Preparing for a Carbon-Constrained Future

American business faces a carbon-constrained future, and SAIC's Michael Mondshine offers a central insight into dealing with that fact: "As new regulations are implemented, carbon may have a larger impact on your balance sheet than the actual energy purchased."

Mondshine has been named to the United Nations Framework Convention on Climate Change (UNFCCC) Roster of Experts and was recognized by the Intergovernmental Panel on Climate Change (IPCC) for his contributions to IPCC's 2007 Nobel Peace Prize-winning work. He's also manager of SAIC's Climate Change Services program, and since 1993, he and his team have been providing expert advice on the environment to clients, including IPCC, the U.S. Environmental Protection Agency (EPA), and the U.S. Department of Energy.

Follow Mondshine's logic. The nation will eventually have legislation constraining carbon emissions, and it's likely to be a cap-and-trade system like that envisioned in the America's Climate Security Act (ACSA).

ACSA was tabled in the Senate in June, but passage of similar legislation is highly likely during the next two-year congressional term. Both the Democratic and Republican candidates for president back some form of cap-and-trade system, and recent action by the U.S. Supreme Court has also lent support to that outcome. (A cap-and-trade system essentially uses market forces to limit carbon emissions. )

Under such a cap-and-trade regime, businesses will pay for the right to emit greenhouse gases. The Energy Information Administration (EIA), an independent agency within the U.S. Department of Energy, has looked at how much those emissions might cost.

The agency forecasts that in 2020, coal would cost about $1.65 per million BTU (in current dollars). The price of carbon, however — that is, the cost for the right to emit the greenhouse gases created when coal is burned — might range from $2.38 to $7.18 per million BTU. This cost would be incurred when businesses buy "credits" (also called allowances) that permit the release of greenhouse gases¹.

A Hint of What Is to Come

Whatever the actual numbers turn out to be, the EIA's analysis begins to paint a scenario of a carbon-constrained economy as the U.S. attempts to address climate change.

"Many companies need to make capital stock investment decisions now that will be in place for 30 or 40 years," Mondshine said. Businesses that want to prosper, therefore, need to grapple with how decisions they make today are going to affect their operations when carbon constraints are imposed.

Many businesses, including mid-level FORTUNE 500® companies, "are just now confronting what the implications of climate change legislation are," said Steve Messner, SAIC's Climate Change Services Western regional manager. "A failure to understand these implications would place them at a competitive disadvantage in the carbon-constrained future."

The good news for those companies is that Mondshine and his team have the know-how to help customers get smart about energy issues.

The First Step Is the Footprint

A carbon footprint is simply an inventory of the greenhouse gas emissions for which a business is responsible. And for any business, the first part of coming to terms with the carbon-constrained future is that inventory. Without it, a business cannot reasonably expect to plan adequately for the future.

"Completing your inventory is the first step in managing your risk, quantifying your compliance liabilities, and identifying your potential opportunities," Mondshine said.

Depending on the industry and size of the business, companies may or may not be covered by the regulation. Yet companies that won't be covered, Mondshine said, should have an inventory and a strategy, because they will still face risk.

"For example, if you're a non-regulated entity, but you purchase fuel or electricity, the price of those energy purchases is going to go up, depending on how much allowances are going to cost," he said.

"If you're a non-regulated entity, you may very well want to go into the market and buy allowances as a hedge, because if the cost of allowances goes up and electricity goes up, you're going to make money on the other side because you're making money on the allowances."

Mondshine continued: "I would argue that if you haven't done your carbon footprint ... you may be leaving money on the table."

Complying With a Different Future

Under likely legislation, as well as under a number of existing state and regional initiatives, greenhouse gas emissions must be tallied and reported. Generally, how emissions data must be calculated and which emissions must be captured in a company's inventory are delineated in reporting protocols.

For a significant number of companies, dealing with greenhouse gas emissions reporting protocols may be completely new.

While the protocols for coming national legislation haven't yet been set in stone, a number of protocols already exist for mandatory reporting in individual states and more broadly for voluntary reporting.

Many companies, in fact, have already committed to completing an inventory using existing, voluntary protocols because it's good business. They see legislation coming and want to play a part in shaping it. Some also may do business in countries or localities where a cap is already in place.

The Climate Registry is a collaboration among 39 U.S. states and the District of Columbia, eight Canadian provinces, six Mexican states, and several North American Indian tribes. More than 243 businesses (including SAIC) and local governments have also joined as founding members. Participants include Alcoa, Duke Energy, the Los Alamos National Nuclear Lab, Pacific Gas and Electric, and Shell Oil. The Climate Registry's protocols — which Mondshine and his team helped to write — likely have the largest number of adherents.

Because of that, a significant portion of those protocols are likely to be adopted in coming federal legislation, according to Jette Findsen, deputy program manager for SAIC's Climate Change Services. In addition, she said the EPA is building on existing state initiatives by developing a mandatory greenhouse gas reporting rule for large emitters. A draft is expected in September 2008, including a proposed threshold for companies that will be covered under this system. The final rule will be released in the spring of 2009.

The Tricky Part Is Understanding What to Count

"Most of a carbon footprint," Mondshine said, "is multiplication. Energy data and/or activity data multiplied by emissions factors." However, he added, "That is a basic competency that is not sufficient to complete an inventory properly. The real challenge is understanding the protocols relative to defining the boundaries of the company, and applying the appropriate quantitative methods."

In other words, simple multiplication won't do. Also necessary is an understanding of the protocols and how they apply to a company and its boundaries.

The concept of a company's boundaries relates to the emissions sources a company owns or operates directly, such as a boiler and generator, or those sources with emissions levels that are affected by their actions. That could include the purchase of electricity or steam or chilled water from an outside vendor. For example, think of how air travel expands an individual carbon footprint. The traveler doesn't personally own the jet or burn the fuel, but is still responsible for part of the emissions.

Those boundaries may also include minority investments in an emissions source, such as an oil or gas well, with operations that are managed by the company. Also, leased buildings for which a company pays the energy bills. And it's possible that there will be emissions from sources they do not own or operate but for which the company is still responsible.

In many cases, reports will need to have third-party verification or, at a minimum, an audit by the agency receiving the report. According to Messner, "The tricky part is getting a handle on all the moving parts."

In order to obtain verification, "You need an established data collection procedure. You must train the people who are responsible for doing your inventory and you should automate as much of the data collection process as possible in order to ensure the veracity of those data."

For some companies, there will be in-house resources to look after the finer points of the protocols. For others, dealing with accounting protocols may be a job better outsourced to a company like SAIC.

But the Footprint Is Just the First Step

Mondshine and his team recommend that companies have a strategic plan for addressing the climate change issue over the long term.

Such a plan can help position the business not just from a pure regulatory compliance standpoint, but also from a positive public relations perspective. Research has shown, he said, that if there are two competing products of approximately the same price, and one has been demonstrated as "green," the majority of Americans will select the "greener" product.

According to Messner, after the footprint is complete, a company should forecast its future emissions and then "identify a cost-curve for reductions." In other words, each business needs to decide at what dollar value it makes sense to achieve particular kinds of carbon reductions. "At each price for carbon," Messner said, "there would be specific things that you could achieve."

That could be many things — offsetting carbon by planting trees, recovering methane from a landfill, using solar or wind power. Or capturing and sequestering carbon.

Companies may also want to purchase greenhouse gas offset credits from external sources to offset some of the emissions they cannot avoid. Offsets, Messner said, must be both permanent and additional — or something that wasn't just going to happen anyway.

Because SAIC "developed protocols for offsets for the EPA and the California Climate Action Registry," Findsen said, "We understand what the platinum standard is for offsets, and we make sure that our clients only buy the best offsets." That is, the offsets that "will not present any risk to our customer's brand reputation."

Bad offsets — offsets that cannot be verified or do not even exist — can cost a business not just money, but public good will in an era when good increasingly equals green.