- We need to start taxing emissions and incentivizing green technologies.
- Fossil fuel firms should pay for their negative environmental externalities.
- This could usher in a new and fairer economic paradigm.
Climate change has caused widespread destruction. Environmental degradation was responsible for 9 million premature deaths in 2015, besides causing the economic loss of hundreds of billions of dollars annually. It is a grave injustice that we have allowed the fossil fuel companies to make billions of dollars of annual revenue from commodities that have wreaked havoc on animal habitats, humans and our ecosystem as a whole. It is time that we radically shift our economic model to one that taxes emissions (at a suitable rate) and incentivises green technologies.
One way of doing that is to demand fossil fuel companies account for the real social costs of CO2 emissions in their financials. By doing so, we effectively internalise the negative externality of environmental damage while generating funds for a shift towards green technologies. But before we delve into the role accountants can play in tackling the issue, there is some merit in understanding the urgency of enacting the reforms we need to change course.
Have you read?
Understanding the climate challenge
The Paris agreement (adopted by 195 nations in 2015) aimed at capping the global temperature rise this century to well below 2°C above pre-industrial levels and to pursue efforts to limit the increase to 1.5°C. However, the nationally determined contributions (NDCs) within the Paris agreement would lead to a 2.6-3.2°C temperature increase by the turn of the century – which would be catastrophic.
The policy decisions we push for depend on the emission pathway we choose - and for that, we need to understand what is at stake. Take flooding, for example; as the figure below shows, our choices will make a difference to millions of lives - for better or for worse.
What are we doing about it?
The EU Emissions Trading System (ETS), launched in 2005, is a 'cap and trade' system, where companies 'buy' or 'sell' emissions within the total cap of greenhouse gas (GHG) emissions set in the system.
A policy document from the High Level Commission on Carbon Price, supported by the Carbon Pricing Leadership Coalition (CPLC), recommends a carbon price in the range of $40-80 per tonne of CO2 by 2020 and $50-100 per tonne by 2030 to achieve the targets set by the Paris agreement.
Another significant development is headed by the Climate Disclosure Standards Board (CDSB) and the Task Force on Climate-related Financial Disclosures (TCFD), who are putting a spotlight on financial and non-financial disclosures around companies' environmental footprints. CDSB's report, Unchartered Waters, explores how existing international accounting standards (IAS) can be leveraged to report on the financial impacts of climate-related risks.
But barring all the noise, annual global emissions are still on the rise - which tells us that more needs to be done to alter the behaviour of emitters. The 2018 IPCC report underlines that in order to limit global warming to 1.5°C, global CO2 emissions would need to fall by about 45% by 2030. This shift calls for immediate and unprecedented action, not future promises.
How can accounting help?
TCFD and CDSB’s recommendations around IAS, while principally a step in the right direction, fail to internalise the climate externality. A new accounting standard to account for climate costs might be the right approach - and there are multiple reasons why this could nudge emitters in the right direction.
Firstly, an accounting standard that requires companies to account for their environmental footprint shifts the reporting on climate costs from 'voluntary' to 'mandatory'. This approach is radical because, by doing this, firms would incorporate a cost that 'did not exist' in their accounts. This cost 'internalisation' would fundamentally change the behaviour of emitters, in a way and at a pace that our planet demands. My own analysis of the financials of one major international oil producer reveals that internalising their carbon costs would amount to between 0.7%-1.4% of their annual revenue, which would amount to several billion dollars.
Secondly, the prices placed on carbon emissions fall in a wide range. For example, the EU ETS prices carbon at $25 per tonne of CO2 emissions, whereas Sweden charges $127 per tonne. We cannot let the corporates decide on what is the right carbon price to apply.
Lastly, we can leverage the worldwide adoption of the International Financial Reporting Standards (IFRS) - currently this is true in at least 144 jurisdictions - to drastically expand the application of carbon price. Today, according to the World Bank, only 20% of global GHG emissions are covered by a carbon price.
A whole new world?
A new accounting standard is no panacea and there is no denying the fact that drafting an unconventional accounting standard and gaining approval of all the stakeholders is a momentous task. If implemented, though, this could set a precedent for fundamentally altering the existing economic model. We can potentially apply the same principle to internalize other externalities, such as plastic usage by fast-moving consumer goods (FMCG) companies and aggressive deforestation to provide ground for commercial crops such as oil palms.
If there was ever a challenge that called for an innovative solution, it is the climate crisis we face today. The inter-generational injustice has to stop with us. We need to relay this message unequivocally to the emitters; it’s too late for disclosures. They must account for the carbon they produce - as well as its impacts.
What’s the World Economic Forum doing about climate change?
Climate change poses an urgent threat demanding decisive action. Communities around the world are already experiencing increased climate impacts, from droughts to floods to rising seas. The World Economic Forum's Global Risks Report continues to rank these environmental threats at the top of the list.
To limit global temperature rise to well below 2°C and as close as possible to 1.5°C above pre-industrial levels, it is essential that businesses, policy-makers, and civil society advance comprehensive near- and long-term climate actions in line with the goals of the Paris Agreement on climate change.
The World Economic Forum's Climate Initiative supports the scaling and acceleration of global climate action through public and private-sector collaboration. The Initiative works across several workstreams to develop and implement inclusive and ambitious solutions.
This includes the Alliance of CEO Climate Leaders, a global network of business leaders from various industries developing cost-effective solutions to transitioning to a low-carbon, climate-resilient economy. CEOs use their position and influence with policy-makers and corporate partners to accelerate the transition and realize the economic benefits of delivering a safer climate.
Contact us to get involved.