environmental goods and services provided by land, such as biodiversity, climate regulation and flood barriers, by factoring the value of services provided by land when considering its conversation to industrial or agricultural use. In this way, the most valuable land can be secured (Table 3). TABLE 3: NATURAL CAPITAL COSTS OF ACROSS REGION NATURAL CAPITAL COST OF (MILLION) PROPORTION OF REGIONAL NATURAL CAPITAL COSTS SOUTHERN 356,410 25% EASTERN 211,801 14% SOUTH-EASTERN 133,767 47% WESTERN 26,541 6% CENTRAL 21,907 21% 1.2 GREEN FUNDING POLICIES TRUCOST PLC ACCOUNTING FOR S NATURAL CAPITAL REGULATORY DRIVERS Policy makers can also apply policy drivers to support the development of environmentally efficient technologies, products and services. Using natural capital accounting as an input to green funding policies identifies investments that will most effectively support regional resource-efficiency objectives by systematically factoring the local natural capital net benefits of more environmentally efficient products into decision-making. Figure 2 demonstrates how multiple natural capital considerations can be factored into green funding decisions. In this example we compare the natural capital cost savings of a decentralized energy project to grid average natural capital costs, factoring the local natural capital costs of greenhouse gas emissions, water use, air pollution, waste and other pollutant impacts. We find that the decentralized energy strategy offers natural capital cost savings of 30-40%, while also securing energy supplies and reducing exposure to volatile prices. 3
FIGURE 2: NATURAL CAPITAL NET BENEFITS OF A DECENTRALIZED ENERGY STRATEGY HEAVY METALS AIR POLLUTION & FROM LANDFILL AIR POLLUTION AIR POLLUTION & FROM LANDFILL AIR POLLUTION Biomass Burner offers 30-40% natural capital savings DIVERSION OF WOOD TO LANDFILL BIOMASS BURNER GRID AVERAGE TO LANDFILL TO LANDFILL COD COD WOOD TO LANDFILL 2. CORPORATE ACTION Population growth and rising consumption patterns provide abundant opportunities for companies. But they also intensify natural resource and pollution challenges. Companies that take the lead in minimizing unsustainable natural resource dependencies and pollution impacts will achieve competitive advantage in the transition to a resource-efficient green economy. Companies can apply shadow natural capital costs to their financial decision making to identify opportunities to decouple growth from unsustainable natural capital impacts - and minimize natural capital costs in advance of them being internalized by regulators. In this way, companies can use natural capital accounting to identify more sustainable raw material product inputs. For example, Figure 3 shows the varying natural capital costs linked to different energy sources in Asia. CORPORATE ACTION Companies can also use natural capital accounting to optimize the locations of natural resource intensive operations in line with local resource availability and prioritize investment in resource-efficient practices where it counts, thereby protecting their social licence to operate. For example, Eastern Asia and Southern Asia both produced 47% of Asia s cotton in 2010, however, the natural capital cost of water associated with Eastern Asia s cotton production is almost 50 times lower than that of Southern Asia. This is largely due to higher water availability in Eastern Asia combined with more efficient water use; Eastern Asia uses 247m3 of water per tonne of cotton production compared to Southern Asia, which uses 1,990m3 of water per tonne of cotton production (Table 4). This provides important insights for Governments wanting to protect vulnerable water stocks, as well as for companies wanting to optimize the water efficiency of their cotton production or reduce risk in their supply chain from increasing water scarcity. TABLE 4: NATURAL CAPITAL COSTS OF ACROSS REGION TONNES OF PRODUCTION NATURAL CAPITAL COST OF USE, MN NATURAL CAPITAL COST OF COTTON PRODUCTION, PER TONNE USE, m3 PER TONNE EASTERN 19,131,000 1,212 63 4,721 247 SOUTHERN 18,836,604 58,668 3,115 37,480 1,990 WESTERN 1,799,993 3,285 1,825 4,319 2,400 CENTRAL 615,195 1,306 2,123 1,690 2,747 COTTON PRODUCTION DATA WAS UNAVAILABLE FOR SOUTH-EASTERN 4 OF COTTON PRODUCTION, MN m3
FIGURE 3: NATURAL CAPITAL COST OF ENERGY SOURCES (US mn) PER MILLION MWh COAL NATURAL GAS 1.27 0.06 22.27 124.89 HYDROELECTRIC 63.45 <0 10.39 2.24 <0 16.88 WIND 0.28 3.35 150 120 <0 3.63 1.14 1.76 15.10 6.92 72.60 0.02 11.14 GHG AIR POLLUTION SOLAR WIND 90 60 30 0 COAL NATURAL GAS NUCLEAR ELECTRIC HYDROELECTRIC TRUCOST PLC ACCOUNTING FOR S NATURAL CAPITAL CORPORATE ACTION NATURAL CAPITAL COST OF ENERGY SOURCES (US MN) PER MILLION MWh 9.69 SOLAR 0.70 101.28 NUCLEAR ELECTRIC 5
Alongside helping companies to optimize raw material inputs and production locations, natural capital accounting can be used to strengthen the business case for the development of resource-efficient products and services by evidencing the natural capital net benefits of new technologies, products and services to financial stakeholders. Companies can also strengthen the investment case for resource-efficient products and services to customers based on reduced natural capital costs during the product life time. Figure 4 demonstrates how, by factoring reduced natural capital costs of water, water efficient technologies can be shown to deliver long term financial benefits over baseline products. This will become increasingly compelling if the trend towards increased internalization of water s value, particularly in water constrained regions, continues. FIGURE 4: EFFICIENT PRODUCT DEVELOPMENT NATURAL CAPITAL COST OF BASELINE OPERATING EXPENDITURE EFFICIENT CAPITAL EXPENDITURE OVER LIFETIME OF -EFFICIENT PRODUCT 3. ACCOUNTING MECHANISMS Integrating economic and natural capital indicators enables governments and policy makers to factor the economic cost of natural resource degradation and pollution impacts in decision making. In this way, natural resource efficiency and optimization can be viewed strategically as a central growth opportunity (Table 5). TABLE 5: INTEGRATED ECONOMIC AND NATURAL CAPITAL METRICS (, 2010) NATURAL CAPITAL COSTS (MILLION) USE ACCOUNTING MECHANISMS SOUTHERN 6 GHG EMISSIONS LAND USE AIR POLLUTION LAND AND POLLUTION GDP TO NATURAL GDP CAPITAL (MILLION) COST RATIO 1,145,288 1,403,331 750,426 206,574 184,872 10,127 3,700,618 19,762,383 19% 720,350 257,002 356,410 20,188 60,791 519 1,415,261 2,495,497 57% CENTRAL 40,589 32,457 21,907 4,149 2,773 44 101,920 220,053 46% WESTERN 265,283 97,551 26,541 16,309 10,554 156 416,394 2,493,641 17% SOUTHEASTERN 10,514 106,583 133,767 16,243 19,798 108 287,013 1,829,881 16% EASTERN 108,552 909,738 211,801 149,684 90,956 9,301 1,480,031 12,723,311 12% Companies that integrate financial and natural capital metrics will also benefit from improved strategic visibility of their natural resource dependencies and pollution impacts. This enables companies to manage risk from unsustainable natural resource consumption and increasing environmental costs by optimizing raw material inputs and production locations, as well as introducing resource-efficient processes and technologies where it counts (Figure 5).
FIGURE 5: PROFIT AND LOSS ACCOUNT (PUMA, 2010) OTHER AIR POLLUTION million million million million % OF 2% 3 100% 145 100% 8 6% Tier 1 13 9% Tier 2 14 10% Tier 3 27 19% Tier 4 83 57% PUMA operations million million 33% 47 32% 47 26% 37 7% 11 Long-term investors are also increasingly monitoring the natural capital impacts and policies of companies; a 2013 survey by the Global Investor Coalition on Climate Change found 70% of asset owners are influenced by climate change factors. Companies that are able to demonstrate that they have strategies in place to minimize natural capital costs, have a secure long-term licence to operate and are well positioned to capitalize on the transition to a resource-efficient green economy will be well positioned to secure long-term capital investment. CONCLUSION The choices that Asian policy makers make in relation to economic and environmental strategies in the next decade will be of critical importance to the future of the region s people and for the planet as a whole. Natural capital accounting provides an important framework to deliver the transition to a resource-efficient green economy by enabling the integration of economic and environmental metrics. If accompanied by long term environmental policies that protect vulnerable resources and drive resource-efficient business, it could provide a vital key to unlock critical resource and pollution challenges. Against a backdrop of increasing natural resource vulnerability, volatile commodity markets and intensifying environmental regulation, fuelled by population growth and increasing consumption, companies that act now to decouple growth from natural capital cost will be the successful companies of the future. Natural capital accounting enables companies to do just that with natural capital insights that drive sustainable decision-making. Financial insights that everyone, from product managers and sourcing strategists to financial managers and board members, can understand and act on. CONCLUSION TRUCOST PLC ACCOUNTING FOR S NATURAL CAPITAL 7
GETTING STARTED FOR GOVERNMENTS: Trucost has developed a vast library of regional natural capital valuation methodologies and benchmarks based on peer reviewed academic research. Contact info@trucost.com to arrange an interview. FOR BUSINESS LEADERS: Trucost has developed The Materiality Report to provide a fast overview of companies natural capital risks and opportunities. Find out more at www.trucost.com/thematerialityreport or contact info@trucost.com FOR INVESTORS: Trucost provides the world s most comprehensive natural capital metrics to help investors identify risk and opportunity in the transition to a resource-efficient, green economy. Find out more at www.trucost.com/investors or contact info@trucost.com Data used by this paper were first published in Natural Capital at Risk: The Top 100 Externalities of Business commissioned by the TEEB for Business Coalition and undertaken by Trucost. Trucost Plc Trucost has been helping companies, investors, governments, academics and thought leaders to understand the economic consequences of natural capital dependency for over 12 years. Our world leading data and insight enables our clients to identify natural capital dependency across companies, products, supply chains and investments; manage risk from volatile commodity prices and increasing environmental costs; and ultimately build more sustainable business models and brands. Key to our approach is that we not only quantify natural capital dependency, we also put a price on it, helping our clients understand environmental risk in business terms. It isn t all about carbon ; it s about water; land use; waste and pollutants. It s about which raw materials are used and where they are sourced, from energy and water to metals, minerals and agricultural products. And it s about how those materials are extracted, processed and distributed. www.trucost.com The information used to compile this report has been collected from a number of sources in the public domain and from Trucost s licensors. Some of its content may be proprietary and belong to Trucost or its licensors. The report may not be used for purposes other than those for which it has been compiled and made available to you by Trucost. Whilst every care has been taken by Trucost in compiling this report, Trucost accepts no liability whatsoever for any loss (including without limitation direct or indirect loss and any loss of profit, data, or economic loss) occasioned to any person nor for any damage, cost, claim or expense arising from any reliance on this report or any of its content (save only to the extent that the same may not be in law excluded). The information in this report does not constitute or form part of any offer, invitation to sell, offer to subscribe for or to purchase any shares or other securities and must not be relied upon in connection with any contract relating to any such matter. Trucost is the trading name of Trucost plc a public limited company registered in England company number 3929223 whose registered office is at One London Wall, London EC2Y 5AB, UK. GETTING STARTED Trucost 2013 8 TRUCOST PLC NOVEMBER 2013 Copyright Trucost www.trucost.com info@trucost.com @Trucost