In the previous lessons, we have learned about nonmarket analysis, public politics (nonmarket action that takes place in government arenas) and private politics (nonmarket action that takes place outside of public arenas). In this lesson we are going to examine several specific nonmarket developments of special significance to energy companies: shifts in corporate reporting of externalities (including physical impacts of climate change on energy industry), social cost of carbon (SCC), and energy return on energy invested (EROI).
By the end of this lesson, you should be able to...
The table below provides an overview of the requirements for Lesson 4. For details, please see individual assignments.
Please refer to the Calendar in Canvas for specific time frames and due dates.
REQUIREMENT | SUBMITTING YOUR WORK |
---|---|
Read Lesson 4 content and any additional assigned material | Not submitted. |
Weekly Activity 4 | Yes—Complete Activity located in the Modules Tab in Canvas. |
Case Study--work with others on your Team to prepare Case Study, following course guidelines | Check Canvas calendar for all Case Study Due Dates. Plan your Team's work schedule accordingly. |
At this point, please complete Corporate Reporting and Externalities, an essay by Jeff Honhensee in the book, Is Sustainability Still Possible? State of the World 2013 [1], by the WorldWatch Institute. (In case you are not familiar with it, the "State of the World" series is great! I highly recommend it.) You will find this reading under the Lesson 4 tab in Canvas.
In the reading above, Honhensee makes a strong case for corporate reporting of externalities as a company's responsibility to the public, which by definition bears the costs, as well as to its investors. Remember, externalities are the costs (or benefits) from economic activity that are borne by someone who did not play a role in said activity. Positive and negative externalities are not fully reflected in the price of products or services.
Upfront acknowledgment of risks to the business can help management anticipate, and plan for, future developments and increases investor confidence. In other words, what may have been once seen as a pure externality can, with a turn of events, cost a company and its investor's real money. For energy companies, many externalities fall into the category of risks that may suddenly become costly to the business, but probably none more so than externalities related to climate change. Perhaps more importantly in the near term, potential nonmarket action - particularly in the public sector, but also via private political action - can pose significant business risk(s) to a firm. Most of these actions are related to climate change externalities.
The Securities and Exchange Commission (SEC) is tasked with assuring firms provide reasonable disclosure of business risks to their shareholders. In 2010, the SEC issued the first (voluntary) Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change [2]. The guidelines did not create new legal requirements but provide guidance on existing disclosure rules that may require a company to disclose the impact business or legal developments related to climate change may have on its business.
Read the SEC's January 27, 2010 Press Release regarding disclosure of climate change-related risks. This guidance is still seen as a major turning point in climate disclosure initiatives in the U.S.:
From the press release:
Specifically, the SEC's interpretative guidance highlights the following areas as examples of where climate change may trigger disclosure requirements:
Why did the SEC decide to issue these new guidelines? A press release [4]from Ceres [5] and the Environmental Defense Fund [6] (both 501(c)(3) non-profits), described it this way, "Today’s decision comes after formal requests by leading investors for the SEC to require full corporate disclosure of wide-ranging climate-related business impacts – and strategies for addressing those impacts – in their financial filings. More than a dozen investors managing over $1 trillion in assets, plus Ceres and the Environmental Defense Fund, requested formal guidance in a petition filed with the Commission in 2007, and supported by supplemental petitions filed in 2008 and 2009." Addressing the way risks of externalities related to climate change are being included in corporate reporting is seen as a matter of protecting investors. For many, protecting the public and the environment would be sufficient cause. But here, the winning nonmarket strategy in the regulatory arena was the one that built a successful case, in the eyes of the SEC, by connecting the need to disclose climate-change risks with the need to protect investors.
As I'm sure you can imagine, the SEC's decision in 2010 has not been embraced by everyone. The article below provides some insight into one nonmarket approach to mitigate its impact.
As indicated in the article, assessing the financial risks posed by climate change are not limited to the U.S. In 2016, the Financial Stability Board (FSB) of the Group of 20 [8], usually referred to as the "G20", asked [9]its Task Force on Climate-related Financial Disclosures [10] (TCFD) to "develop a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders, and insurance underwriters about the financial risks companies face from climate change." (The G20 is a forum of wealthy and economically emerging countries of the world. The official group is made up of government representative such as finance ministers, heads of state, and central bank governors. At the annual G20 meetings, the representatives consult with many international organizations such as the OECD, the World Trade Organization, International Monetary Fund, as well as private sector businesses, non-governmental organizations, and more. The G20 [11]"traditionally focus on issues concerning global economic growth, international trade and financial market regulation.") It has become apparent to G20 members that issues related to climate change pose risks to businesses worldwide, and the establishment of the TCFD is an attempt to provide guidance on how to manage those risks.
The TCFD released its full report [12]on December 14, 2016; you may be interested in reading it. For a summary of the report, please read the speech by the Chair of the G20 FSB below.
With the risks of climate change-related externalities explicitly acknowledged, management is in a position to anticipate, plan for, and manage the risk (physical, policy, regulatory or otherwise). One way to mitigate these risks is by placing a price on carbon emissions, usually expressed in dollars (or whatever the relevant currency) per metric ton (tonne) of emissions. Carbon markets have been established at different scales throughtout the world, but companies are increasingly utilizing an internal cost to reduce risks and spur carbon reductions.
According to the Carbon Disclosure Project (CDP) [17], an English non-profit that publishes environmental impacts of companies across the world, as of the fall of 2016 more than 1,200 companies worldwide utilized internal carbon pricing in some form or another, with almost 150 "embedding a carbon price deep into their corporate strategy." As indicated in the articles above, there are different ways that companies do this. Microsoft actually charges individual units within its company based on their energy-based emissions, then uses these charges (expected to be $20 million in 2015!) to implement energy efficiency (e.g., building efficiency upgrades) and clean energy (e.g., solar, wind) measures in company units. Disney, Shell, Novartis, and Nissan also use this model.
Many other companies [18] are using internal carbon pricing when determining cost-benefit projections of potential projects and investments. This is what the Institute for Climate Economics referred to as a "shadow cost." Some of the world's major companies (including ExxonMobil and Shell!) price carbon internally. Though the price can vary widely by company, it has the effect of making projects that will result in lower emissions look more economically attractive.
In policy making, we must consider the cost of a proposed policy against the benefits of the proposed policy. How much would it cost taxpayers? How much would it benefit tax payers?
In the case of policies designed to address climate change, how does government put a value on the benefits of reducing emissions? What is saving a ton of CO2 emissions worth to tax payers? A mechanism used to give a value to emission reductions is called the Social Cost of Carbon (SCC). It puts a dollar value of the costs to society caused by a single ton of carbon dioxide (CO2) emissions. In other words, the SCC is the cost, in dollars, of the externalities of carbon emissions.
The SCC is set by the federal government [20] (note that this is "note the current EPA website" due to changes from the Trump Administration) and is used to determine the value to tax payers of proposed policies designed to reduce CO2 emissions. As such, it is a matter of public politics with a wide range of highly motivated and engaged stakeholders.
More than Meets the Eye, The Social Cost of Carbon in U.S. Climate Policy, in Plain English [21] (July 2011, World Resources Institute [22], Environmental Law Institute). Read Summary through section 4a How do the SCC Models Work?
Developing a Social Cost of Carbon for US Regulatory Analysis: A Methodology and Interpretation [23] (2013, Review of Environmental Economics and Policy [23]). Read Abstract, Introduction and Conclusions
Calculating and utilizing the SCC is a complicated and controversial topic. The following articles are not meant to be comprehensive, but to provide a snapshot of the science behind, and some competing views of SCC.
Energy Return on Energy Invested, usually phrased as "Energy Return on Investment" (EROI) is the ratio of energy returned to society divided by the energy required to get that energy.
What does this mean? Charles A.S. Hall, generally recognized as the father of this concept, explains it this way, "EROI is simply the energy gained from an energy-obtaining effort divided by the energy used to get that energy. For example, one barrel of oil invested into getting oil out of the ground might return fifty, thirty, ten or one barrel, depending when and where the process is taking place." (Synthesis to Special Issue on New Studies in EROI (Energy Return on Investment) [29], Sustainability, Charles A.S. Hall, 2011) EROI is also referred to as "energy profit."
In other words, it takes energy to acquire energy. "To make economic use of a barrel of oil requires not only drilling the well but also transporting the oil to a refinery, concerting it to a variety of petroleum products, and shipping them to end users--as well as expending energy to make the drilling rig, the steel in the refinery equipment, the tank trucks that take gasoline to service stations, the automobiles that burn the fuel, and so on." This is the energy expense, the "energy required to get that energy." (Energy as Master Resource, State of the World 2013, Eric Zencey, p 78) How does this energy expense compare to the energy in the barrel of oil, the "energy returned to society"? This is the ratio, EROI.
The higher the EROI, the higher the energy profit. The higher the EROI, the more energy is returned to society compared to the energy cost of getting that energy.
Many of you may be familiar with the controversy surrounding corn-derived ethanol, does it take more energy to produce than is available in the final product? Many argue yes. If so, the EROI of corn-based ethanol is less than 1.
"The concept of Energy Return on Investment (EROI) is a concept originally derived in ecology but increasingly applied to oil and other industrial energies. It had precedents in the idea of 'net energy analysis' used by Leslie White, Kenneth Boulding, and especially Howard Odum [1,2]. Similar but less explicit and focused ideas can be found in the newer field of 'life cycle analysis' that is better developed in Europe than in the US. The word investment usually means energy investment but sometimes may also include financial, environmental, and/or other kinds of investments. Some people like the term EROEI as a more explicit term, but we find it less useful and harder to pronounce. The term EROI has been around since at least 1970, but it gained relatively little traction until the last five or ten years. Now there is an explosion of interest as peak oil and the general economic effects of increasingly constrained energy supplies are becoming obvious to investigators from many fields." (Introduction to Special Issue on New Studies in EROI (Energy Rertun on Investment) [30], Sustainability, Charles A.S. Hall, 2011)
This is a course called Global Energy Enterprise, with a special emphasis on nonmarket issues for energy industries. How does EROI fit this discussion?
Let's start with this, "EROI analysis reveals the irrationality of making those choices [between different energy systems] according to current market price, which is a human construct dependent on current demand, subsidies, taxes, and the rates at which a flow of energy is extracted from its global stock. At the macroeconomic level, rational policymakers would be trying to maximize total sustainable delivered well-being, which (other things being equal--which they are not) would mean maximizing the EROI of a sustainable energy system for the economy. The effort to use price signals to find and promote that outcome requires that the relative monetary prices of difference kinds of energy reflect their relative social costs and benefits--a project that must begin with their relative EROIs." (Energy as Master Resource, State of the World 2013, Eric Zencey, p 78)
In other words, if we hope to use market forces to move society toward a sustainable energy system, then the prices of different kinds of energy will need to reflect the EROI relative to other options. Though this hasn't happened (yet), momentum and awareness of EROI is building in nonmarkets.
For example, an article by an environmental advocacy group, was simply titled "Oil Sands Mining Uses Up Almost as Much Energy as It Produces [34]." That's EROI. The article explains: "Tar sands retrieved by surface mining has an EROI of only about 5:1, according to research released in 2013. [35] Tar sands retrieved from deeper beneath the earth, through steam injection, fares even worse, with a maximum average ratio of just 2.9 to 1. That means one unit of natural gas is needed to create less than three units of oil-based energy." A peer-reviewed study published in May of 2017 found that though "increasing gradually," the EROI of Canadian oil sands was between 3.2 and 8 from 2009 to 2015 (Wang, et al., Energy Return on Investment of Canadian Oil Sands Extraction from 2009 to 2015. Full text available here [36].)
EROI is also becoming a proxy, of sort, for energy industry externalities. To say that using that kind of energy requires a lot of energy implies not only the cost of the energy inputs but also all of the associated externalities (emissions, environmental destruction, and so forth).
Advocates will argue, effectively, for and against energy choices based on EROI. It's a concept the public gets. Management in energy firms must be cognizant of and prepared to deal with these positions in the nonmarket. Policy makers may be pressured by EROI-based arguments to put a price on carbon, internalizing the externalities of fossil fuels and making energy market price better reflect the true cost to society.
For those of you who took EM SC 240: Energy and Sustainability in Contemporary Culture, you may remember that EROI was covered. Some of the content [37]from that course bears repeating because it provides some important considerations of the limitations of EROI.
All this being said, above a certain EROI, there is not much additional benefit in terms of percent energy out. (This article from The Oil Drum [38] has a really good discussion of this.) Let's look at the difference between coal (46:1), hydroelectric (84:1), and diesel from biomass (2:1). To calculate the percent energy out, you simply divide the energy out by the total energy used.
- For coal: Total energy = 46 + 1 = 47; energy out = 46; percent energy out = 46/47 = 0.979 = 97.9%
- For hydroelectric: Total = 84 + 1 = 85; energy out = 84; percent energy out = 84/85 = 0.988 = 98.8%
- Biomass diesel: Total = 2 + 1 = 3; energy out = 2; percent energy out = 2/3 = 0.667 = 66.7%
Do we care if we get 97.9% or 98.8% of the energy out? Probably not. Do we care if we get only 67% out? Probably. What is usually more important is the type of energy we are generating vs. what type we need. For example, the EROI number for coal only indicates the energy in the coal, not necessarily the useful energy you get out of it. So even though coal is efficient on an EROI basis, recall from Lesson 1 that generating electricity from coal is only around 33% efficient. Since hydroelectric dams generate electricity directly at a very high efficiency (up to 90% [39]!), hydroelectric electricity has a higher EROI than coal-based electricity. Finally, the net energy is also an important consideration - if we can get something really efficiently, but there is not a lot of it, then that may not help very much. But all else being equal, a higher EROI is better.
One extremely important thing to note: EROI only describes energy use. It says nothing about the other important impacts. For example, coal has a relatively high EROI, but is the most polluting energy source we use. Hydroelectricity has a very high EROI, but if done the wrong way can have negative impacts as well. Tar sands, on the other hand, have both a low EROI and a very negative impact on the environment. In short, EROI is only one consideration to be made.
Please review Canvas calendar for all due dates related to your Nonmarket Analysis Case Study.
Complete "Weekly Activity 4," located in the "Weekly Activities" folder under the Modules tab in Canvas. The activity may include a variety of question types, such as multiple choice, multiple select, ordering, matching, true/false, and "essay" (in some cases these require independent research and may be quantitative). Be sure to read each question carefully.
Unless specifically instructed otherwise, the answers to all questions come from the material presented in the course lesson. Do NOT go "googling around" to find an answer. To complete the Activity successfully, you will need to read the lesson, and all assigned readings, fully and carefully.
Each week a few questions may involve research beyond the material presented in the course lesson. This "research" requirement will be made clear in the question instructions. Be sure to allow yourself time for this! You will be graded on the correctness and quality of your answers. Make your answers as orderly and clear as possible. Help me understand what you are thinking and include data where relevant. Remember, numbers should ALWAYS be accompanied by units of measure (not "300" but "300 kW"). You must provide ALL calculations/equations to receive full credit - try to "talk me through" how you did the analysis.
This Activity is to be done individually and is to represent YOUR OWN WORK. (See Academic Integrity and Research Ethics [40] for a full description of the College's policy related to Academic Integrity and penalties for violation.)
The Activity is not timed, but does close at midnight EST on the due date as shown in Canvas.
If you have questions about the assignment, please post them to the "Questions about EME 444?" Discussion Forum. I am happy to provide clarification and guidance to help you understand the material and questions (really!). Of course, it is best to ask early.
In this lesson, you learned about significant nonmarket forces that are increasingly creating opportunities for stakeholders to shape the business environment for energy firms: shareholder pressure to report and address risks to the business from climate change, the use of a social cost of carbon (SCC) to assess proposed policy, and an emerging awareness of energy return on investment (EROI).
You learned:
You have reached the end of Lesson 4! Double-check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there.
Links
[1] http://www.worldwatch.org/bookstore/publication/state-world-2013-sustainability-still-possible
[2] http://www.sec.gov/news/press/2010/2010-15.htm
[3] https://www.sec.gov/rules/interp/2010/33-9106fr.pdf
[4] https://www.edf.org/news/sec-issues-ground-breaking-guidance-requiring-corporate-disclosure-material-climate-change-risk
[5] http://www.ceres.org
[6] http://www.edf.org/
[7] https://www.nytimes.com/2016/09/27/business/energy-environment/a-new-debate-over-pricing-the-risks-of-climate-change.html?_r=0
[8] https://www.g20.org/Webs/G20/EN/Home/home_node.html
[9] http://www.fsb.org/2016/12/fsb-welcomes-task-force-consultation-on-recommendations-for-climate-change-disclosure/
[10] https://www.fsb-tcfd.org/
[11] https://www.g20.org/Webs/G20/EN/G20/FAQs/faq.html
[12] https://www.fsb-tcfd.org/wp-content/uploads/2016/12/16_1221_TCFD_Report_Letter.pdf
[13] http://www.fsb.org/wp-content/uploads/Remarks-on-the-launch-of-the-Recommendations-of-the-Task-Force-on-Climate-related-Financial-Disclosures.pdf
[14] http://www.i4ce.org/wp-core/wp-content/uploads/2016/09/internal-carbon-pricing-november-2016-ENG.pdf
[15] https://www.nytimes.com/2015/09/27/business/energy-environment/microsoft-leads-movement-to-offset-emissions-with-internal-carbon-tax.html
[16] https://www.e-education.psu.edu/eme444/sites/www.e-education.psu.edu.eme444/files/2015%20-%20Microsoft%20Leads%20Movement%20to%20Offset%20Emissions%20With%20Internal%20Carbon%20Tax%20-%20The%20New%20York%20Times.pdf
[17] https://www.cdp.net/en/articles/media/press-release-major-multinationals-at-forefront-of-drive-to-price-carbon-and-meet-climate-targets-but-many-companies-still-unprepared
[18] http://www.triplepundit.com/2016/12/corporations-set-internal-carbon-prices/
[19] http://energy.gov/sites/prod/files/2015/10/f27/Regional_Climate_Vulnerabilities_and_Resilience_Solutions_0.pdf
[20] https://19january2017snapshot.epa.gov/climatechange/social-cost-carbon_.html
[21] http://www.wri.org/sites/default/files/pdf/more_than_meets_the_eye_social_cost_of_carbon.pdf
[22] http://www.wri.org/publication/more-meets-eye
[23] http://reep.oxfordjournals.org.ezaccess.libraries.psu.edu/content/7/1/23.full?maxtoshow=&hits=10&RESULTFORMAT=&fulltext=Developing%20a%20Social%20Cost%20of%20Carbon%20for%20US%20Regulatory%20Analysis%3A%20A%20Methodology%20and%20Interpretation&searchid=1&FIRSTINDEX=0&resourcetype=HWCIT
[24] http://www.triplepundit.com/2016/08/federal-court-rules-favor-social-cost-carbon-environmental-justice/
[25] https://www.bloomberg.com/news/articles/2016-12-15/how-climate-rules-might-fade-away
[26] https://www.bloomberg.com/view/articles/2017-03-29/making-sense-of-trump-s-order-on-climate-change
[27] http://news.stanford.edu/news/2015/january/emissions-social-costs-011215.html
[28] http://instituteforenergyresearch.org/wp-content/uploads/2013/07/2013.07.18-Murphy-EPW-Testimony-on-Social-Cost-of-Carbon-FINAL.pdf
[29] http://www.mdpi.com/2071-1050/3/12/2496
[30] http://www.mdpi.com/2071-1050/3/10/1773
[31] https://www.e-education.psu.edu/emsc240/sites/www.e-education.psu.edu.emsc240/files/images/1-s2.0-S0301421513003856-main.pdf
[32] http://literacy473.weebly.com/uploads/9/1/6/7/9167715/inman_2013_true_cost_of_fossil_fuels_scientificamerican0413-58.pdf
[33] http://www.scientificamerican.com/article/eroi-behind-numbers-energy-return-investment/
[34] http://insideclimatenews.org/news/20130219/oil-sands-mining-tar-sands-alberta-canada-energy-return-on-investment-eroi-natural-gas-in-situ-dilbit-bitumen
[35] http://www.postcarbon.org/drill-baby-drill/
[36] http://www.mdpi.com/1996-1073/10/5/614
[37] https://www.e-education.psu.edu/emsc240/node/516
[38] http://www.theoildrum.com/node/8625
[39] http://www.usbr.gov/power/edu/pamphlet.pdf
[40] http://www.ems.psu.edu/current_undergrad_students/academics/integrity_policy