A Two Degree World

The global movement to take greater action on climate change means boards and directors need a greater understanding of the impact this may have on their organisations.

At the Paris Climate Conference in December last year, 195 countries agreed to take action against climate change in an unprecedented legally binding deal.

“There is now a very clear global focus on keeping temperature increases below two degrees,” says Louise Davidson, chief executive officer at the Australian Council of Superannuation Investors (ACSI) and a director of the Peter MacCallum Cancer Institute. “As a result, I think we can expect to see some quite significant changes in terms of policy and constraint on carbon emissions.”

Carbon dioxide (CO2) is the primary greenhouse gas emitted as a result of human activities and coal-fired power plants are the prevalent source.

“I doubt there’s much of a future now for poorly performing mines and poor-quality coal for the energy market,” says Dr Matthew Bell, EY’s Oceania leader of climate change and sustainability services. “But, conversely, and somewhat perversely for environmental activists, it could mean we see an increase in demand for high-performing coal as developing countries become more energy efficient.”

Brendan Pearson, chief executive of the Minerals Council of Australia, believes that technology will play a central role in steadily lowering CO2 emissions over coming decades.

“The outcome [of the Paris Agreement] will support and accelerate the further roll-out of low-emissions coal technologies, which can reduce CO2 emissions by up to 50 per cent,” he says. “As a key energy exporter, Australia will play an important part in helping East Asian nations achieve their targets while also having access to affordable and reliable base-load energy.”

However, the future of Australia’s miners ultimately depends on the strategies adopted by international markets.

“Forty per cent of our coal currently goes to Japan, so what Japan does over the next 20 years will have a dramatic effect on our export potential,” says Bell. “The same is true for India, China and all of our other export targets.”

Stakeholders’ choices

Stakeholders are also playing a role in shaping the industry’s future. The coal divestment movement, which aims to restrict investment in coal, is gaining global momentum – in December, the fossil fuel divestment campaign reported that more than 500 institutions representing over $3.4 trillion in assets have made some form of commitment to divestment.

There is also growing concern among investors that regulatory events or market changes associated with climate change could result in stranded assets. Thirty-six per cent of the institutional investors who responded to the 2015 annual survey by EY’s Climate Change and Sustainability Services said this risk persuaded them to divest holdings of a company’s shares during the last year.

“The debate about stranded assets has been live for some time and, as investors, we’re interested in talking to companies about how they are managing that risk,” says Davidson. “When we meet with listed companies we want to know what kind of inventory they’ve done of their assets to establish the extent of the risk and over what time frame. Boards should be considering how well their organisation is gathering and communicating this information.”

Impacts across the board

The impact of the Paris Agreement won’t be limited to the resources sector.

“Very few businesses can say they’re entirely domestic these days, so boards will need to be very mindful of what’s happening in international markets,” says Bell. “This is where the complexity lies for governance. Directors really need to work through how the countries where their companies operate, or which form part of their supply chain, will respond to climate-change risk through regulatory and voluntary change and then what they need to do to navigate this.”

Directors should also assess the effects of climate change on communities and the environment, how this will affect their bottom line and how they can be part of the solution.

“This will be a major and multi-faceted challenge for boards because we’re entering a period of rapid change,” says Norman Pater, founder and non-executive director of Scope Systems and a director of the Conservation Council of Western Australia. “Forward-thinking organisations are already acting to reduce their carbon footprint and some are anticipating tougher rules. BHP, for example, has already modelled the impact that different carbon price scenarios would have on its profits. But modelling alone is insufficient – organisations also need to act on projected carbon budgets and increases in carbon pricing. The longer they wait, the steeper the price curve will have to be over the next five to 10 years.”

A change in attitude

Over the past six months Robert Gordon, director of programs at Board Accord, has seen a change in Australian boardrooms.

“There’s definitely a growing appreciation of the need to take climate change into account and to sign off on genuine rather than perfunctory policies and practices in relation to this,” he says. “However, there is also a growing imperative for boards to understand and capitalise on the tsunami of disruptive technologies and innovations that are on the horizon in response to climate change. I think this has yet to take its rightful position centre stage – but, hopefully, the recent Federal Government innovation push will be a carbon-reduction game changer.”

Dr Simon Divecha MAICD is director of Greenmode, a MetaIntegral Associate and researches the impact of climate change on business strategy, culture and collaboration at the University of Adelaide’s Business School. He estimates that just 10 to 20 per cent of organisations are searching out opportunities and ways to reshape themselves in the context of next-generation business models, while the rest wait to see what will happen by way of regulation.

“This is where the risk lies,” he says. “These companies will not only find themselves playing catch-up with the technical aspects of new legal requirements but also how they’re going to manage this type of complex challenge – what it means for the work they do, how they conceive their business models and what the new, disrupted future markets are likely to look like.”

Many already have a history of missed opportunity.

“Every Australian business has a carbon footprint and, for many, that is where the most significant opportunity lies,” Divecha continues. “We’ve known for 10 years or more that there are cheap, low-risk ways of cutting energy use that can increase profits as they deliver the same outcomes. The payback can often be seen in a matter of months or even weeks, yet many companies are failing to take advantage of this.”

As the demands on the board continue to change, it’s up to directors to gain relevant skills.

“The better prepared they are the sooner they can take action and the more likely it is that they will be able to fulfil their duty to deliver sustainable profitability,” says Divecha.

It is also important for the board to be clear about where the new responsibilities lie.

“Directors need to decide whether carbon and climate change are a matter for the risk committee, a new, dedicated strategic committee or a recurring agenda item for the whole board,” says Davidson.

Clear communication

In September last year, Mark Carney, governor of the Bank of England and chairman of the G20’s Financial Stability Board (FSB) told insurers at Lloyds of London that any efficient market reaction to climate change risks, as well as technologies and policies to address them, must be founded on transparency of information.

“A ‘market’ in the transition to a two-degree world can be built,” he said. “It has the potential to pull forward adjustment – but only if information is available and, crucially, if the policy responses of governments and the technological breakthroughs of the private sector are credible. That is why, following our discussions at the FSB last week, we are considering recommending to the G20 summit that more be done to develop consistent, comparable, reliable and clear disclosure around the carbon intensity of different assets.”

Bell would also like to see clear communication of companies’ strategies for creating long-term value.

“At the moment you’re most likely to see how businesses have performed in the last 12 months and what is in the pipeline for the next year or so,” he says. “Strategy functions tend to look out to a maximum of five years and the chief risk officer’s view is generally limited to a year or two, but both organisations and their stakeholders are increasingly aware that regulated markets on climate change are going to have a fundamental impact on businesses over the next 40 years.

“Paul Polman, chief executive officer of Unilever, recently told the investment market that he was no longer going to produce quarterly results because he felt this was creating a focus that was too short term. I think this is a good example of a subtle change in the narrative we’re seeing between astute business leaders and their stakeholders.”

New collaborations

The philosophies and motivations may still differ but businesses and non-government organisations (NGOs) are increasingly finding themselves in pursuit of the same outcome – and, as a result, more likely to collaborate.

“I have personally seen the dialogue change in boardrooms over the last 18 months,” says Bell. “For example, industry groups and NGOs recently came together to discuss appropriate climate change policy in Australia. I think this is a clear demonstration that boards now recognise that this is relevant to their organisation. Another example is the “We Mean Business” campaign instigated by the World Wildlife Fund and the International Finance Corporation. This has a goal of persuading businesses to align with principles that will help us move towards a two-degree economy.”

Davidson has found NGOs to be a useful source of information and ideas.

“As long as you remember that their objectives are often a bit different from those of investors you can have a constructive and respectful engagement,” she says. “It’s also important to remember that some will always be campaigning organisations which prefer to stay outside of the tent and that this is also a perfectly legitimate role. Different perspectives can make for a good outcome for everyone in the end.”

Questions for boards on climate change risk

• How could climate change affect the bottom line?
• How will other countries interpret and act on climate change and what will this mean for any international operations or supply chains?
• Have we considered the opportunities and risks associated with changing business models under a low, or zero, carbon economy?
• Are we in a position to use disruptive technologies and innovation to our advantage?
• Are we able to exploit cheap, low-risk ways of cutting energy use and reducing our own carbon footprint?
• Do we have meaningful policies and practices in place to demonstrate that we are governing for the creation of sustainable value?
• Are we clearly communicating how we are going to continue to create value over the long term to our stakeholders?
• Have we established where in the governance structure new responsibilities lie?
• Do we have access to relevant skills within and outside our business?
• Could collaborating with an NGO provide us with useful information and ideas?

Companies in the resources sector

• Do we have an inventory of assets that establishes the nature and extent of any associated risk?
• Are we communicating risk effectively to our stakeholders?