Assessing businesses' $7.3 trillion annual cost to natural capital

The cost business is levying on the planet’s natural capital is large and likely to grow. The risks to business are growing, too.

Primary production and processing industries are costing the global economy around $7.3 trillion a year in terms of the economic costs of greenhouse gas emissions, loss of natural resources, and other factors, according to a new study.

The report, Natural Capital at Risk — The Top 100 Externalities of Business, released today at the Business for the Environment summit in New Delhi, was produced by Trucost for the TEEB for Business Coalition. It identifies financial risk from environmental externalities such as damages from climate change, pollution, land conversion and depletion of natural resources, across business sectors at a regional level.

According to the report, the primary production (agriculture, forestry, fisheries, mining, oil and gas exploration, utilities) and primary processing (cement, steel, pulp and paper, petrochemicals) is estimated to have externality costs totaling $7.3 trillion, roughly equal to 13 percent of global economic output in 2009. The majority of environmental externality costs are from greenhouse gas emissions (38 percent), water use (25 percent), land use (24 percent,; air pollution (7 percent), land and water pollution (5 percent) and waste (1 percent).

The highest-impact sectors by region globally include:

• Coal-fired power in Eastern Asia and in Northern America, which rank No. 1 and No. 3, respectively, collectively estimated at $780 billion annually. These consist of the impacts of GHG emissions and the health costs and other damage due to air pollution. In both instances, these social costs exceeded the production value of the sector.
• Other high-impact sectors are agriculture: Cattle ranching in South America, for example, at an estimated $354 billion, ranks second. Wheat and rice production in southern Asia rank fourth and fifth respectively.
• Iron, steel and ferroalloy manufacturing ranks sixth, at $225 billion. Cement manufacturing globally accounts for 6 percent of carbon dioxide emissions, and eastern Asia produces an estimated 55 percent of the world’s cement, resulting in it coming in seventh among high-impact sectors and regions.

“During the past decade commodity prices erased a century-long decline in real terms, and risks are growing from over-exploitation of increasingly scarce, unpriced natural capital,” write the authors, according to a draft copy of the report I received last week. “Depletion of ecosystem goods and services, such as damages from climate change, pollution or land conversion, generate economic, social and environmental externalities. Growing business demand for natural capital, and falling supply due to environmental degradation and events such as drought, are contributing to natural resource constraints including water scarcity.”

The report assessed more than 100 environmental impacts using the Trucost environmental model, which condenses them into six “environmental key performance indicators,” or eKPIs, covering the major categories of natural capital consumption: water use, greenhouse gas emissions, waste, air pollution, water and land pollution, and land use. The eKPIs were quantified by region across more than 500 business sectors. The model covers only “standard operating practices, excluding catastrophic events.” The authors acknowledge that the methodology has limitations and is designed only to give a high-level indication of the priority sectors and regions where natural-capital risk lies.

Still, the message is clear. “These are material issues, and they're not going to come in 50 years’ time. They’re here,” Richard Mattison, Trucost’s CEO, told me recently. “And you have to care about it now because it won’t require regulations to impose costs on businesses. It requires a change in the state of our natural resources, which is already happening.” (Trucost was GreenBiz Group’s partner in producing the 2013 State of Green Business Report.)

Mattison continued. “If you ever wondered how material this is, simply compare the numbers in this report to the combined losses of OECD pension funds in 2008. And the externalities identified in this report are larger than those. We’re facing a risk to business that is larger than they faced during the global financial crisis.”

Natural capital assets fall into two categories: those which are non-renewable and traded, such as fossil fuels and minerals; and those which provide finite renewable goods and services for which no price typically exists, such as clean air, groundwater and biodiversity. Write the authors:

During the past decade commodity prices erased a century-long decline in real terms, and risks are growing from over-exploitation of increasingly scarce, unpriced natural capital. Depletion of ecosystem goods and services, such as damages from climate change or land conversion, generates economic, social and environmental externalities. Growing business demand for natural capital, and falling supply due to environmental degradation and events such as drought, are contributing to natural resource constraints including water scarcity.

Government policies to address the challenge include environmental regulations and market-based instruments, which may internalize natural capital costs and lower the profitability of polluting activities. In the absence of regulation, these costs usually remain externalized unless an event such as drought causes rapid internalization through supply-chains through commodity price volatility; although the costs arising from a drought will not necessarily be in proportion to the externality from any irrigation.

According to Mattison, much of the problem stems from the lack of information companies have about their operations, the result of an outsourcing trend that begin after World War II. “The only information that flows through the global economy today is price,” he says. “That means you don’t have information whether you’re employing children in your supply chain. You don’t have information about whether you’re causing huge amounts of air pollution in Beijing that is killing kids. You’ve got no idea whether your product is creating something downstream from you that is causing a major environmental impact. Businesses that really think about this do. They are starting to get hold of this information and turn it to their advantage.”

The TEEB for Business Coalition describes itself as “a global, multi-stakeholder open-source platform for supporting the development of methods for natural and social capital valuation in business,” with the goal to “change the way business is done and to be part of forging the new capitalism.” The group includes NGOs like WWF, Conservation International and the Global Reporting Initiative; business groups like BSR, the World Business Council on Sustainable Development and the Corporate Eco Forum; the World Bank; and the accountancies Deloitte and Ernst & Young. Seed funding comes from foundations and the UK Department of the Environment Food and Rural Affairs.

I asked Mattison whether companies really needed to think about this stuff. After all, most have gotten through each day, week and quarter without worrying about their firms’ natural capital costs, which they don’t directly pay and which don’t appear on their financial statements. “Isn’t this a case where ignorance is bliss?” I asked.

“Ignorance is bliss works fine in a world where the cost of raw materials is going down, because efficiency gains are coming in and we haven’t had a more global functional market,” Mattison responded. “That was last century. This century, that has completely reversed. Costs are going up and have become much more volatile.

“So, you're taking risks not just through rising costs but also huge volatility. And volatility is the hardest thing to manage. And that volatility in part is being driven in part by risks that are impacting on natural capital. And because these risks are nonlinear and disruptive, you don’t necessarily know exactly when they are going to come. You just know that when they do come they’re going to be big.”

He concluded: “Increasingly, ignorance is risk.”