Environmental damage caused by human activity in 2008 was estimated to be $6.6 trillion, equivalent to 11% of global GDP, calculates a United Nations study released today. Global in scope and covering a wide range of environmental impacts by all industries, the new report is an ambitious attempt to estimate environmental externality costs.
Putting monetary values to environmental externalities should help answer the question: Are fossil fuel energies truly cheaper than renewable energies? As the world moves towards a “polluter pays” principle, this could also affect financial performance of companies and investor’s return on investment.
Externalities are costs incurred by one party but borne by external parties. An example of environmental externalities is greenhouse gas (GHG) emissions by industries causing global warming and climate change with the consequential costs borne by the public. Another example is air pollution from coal fired power plants causing increases in health care costs borne by the public.
Traditional fossil fuel energies appear far cheaper than green energies because their high externality costs are poorly understood and usually ignored in comparisons. The new UN report put forward a monetary value to these externalities and could help make better comparisons.
Of the seven major types of environmental impacts analysed in the report, the impact by greenhouse gas emissions was by far the largest. At an annual cost of $4.5 trillion, GHG emissions accounted for approximately 70% of all impacts. The other environmental impacts covered were water abstraction, pollution, general waste, natural resource of fish, natural resource of timber, and other ecosystem services, pollutants and waste.
The world’s 3,000 largest public companies by market capitalization caused approximately one third of the environmental damage. The most environmentally damaging business sectors are utilities; oil and gas producers; and industrial metals and mining. Those three accounted for almost a trillion dollars worth of environmental harm.
Putting the financial figures in perspective, the environmental costs of $2.2 trillion by these 3,000 companies were equivalent to nearly 7% of their combined revenues or 50% of their earnings. These costs are borne by external parties and are not reflected in the financial performance of the companies or the return on investment of their shareholders. However, if governments start to apply a “polluter pays” principle, some of the companies’ performance could be severely impacted.
Smart investors should take note that the materiality of externalities do not apply equally to all companies, but varies at a company and sector level. Assuming all environmental costs were internalized for each company, they would equate to between 0.34% and over 100% of revenue. Levels of externalities also vary for companies within the same sector. For example, environmental costs in the Basic Resources sector would equate to between 0.90% and 84% of revenues at a company level.
In other words, some companies incur little environmental cost, others incur a lot. Some companies’ profit rely mostly on their environmental costs being paid for by external parties, others don’t. While they all occupy a spot on the 3,000 largest companies list now, some may not in the future.
These staggering numbers are alarming and naturally cause one to examine the estimation methodology. Uncertainties are inherent in estimates of externalities but what could be the margins of error? The largest impact comes from GHG emissions, estimated at $4.5 trillion in 2008. A carbon price of $85 to each tonne of GHGs emitted in 2008 was used in the calculation. This represents the present day value of future climate change impacts and is based on the social cost of carbon from the Stern Review on the Economics of Climate Change (2006).
Other impacts were estimated by various methodologies. The report states that actual figures are likely even higher, as the analysis excludes most natural resources used, as well as many environmental impacts including water pollution, most heavy metals, land use change and waste in non-OECD countries.
Externalities would also be higher if degradation of environmental services such as watershed protection or climate regulation could be accounted for. The analysis also excludes external costs caused by product use and disposal, as well as companies’ use of other natural resources and release of further pollutants through their operations and suppliers.
The study was commissioned by United Nations Environment Programme Finance Initiative and the Principles for Responsible Investment and conducted by Trucost, a London-based environmental consultancy. The report is available on www.unepfi.org.
Derek Wong is a Toronto based climate change and sustainability consultant. Contact him through his blog Carbon49.com.