Everybody’s talking about it: the cost of going green

Read the papers, listen to pundits, and you will know that everyone says it costs money to “go green” – and in a recession, it’s a luxury few firms can afford. This is consistent with other things we know – we think of environmental regulations, and we know that regulations often add cost to business. Take waste electrical goods – these now have to be disposed of correctly (WEEE regulations), and you can’t just hide them in the skip with the rest of your trash. So if everyone says it, and it makes sense, the logical conclusion is that it must be true.

Why would lemmings commit suicide?

There is a lovely example in this month’s news from an organisation that should know better: The Carbon Trust. This non-profit organisation has laboured with ingenuity and style for many years to help UK businesses become more cost competitive by reducing their emissions. Yet the first line of their press release says that four public sector organisations will “defy” the economic downturn by reducing their carbon footprints and slashing their energy costs by 25%. How cutting costs by reducing waste energy amounts to defiance in the face of pressure to reduce costs, is not made clear in the article. Could the strategy here be to use a standard prejudice about the cost of going green in order to lure readers in?

Many years ago, I was given a selection of books as a leaving present from a generous boss, of which my favourite was You Know What They Say... The Truth About Popular Beliefs. This book tackled a huge number of well-known “truths”, and examined the evidence for them in detail. These varied from things that just about everyone over five years old will tell you (“No two snowflakes are alike”) to beliefs that have serious consequences (“Rewards motivate people”). In some cases the evidence was mixed or reasonably good, but for most, the real evidence was so poor or non-existent that you wondered how people could go on saying these things (“Lemmings commit mass suicide”).

So what’s the evidence for the cost of going green? It is overwhelmingly in favour of saving money. There are of course rare exceptions – green initiatives that attract nothing but cost. In their excellent book Green to Gold, Winston and Esty describe how “going green” can (accidentally) reduce profits – most notably, through misunderstanding the market, for example by expecting a price premium, or planning on customer tastes fitting your planned innovations. However, the book mainly focuses on the plentiful examples of companies generating huge profits through environmentally sound strategies that are implemented well.

Recent research has continued to support the benefits of pursuing a green business strategy. For example, research published in January showed that firms that report emissions produce a bounce in their share price – especially if they’re small. In a study published last month, ISO 14001 certification in Brazilian firms was shown to correlate directly with improved profitability. There is a rapidly growing literature that looks at “green strategy” from a variety of perspectives, and shows that when executed well, green strategies pay dividends.

So, the next time someone tells you that going green will hurt your profitability, ask them if they know anything about lemmings.

Will the Green Deal help my business be more energy efficient?

Greg Barker and Green Deal providers.  Credit: DECCgovuk

The government wants businesses to become much more energy efficient, and the Green Deal was meant to be one of the ways to encourage it.  Big firms may be able to finance their own improvements, but finance was seen as an obstacle for SMEs in particular.  This was to be the purpose of the Green Deal for business customers – to provide affordable financing for energy efficiency on a “pay-as-you-save” basis.  Yet the media is full of assertions that it will do no good.  Do we have a problem?  Is the Green Deal a big deal for your company?

Delay

DECC announced recently that the Green Deal will roll out for domestic properties in October as planned, but that it won’t be available to non-domestic properties until later.  Ostensibly this is because it is more complicated.  Whatever the reason, this does mean that only home-based businesses will qualify in October – as long as they apply under the umbrella of the domestic Green Deal.  Any firm that has outgrown the dining room or barn conversion will have to wait – and as yet we don’t know exactly how long.

Landlord – Tenant problem

The Green Deal improvements are paid for by a financing company, while the beneficiary pays for them over the life of the project through their electricity bill.  How will this work for business tenants?  Apparently this has not been thought through, even though there are plans in place for ensuring domestic tenants and landlords can take advantage of Green Deal offers.  Commercial tenancies may be sufficiently different from their domestic counterparts that significant alterations need to be made to the scheme to make it suitable for companies.

So now we can see some problems.  However, just because a policy is coming under fire from the media and commentators, that doesn’t mean it will be no good, nor does it mean that you shouldn’t be interested.

So does my company need the Green Deal?

Most companies can save substantial sums by revisiting their use of energy and other resources.  However, the largest companies – and some smaller ones – have already been gaining enormous profits from doing this, without the Green Deal.  Why might your company need it?

First, the Green Deal specialises in sorting out energy usage.  This will give your organisation focus, if that’s what you need.

Second, the Green Deal will have specially trained energy advisers who will give your firm a report on energy efficiency opportunities.  Many such people exist already, and some NGOs even offer this service for free to qualifying companies, but if your firm hasn’t located this sort of expertise, the Green Deal might simplify the process.

Third, and by far the most compelling, is that the Green Deal offers finance.  The “pay-as-you-save” approach to efficiency improvements has been tried elsewhere and can be very attractive to a firm short of cash.  The concept is simple: a finance firm pays for the efficiency investment.  Payments to the finance firm come from the beneficiary’s electricity bill.  The “Golden Rule” means that the extra payment to the finance company must be less than the savings made through efficiency, so the beneficiary still saves a bit of money (and much more once the finance firm is paid off), but doesn’t need to invest their own capital.

This may be attractive to those firms eager to invest, but without other access to capital at affordable rates.  For firms that are sitting on cash, or whose credit rating makes loans affordable, the Green Deal may not offer a better rate than they would have been given elsewhere.

What should my business priorities be as regards the Green Deal?

Here there is no question.  Your priority should be to invest in people, technologies, processes and knowhow that cost-effectively reduce your environmental footprint – your use of energy, water and other resources, and your emissions of greenhouse gasses and waste.  This is a tall order – it’s hard work and takes commitment from the top of the business and engagement of every stakeholder in the firm.  If the Green Deal has no place in your sustainable strategy because it doesn’t offer what you need, then forget the Green Deal and do what you need to do.

Competition on sustainability is not about installing energy efficient technology.  It’s about making money now, and doing it in a way that means you will still be making money in 40 years’ time – that is sustainability.  That might or might not involve solar panels and insulation, but it definitely involves thinking strategically about the way you do business in terms of resources in and out.  Get to know what is available to you from the Green Deal, but don’t let it lead your strategy.  Your firm has its own place: you should take the lead, and use the Green Deal if – and only if – it suits your strategy.

Is your firm safe from oil price increases?

There is a story about two hikers in the Rockies who spot a grizzly bear, as species known for its aggression towards humans.  As the bear charges one hiker turns to run, but the other sits down, unpacks his trainers, and starts unlacing his boots.  “What are you doing?” asks his companion, “you can’t outrun a bear!”  He replies, “It’s not the bear I’m trying to outrun.”

Monthly oil price spot.  Credit: TomtheHand/Wikimedia

Many commentators are forecasting oil price rises as demand from the developing world increases post-recession, and as supply from Saudi Arabia diminishes.  Rises of around a third are bandied about, and greater increases are not out of the question, over a vague time period but certainly during this decade.  As repeated economic squeezes come, how will you stack up against your competitors?

If you use oil-derived products for heat, transport, or lubrication, you will of course see an increase in these costs.  Your suppliers will see their costs rise, increasing your input prices, and your customers will similarly feel the pinch, reducing their margins and provoking them into looking for savings up their supply chain.  End customer demand should also decline as fossil fuel prices eat into disposable income.  In other words, we would be in for another recession each time oil prices spike.

As it looks increasingly likely that this is the sort of future we have to look forward to, many firms are looking at ways of freeing themselves from oil-derived products in their processes and supply chains.  This is no easy task because there are still no economic substitutes for oil in most applications.  However, as we know from the recent global recession, keeping ahead of the competition on cost can be a matter of company life or death.

In the search for practical ways to prepare for volatile and/or high oil prices, here are some of the approaches that firms small and large are already pursuing:

• Supply chains: redesign of distribution e.g. route planning, creating more localised supply chains, optimising vehicle technology and driver behaviour
• Products: Making products more fuel efficient in both production and use
• Systems: Identifying low-value-added uses of oil and designing them out of the business model
• Resource stewardship: waste elimination and recycling
• Substitution: identifying those uses of oil for which cost-effective substitutes are now or will soon be available.

Tackling these issues now will make your firm more resilient during periods of oil price volatility.  While no firm needs to be best in class in every area, it does need to be better than its competitors overall when the economics squeezes come.

Electric vans - does the £8000 grant make them a good buy?

The UK government has just announced grants of up to £8000 to support sales of electric vans.  Will the take-up on these be better than the take-up of electric cars?  Arguably yes.  Businesses tend to make decisions based solely on economic criteria, and the economics support the purchase of an electric van under the right circumstances.  However, the truth is that very few firms would currently benefit from buying an electric van.  This is because of current technical constraints – they won’t last forever, but they will dent the growth prospects of EV vans in the short term.

Range: who will be able to use an EV van?

The first question everyone asks about electric vehicles is range.  Take for example the Renault Kangoo ZE, with a range of 106 miles.  Assuming no power infrastructure, that gives a return range of 53 miles, the distance from Bristol to the M50 junction with the M5.  At the moment, the UK network of EV charging points is underdeveloped, although Ecotricity is working on this.  The Ecotricity charge points are currently slow (6-8 hours for a full charge on a Renault Kangoo van), making their use for commercial transport impractical.

This means that at present, electric vans are only suitable for businesses that mainly serve their local area, or which have a fleet of more than one van, where at least one (electric van) could be dedicated to local service.

The typical charging time means these vans are also mainly going to be used only by firms that need the van intermittently, rather than driving all day.  For all day driving one would need either several vans, or a fast charge point, and while the prices of these are coming down they are still prohibitively expensive.

Running cost: who will gain financially?

Even at today’s high electricity price levels, running an EV is cheap compared to either diesel or petrol – about one fifth the cost.  On the other hand, the van itself is more expensive.  How many miles would you need to do to make the EV worthwhile?

This depends on your firm’s economic circumstances, of course, because the cost needs to be paid up front, while the savings will come over a number of years.  Let’s compare two firms – one drives about 115 miles per week, or 6000 miles per year, using the van for only about ¾ of an hour each weekday.  The other firm does 15K miles per year, or about 288 miles per week, using the van for nearly 2 hours per day on average.

First, the lower-mileage firm:

	Kangoo EV	Kangoo diesel	Difference
Price after subsidy	13,592	8,950	-4,642
Miles per gallon		54
KwH / mile	0.21
Battery lease £/month	60
cost per mile	0.02	0.11
miles per year	6,000	6,000
Road tax		115
Running cost per year	844	788	-56

In other words, for the low mileage firm it’s actually more expensive to run the electric van, even before we look at the up front cost.

Now let’s look at the higher mileage firm:

	Kangoo EV	Kangoo diesel	Difference
Price after subsidy	13,592	8,950	-4,642
Miles per gallon		54
KwH / mile	0.21
Battery lease £/month	105
cost per mile	0.02	0.11
miles per year	15,000	15,000
Road tax	-	115
Running cost per year	1,570	1,798	228

Unlike the other firm, this one gets an annual saving from driving the electric van, but the payback time is only about 20 years.  This means that even for the high mileage firm, which generates the most savings from driving, the electric van is still not currently worthwhile.

So will anyone benefit from buying an electric van?

There are some additional considerations on the financial side.  First, a central London-based firm will save on the congestion charge, which could mean that the choice to go electric pays for itself in a couple of years.  A firm with just one van delivering every weekday for 50 weeks of the year would save £2600.  Combined with the good EV charging network in London, this makes EV vans an excellent choice for firms that deliver within the London congestion charge zone.

Another consideration is the capital allowance – firms can claim 100% of the van’s cost in the first year.  Of course, SMEs with low capital spend may be able to do this anyway.  Whether this benefits your firm depends entirely on your circumstances.

Last but not least is the marketing benefit of driving a green vehicle.  Whether your customers are private sector bodies, socially conscious urbanites, or commercial firms looking to green their supply chain, driving an electric van can send out a useful marketing message.  It is difficult to quantify this but plenty of firms will no doubt use this argument to tip an uncertain financial decision in favour of the electric van.

Does this mean electric vans will never dominate?

No.  Many of the drawbacks depend on things that will change.  Range will improve.  The differential between electricity and petrol / diesel prices may widen.  EV charging will get faster, cheaper, and more ubiquitous.  So the economics of electric vans will change, and they will undoubtedly change for the better.  Of course, by that time there may be hydrogen powered vans competing for our business buck, but that blog entry will have to wait until 2015. 

Are companies that actively manage their environmental impacts worth more?

Waste heat is invisible to the naked eye but costly.

In short – yes.  They’re worth more money than those that don’t.  Regardless of your feelings about the environment, as long as you care about money, then you should be more willing to invest it in a firm that manages its impacts.

Some of you will say that of course, that’s because such companies know about regulations and meet them, so they face lower risk of fines or emergency costs.  That is certainly true, but it is not the main reason such companies are worth more.  Even without any fines or emergencies, those companies are likely to grow faster than their peers.

This is the finding of a recent piece of research from academics at the University of California.  They don’t look at why this would be so, but they do demonstrate that it works.  Companies that disclose their emissions aren’t just being “good citizens”, they’re also doing smart business.

In fact, there are two likely reasons for this – and both point to a conclusion that managing your environmental impacts will boost the value of your business. 

First, the group is self-selecting.  Those that benefit from reporting will do so.  That means the reports will almost always come from those companies that a) measure their impacts already, so there’s little extra cost in reporting, and that also b) will suffer no great embarrassment – in particular, it will be those for whom impacts are falling, or rising slower than the business as a whole is growing.

Second, the old saying “what gets measured, gets managed” is true, and this is especially true for cost areas like energy and materials.  Business leaders hate seeing cost per unit of output go up, because it means that they either need to accept less profit or charge more money.  When impacts are reported, they are usually directly connected to the use of resources – for example Greenhouse Gas Emissions relate to the use of fuel and power.  If the measures of consumption per unit of output go down, it’s good news – but no one will be working hard on the process of making that happen if there is no one measuring the result.

Should your firm report its emissions, or other environmental impacts?  My view is that this is the wrong question.  Yes, the research showed that this was associated with growth and value, but in my view it is not the reporting itself that generated this – it is the act of measuring impacts and thinking about cost-effectiveness that led to these firms outperforming the markets.  Because they were in a position to manage their costs down, they thrived.  Companies that measure their impacts will manage them better.  Managing impacts drives company value.  The reporting was just a signal to the market.

Would you like to explore how managing your firm's impacts could boost your growth and increase value?  Contact Julia at julia@jlsbm.co.uk, or (07766) 333864.

How much energy can your company save?

Lights are often left burning in offices at night.  Photo: caribb

With no end in sight to our tight economic times, companies are redoubling their efforts to reduce costs.  The continued high cost of energy makes this a favourite area to target.  Just how much can a company actually save on its energy bills?

Savings from equipment

Anything that uses power – electricity or process heat – should be your number one priority.  Lighting uses about 40% of a building’s power and is a top target, with savings of 40-70% of lighting energy within reach.  The Carbon Trust estimates that investing in better lighting equipment can reduce electricity consumption by 20%.  Motors and drives are another area with great potential for savings – up to 60% according to ABB – and payback periods are usually very quick for switching to variable speed drives.

Virtually all machines have potential for improvement, either through replacement of less efficient technology, or introduction of controls to make the best use of the technology you have.

Savings from buildings

Buildings are great wasters of energy.  The principle problems come from heating and cooling.  Older building stock often suffers from inadequate insulation – the standards and practices set in the past were based on lower energy costs.  Even newer buildings designed with high energy efficiency in mind may not perform as expected if commissioning was rushed, or if building use differs from what was initially envisaged.

Savings from waste

Waste costs far more than most firms realise.  The cost of disposal is a tiny fraction of the true cost of waste.  Consider the cost of producing that waste in the first place – not just materials but also the labour and facilities time.  Even worse is the waste that slips past quality controls and isn’t identified as waste until it reaches a dissatisfied customer.

Figures on waste vary dramatically, but most firms waste considerably more than they realise.  In the food industry it totals around 30% of production – in developing countries most is lost at harvest and storage, and in the developed world it is lost most through consumers and distribution.

Much waste is actually visible to employees, but often considered unimportant, or impossible to eliminate.  The source of these attitudes is often in a failure to realise just how much waste costs.  Also, it is difficult to tackle waste that is unintentionally designed in to agreed processes and systems.

Savings from behaviour change

How often have you passed an empty office building at night and seen all the lights blazing?  For those of you who have worked in production facilities, how many times have you seen refrigeration unit doors left open, or machines left idling between shifts?  In the service industry, have you ever seen an open plan office where all the computers and printers were shut off at night?  Who has seen windows opened because the air conditioning or heating was set too high?

We need control over the equipment that serves us, but often in the rush of work people make choices that waste energy.  Replacing equipment may mean that the waste is reduced, and in some cases controls can help, but an even better solution is to eliminate this waste altogether – and without capital cost – by changing behaviour.  Of course this is no easy task – but there are approaches to educating and motivating the people that really work.

How do you know how much you can save?

There are three essential steps in estimating how much you can save.  First, you must footprint your firm – find out how much energy you use, in what forms, when, and for what purpose.  This takes time to set up, but it is well worth it in terms of the savings it prepares you for.

Second, you need to estimate the potential to change each area of energy consumption.  This can be done at a high level, through benchmarking and similar comparative exercises, or at a more granular level by looking at technology alternatives or proportions of energy wasted.

Third, you need to pull together this analysis to show the big areas of energy spend, and the top areas of potential improvement.  Bring together the key people from across your organisation to examine the results.  Chances are that any area of potential savings is going to involve many departments – this is one of the reasons energy efficiency opportunities are often not spotted.

If you need help with any of this, please contact us: enquiries@jlsbm.co.uk.  We offer unbiased advice and expert consultative assistance to UK firms.

Which retailers are most efficient?

Retailers are under considerable margin pressure, so you would expect them to take any measures possible to reduce cost.  Much work has focussed on labour productivity, or getting more sales per staff person, for example by introducing self-checkout.  However there is still much to be done on resource productivity.

A recent data set on leading retailers’ greenhouse gas emissions, sales, and employee numbers shows a wide variation in labour productivity and sustainability.  Interestingly, the most labour efficient retailers are also the most emissions efficient – no company is just “green” or solely focussed on automation or scale.

CVS (a pharmacy retailer) and Costco (a warehouse club) exceed their peers on both measures, but amongst the others there are some interesting differences.  Walmart and Tesco do not achieve the labour productivity of Kroger (a leading US supermarket), but both are significantly more efficient on greenhouse gas emissions.  This is probably no accident – both Walmart and Tesco have made bigger commitments to reducing emissions.  

Tesco aimed to reduce energy use by 50% from 2000 to 2010, versus Kroger’s target of a 30% reduction over the same period.  Walmart gave themselves just 4 years to achieve a 30% reduction (from 2005-2009), and they aspire to supply their stores with 100% renewable energy.

There are big savings for retailers who make efficiency their priority.  Improved lighting systems, daylighting, energy controls, heat recovery, behavioural change, and many other approaches can reduce costs significantly, often with a 2-3 year payback period.  For any firm in the retail sector, sustainability in terms of a reduced carbon footprint should have a leading role in their effort to thrive in these challenging times.

Why your waste costs 20 times more than you think

Waste disposal costs are rising.  Heightened attention is being turned to dealing with it cost-effectively, diverting it from landfill and getting the best possible income stream from recycling or re-using it.  This attention to waste is a good thing.  We want to reduce the cost of it, to make our businesses more competitive.  However the truth is that most managers are missing 95% of the cost of their waste.  If your facility’s waste costs were 20 times higher than you thought, what action would you take?

The answer is obvious – you would stop trying to maximise the recycling and re-use value of your waste stream.  Instead, you’d try to stop producing it in the first place.

Let’s look at a hypothetical manufacturing company[i].  Imagine a firm that produces high quality ready meals.  Our firm has operating costs of £50 million a year, and runs two shifts a day.  They produce 500 tonnes of waste per year, and it costs them £100 per tonne to dispose of it (fees and handling costs).  So this firm believes that its cost of waste is £50,000 per year.  This is significant enough to get attention, but at just 0.1% of total cost, it is not the highest priority.

Now, imagine that each day, an average of 10 minutes of each 8-hour shift produces waste.  This takes two main forms: 

• Occasional quality failures (e.g. too little product in one tub, or a run with wrong dates)
• Planned waste, while a new run is started, and the machines are adjusted to get the machines aligned perfectly

So for an average of 20 minutes per day (10 minutes for each of two shifts), the facility is producing waste.  That’s roughly 2% of a 16 hour day.  In other words, 2% of the operational time, and therefore 2% of the operational cost (electricity, people, facilities costs, materials, etc) is waste.  In a facility that costs £50 million per year to run, that’s a cost of £1 million, spent on producing product that will never be sold.

This is just a hypothetical example.  Is it typical?  In fact, this is close to the average for the UK economy as a whole.  As I’ve reported elsewhere, DEFRA estimates there are £23 billion of resource efficiency savings with a year payback or less, just waiting for firms to take advantage of them – about 1.6% of GDP.

A million pounds of a £50 million budget is a substantial sum – it could be better spent holding off the next round of unwanted redundancies, investing in new capital equipment, or developing new products.  If this were your firm, wouldn’t you do whatever you could to stop the waste?

So... just how much of your operational time each day is spent producing waste?

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[i] This could apply just as well to a service company.  For example, in a call centre, it might include outbound calls to wrong numbers, and times when the computers or phone lines are down.

Do more with less – and save £23 billion

That, at least, is the conclusion of a DEFRA study published in March.  It found that for very little cost, UK businesses could produce just as much as they do today, while saving £23 billion in costs.

Given our current economic troubles, it is surprising that this hasn’t been headline news.  The topic is called “resource efficiency.”  The UK government has been trying to encourage firms to improve their resource efficiency by providing advice and grants, and even the European Commission has urged firms on, claiming that “Increasing resource efficiency will be key to securing growth and jobs”.

These claims are entirely realistic.  There are multitudes of case studies available through government agencies and in business school texts, and of course many cases have never been documented.  Just tackling the production of waste products alone – without considering any other efficiency savings – could produce big savings to the bottom line.

The fact is that the funding interventions from the government have so far been very small – less than £100 million per year of the Business Resource Efficiency and Waste scheme.  However, they indicate big potential – every £1 spent by the government achieved an average £1.64 in additional sales and £3.20 in cost savings – and those are the benefits in just one year.  Unfortunately, the budgets for this work are now being cut.

As the ENDS Report has observed, “government will have to depend on businesses stepping up their own efforts independently, without relying on public funds for advice and support.”  Increasing landfill taxes are meant to encourage firms to address their inefficiencies, but waste handling costs represent only a tiny fraction of the true cost of waste.  Moreover, there are many more inefficiencies that have nothing to do with the waste stream.

When so many companies have tackled their waste stream, why have so few put the same energy into efficiencies – that is, into not producing the waste in the first place?  It’s often no one’s job – we assume our employees will identify and eliminate waste if they can, but no one is tasked or measured on this.  And why not?  Well – since the cost of producing waste, or working inefficiently, is almost never measured, those in charge don’t realise it deserves an explicit place in their management structure.

For those companies that grasp the opportunities in resource efficiency, the prize will be higher profits, greater security, and growth.  The government will no longer take the lead, though it is a wonder that it was ever necessary.  Given the size of the prize, it is time more firms put resource efficiency on the CEO’s agenda.

Why your business customers want you to cut carbon

Recent research from The Carbon Trust reveals a potentially unsettling truth for the B2B market: multinationals are not just addressing their own greenhouse gas emissions.  They are also increasingly including carbon in their selection criteria for suppliers.  Within three years, the vast majority will do so – only 10% say otherwise.

Why this move – is it part of these multinationals’ attempts to look green?  The report ascribes the trend to “shareholder pressure”.  Are these shareholders investing in an increasingly ethical way, or are they looking for financial value?  I would suggest the latter - in other words, this isn't a fad.  It's part of a trend towards shareholders actively looking after the value of their investments.  Suppliers should take note.

It is not only shareholders who know that low carbon can translate into good value.  Sourcing professionals look for signs of quality and efficiency to ensure that they are getting the best goods at the best price.  Low carbon emissions signal efficiency – that a supplier is using less inputs for the same output.  That will translate into a sustainably lower cost structure, from which the buyer hopes to benefit.  Multinationals are sourcing low carbon because it’s often cheaper, and is likely to get even more competitive if fossil fuel costs rise further.  Shareholders and management want to know that their companies are managing for value.

A quote from Chris Harrop of Marshalls plc is particularly revealing: “By choosing suppliers of responsibly sourced goods not only do we cut carbon emissions but invariably there are cost and efficiency gains to be had, which all adds up to a strong competitive advantage.”  Perhaps it’s nice to be green, but it’s good business to be cost competitive, and paying attention to carbon in the value chain helps firms solidify this advantage.

So, suppliers now have another reason to address emissions, if cost competitiveness itself were not enough.  Multinationals will be expecting suppliers to report on, and compete on, greenhouse gas emissions.   Their suppliers will be asking the same questions right down the supply chain.  If your business customers are not already asking you to reveal to your carbon footprint, they soon will.

Carbon offsets vs carbon reduction – which is the better investment?

Carbon prices are at an all time low.  What does this mean – and should a business thinking of buying carbon offsets be worried about investing in them?

Carbon offsets are purchased by individuals or firms to offset the emissions they produce in their activities.  The emissions aren’t being taken away of course; the idea here is that somewhere in the world, a project to reduce emissions by the equivalent amount will go forward because this money has been granted to it.  That is supposed to put the project into the black – the UN will only approve offsets if the project would not be financially viable without the money the offset brings in.

Offsets can include landfill methane power generation. Photo: D'Arcy Norman /
Creative commons

The problem right now is that offsets are in low demand, at least partly as a result of the recession.  At the same time, supply of offsets is rising, as more and more projects are approved by the UN.  There is no shortage of companies willing to propose projects, but at current prices, most of these will barely cover their costs.   High supply and low demand have made this one of the worst performing commodities this year.

However, this is not a problem for the buyers of offsets.  In fact, if you are buying in order to become carbon neutral, it has never been cheaper to do so.  So should every firm that aims for carbon neutrality start focussing on offsets to accomplish this?

This is not necessarily wise.  Carbon offsets cost money, and provide no direct return – you have to buy them again next year.  Carbon reductions – for instance reducing waste, energy consumption, and so on – does provide a return, as the cost reductions come year after year.  Like offsets, they may cost money, though many are free or have a payback period of months.  However, even the costly investments do at least have a return, which carbon offsets do not.

On the other hand, some environmental investments will never be profitable.  To take an extreme example, solar panels on a north-facing roof in the UK are unlikely to turn a profit.  How can a firm decide which investments to make, and whether to pursue offsets as well?

A popular tool for selecting green investments is the marginal abatement cost curve.  The vertical axis shows the net present value or cost of the project per Kg of emissions reduced, while the horzontal axis has the total amount of abatement per year.  Investments are ordered by value, with those that create the greatest financial benefit per unit of carbon reduction on the left.

Those projects with a positive net present value are the obvious priority. As for the projects with negative net value, some will be attractive to firms that will gain sufficient indirect value from carbon reductions (morale, reputation, etc).  Those opportunities with a net cost lower than carbon offsets should clearly be favoured next. For projects with a greater net cost than offsets, the strategy should switch to purchasing these instruments instead.  The chart on the right summarises the decision process.

Offsetting is most valuable to firms that have already have a powerful programme of continuing carbon reductions, and who will benefit from the reputation effects of achieving full carbon neutral status.  However, if a firm’s emissions per unit of sales or output are not falling, then there are almost certainly direct carbon reduction options waiting to be uncovered.  In addition to being environmentally sound, these projects are financially more sustainable than offsets.