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 / Spring 2009 / Issue 54(originally published by Booz & Company)


Pollution, Prices, and Perception

Carbon regulation will be unexpectedly complex — and business leaders will need to plan their approach accordingly.

Illustration by Lars Leetaru
Climate change is unlike any other environmental or public-health challenge that industrialized democracies have ever faced. The problem’s sheer scale over time and space, its protean and complex causes, the massive cost of addressing it (and the even more massive cost of ignoring it) all defy our intuition. And this immense complexity will confront executives as they begin to contemplate what the realities of climate policy will mean for their businesses.

Much of the current discussion among business and policy leaders involves details of how to apply a market-based “cap and trade” system. This is, of course, the scheme in which regulators prescribe emissions limits (the “caps”) and set up a system of fungible credits that allow businesses to comply with those limits (the “trade”) — thus creating an incentive to find the lowest-cost, most efficient ways to reduce emissions. It is clear that most governments will end up relying primarily, or even exclusively, on this sort of market-focused approach, and that it will provide a national and global context for business action on climate change.

But cap and trade by itself will be insufficient, for two reasons. First, given current technologies, the price of CO2 credits would need to rise to politically unsustainable levels to achieve the emissions re­ductions that most scientists think are necessary to avoid irreversible damage to the environment. Second, many of the most powerful measures for reducing emissions involve new infrastructure, new technical standards, regional planning, and basic research — domains in which prices and markets, by themselves, are inadequate.

The nature of climate change, as well as the realities of economic and political behavior, make it more likely that a multipronged regulatory approach will end up being used — incorporating, but not limited to, market-based approaches. Although it is impossible to predict exactly what form this set of private and public policies will eventually take, the most realistic possibilities are coming into focus today. Unfortunately, some companies, in planning for a post-carbon future, are betting on strategies that would pay out only in more extreme (and unlikely) scenarios. Currently available carbon sequestration technol­ogy, for instance, makes sense only when the prices of CO2 credits are extremely high; building conventional coal-powered generation plants would work financially only if no limits were placed on CO2. A clear-eyed assessment of the strengths and limits of a cap and trade system suggests a more nu­anced strategic path for energy and industrial producers. 

Costs and Complexities
Climate change is an inherently challenging issue to come to terms with. First is the sheer magnitude of the problem. Under “business as usual” scenarios in which carbon emissions continue growing (or even level off), the total cost of climate change–related damage over the next two centuries is estimated to be “equivalent to an average re­duction in global per-capita consumption of at least 5 percent, now and forever” — and 20 percent in the most vulnerable countries. (The source of these estimates is Nicholas Stern’s authoritative 2007 report, The Economics of Climate Change, published by Cambridge University Press.) These costs can be mitigated, but only if power-sector emissions are cut by 60 to 75 percent, and extensive cuts are made in transportation emissions as well. Even the best-designed approaches may require trillions of dollars to implement. For most of us, these figures are so enormous as to be practically meaningless.

The problem of how to address climate change is equally perplexing, in part because of the diffuse chain of causality and extensive time delays involved. Emissions entering the atmosphere today might have negligible impacts in the short run, but could contribute directly to dangerous greenhouse gas (GHG) levels 100 years or more in the future. The best technological fixes are not yet commercially available, and thus we don’t know how much they will cost to deploy. And the sheer variety of human activities that result in emissions poses its own challenges. Acid rain was reduced successfully by cap and trade, but it was primarily caused by sulfur dioxide and nitrous oxide emissions, both largely from coal-fired power plants; GHG emissions originate from a wide variety of activities and sectors of the economy. No single source of atmospheric carbon represents more than 30 or 40 percent of the total. Indeed, the only current consensus about solutions appears to be that no silver bullet exists.

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