What is the link between businesses and climate change? (by Professor Anant Sundaram)

This is the first of two initial blogs. The next one is on why MBAs graduating today – more generally, business schools – should care about climate change.

An Externality

Few issues will loom larger in the next few decades than climate change. Science says that greenhouse gases (GHGs) – of which carbon dioxide CO2 is the biggest one – linger in the atmosphere for decades, and that higher GHG concentrations will lead to significant surface warming. The consequence is potentially grave and irreversible impacts on a wide range of earth systems. Much of this impact is the result of human-caused GHG emissions, primarily from the burning of fossil fuels, land use (in particular, mining and deforestation), and agriculture (especially, rice farming and meat production).

This imposes an externality: i.e., our private actions that produce GHG emissions impose a potentially serious cost on the rest of society. This cost will be felt in two ways. One, from preempting or mitigating the likely impacts of climate change, and two, where mitigation is too expensive or not feasible, from adapting to its consequences.

At some point, society will then ask emitters to internalize the cost of their actions, by putting a price on GHG emissions, either via a carbon tax or a system of cap-and-trade. Colloquially, people refer to this as a ‘price on carbon.’ Thus, it is quite likely that, in the next few decades, economic growth will unfold in a world with a price on carbon.

Because carbon is omnipresent in our energy chain, and energy is embedded in every economic transaction, the implications are enormous.

What is the Business Link?

Unlike other major global issues – such as, say, hunger or global poverty – climate change is one where businesses have the most significant cause-and-effect relationship. Companies are the largest emitters, and in the final analysis, they will be the ones to commit resources and develop technologies to solve the problem.

As a result, there is a potentially sizeable ‘climate economy’ emerging in two key areas: energy efficiency from existing (fossil fuel-based) operations, and new sources of non-fossil fuel based energy. The challenges and opportunities for businesses from the ‘climate economy’ are vast. Large amounts of wealth will be created (or preserved) by companies that get in front of this issue. Equally, large amounts wealth may be lost (or not captured) by those that fall behind.

Consider this. Just the companies in the S&P500 emit between 3 and 4 billion metric tons of GHGs annually. If the costs associated with this are required to be internalized, the impact will be significant. Using a market price of $20/ton of CO2 as a benchmark, companies would be collectively required to sign a check for $60 billion to $80 billion annually. The present value of this liability could be as high as one-tenth of the market capitalization of all the companies in the S&P500 stocks today.

To preempt such a cost, we will likely see major investments in technologies for emissions abatement and increased carbon productivity – e.g., in areas such as energy efficiency, low-carbon and non-fossil fuel-based energy (renewable sources such as solar and wind, and nuclear), carbon capture and storage, geoengineering, and agriculture, land use, and forestry. Such investments could run into many trillions of dollars across the globe.

Similarly, the market for emissions allowances could become sizable – conservative forecasts put it at a $1 to $2 trillion market within the decade.

The next blog will address implications for MBAs and business schools. (See above).


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