The Sustainability Buzz

How Shadow Pricing Can Improve the Outlook for Sustainability Projects

Shadow Pricing and SustainabilitySuppose you have a project that you’d like to undertake that, based on standard cost/benefit analysis, doesn’t quite meet the payback period that your company requires. However, you know that in addition to the easily quantifiable benefits of the project there is one more, less obvious, benefit. The completed project will reduce the company’s carbon emissions by a substantial amount. You know that your company has recently made it a priority to reduce just those types of emissions. How do you convince the higher-ups that this is a valuable project to approve?

In pre-sustainability days, you just would have been out of luck unless you had a management willing to do something because it was “the right thing to do.” But as companies come to better understand the risks associated with certain environmental conditions such as increasing CO2 emissions and dwindling water supplies, many have introduced the concept of shadow pricing into their cost/benefit analysis process.

To take the definition used in the 2014 State of Green Business Report, “a shadow price is . . . the estimated price of a good or service for which no market price exists, or where the market price doesn’t reflect the full replacement cost.” Let’s consider that in two applications. For CO2 emissions, there is not a carbon market for the United States so it is correct that there is no “price” for carbon in our country. However, there are 19 established emissions trading systems (ETS) in the world, including one in California and one in Alberta.  Based on the prices set by these various carbon markets it is possible to estimate the value of one tonne of “saved” carbon emissions.  Currently prices range from $6 to $60 per tonne.

Shadow pricing is, not surprisingly, used extensively in the energy industry to factor in the impact of future carbon controls that might be imposed. More surprisingly, some 150 companies including Microsoft, Dow, Disney and Delta, outside of the energy field, have disclosed to CDP (formerly the Carbon Disclosure Project) that they are already using a shadow price for carbon to inform business decisions.

How does this apply to your project? If the end result of implementation is a reduction in carbon emissions in addition to whatever other cost savings the project yields, it is now possible to assign a monetary value to those reduced carbon emissions on the benefits side of the cost/benefit analysis. Those additional benefits may tip the scales to clear your company’s hurdle.  Some companies do this informally by, rather than assigning an actual price, allowing longer acceptable payback periods if the project reduces carbon emissions.

Let’s look at the second half of the definition of shadow pricing – where the market price doesn’t reflect the full replacement cost. Projects related to water or other critical raw materials often fall into this category.  A project designed to reduce water consumption may not reach the desired breakeven point because of a relatively low price of water in the area. However, if your product is highly dependent on the reliable availability of water – perhaps in the baking or brewing or bottling industries – then the risk of not reducing water consumption is much higher than that represented by the cost of water. Disruptions to the production line and to the customer need to be considered. If your plant is located in an area where drought is prevalent, which unfortunately now means a significant portion of the U.S., good risk management dictates that you should assign a shadow price to the water to factor in the risk of drought disrupting your water supply. In this situation, the shadow price represents the costs (risk) avoided by the implementation of the project and the reduced consumption of water.

Shadow pricing is a not unfamiliar accounting concept. Businesses already routinely quantify items for which there is no price. “Good will” and “brand value” are often factored into the valuation or sale price for companies. But there are far more opportunities for pricing the cost of externalities – the costs not born by the producer, such as air pollution or depletion of raw materials – into the financial model. In Europe, The Prince of Wales’s Accounting for Sustainability Project has been providing an opportunity since 2013 for the CFOs of many of Europe’s biggest corporations to work together to define how integrating environmental and social issues into financial modeling can improve decision-making and reduce risk and uncertainty.

Next time you have a project with a strong sustainability component that doesn’t quite clear the hurdle, consider factoring in the cost of the carbon emissions you’ll save. Show the monetary value of those avoided emissions. Just the argument alone could make the difference.

Governor Wolf’s New Budget Includes Energy Efficiency and Alternative Energy Programs

Tucked into Governor Wolf’s proposed budget for the fiscal year beginning July 1, 2015, is a $675 million bond program that, among other things, supports investment in infrastructure, energy and technology. The bond program includes a $225 million initiative to ensure a comprehensive energy portfolio that supports gas, coal, oil and renewable resources, as well as encouraging conservation and clean technology alternatives.

Also included are competitive grants to fund energy efficiency improvement projects for small businesses, local government units, schools and non-profit organizations, rebates to homeowners and small businesses for qualifying solar projects, competitive grants to businesses that employ new technologies to produce heat and power on-site from a variety of fuel sources, support for the PA Energy Development Authority to expand the market for clean, advanced energy technologies, services and fuels, funding to facilitate the construction of new wind farms, and grants for projects on Pennsylvania farms to make them more self-reliant through energy efficiency upgrades, bio-digesters and distributed wind generation.

The previous administration’s priorities never included a comprehensive energy portfolio with support for clean energy alternatives coupled with a push for more energy conservation and funding for new technologies. Although the Governor’s budget is hardly a done deal, concerned citizens need to pressure their legislators to keep this portion of it intact so that the Commonwealth can make up for lost time.

Thank you to Colin McEvoy at LVEDC for this information on Governor Wolf’s budget.

Say What? Florida Bans “Climate Change.” (But they’re not the only ones.)

Mouth Taped Shut“Reality is that which, when you stop believing in it, doesn’t go away.” – Philip K. Dick

The Governor of Florida has decided that ignoring climate change will make it go away. According to the Miami Herald, “DEP officials have been ordered not to use the term ‘climate change’ or ‘global warming’ in any official communications, emails, or reports, according to former DEP employees, consultants, volunteers and records obtained by the Florida Center for Investigative Reporting.” The ban was apparently communicated verbally and not written into policy. Hmm, we wonder why?

Read more here.

Sadly, Florida’s not the only state doing the “ignore it and it will go away” dance.  In 2012 North Carolina’s state legislature ruled that any predictions on future sea-level rise could only be based on historical data and only back to 1900. No newer technologies could be employed.  And in Pennsylvania in the same year, the state’s Department of Conservation and Natural Resources  (DCNR) was ordered to remove the term “climate change” from its website.

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