Republished from the Responsible Investor Special Report: ESG Asia 2012; with thanks. 

The S&P/IFCI Carbon Efficient Index was designed to closely track the performance of the benchmark S&P/IFCI
LargeMidCap Composite, but with index weight adjustments utilizing the Carbon Footprint metric1. In this regard, the S&P/IFCI Carbon Efficient Index was conceived as a "beta" product that would serve as a benchmark emerging market index for investors interested in reducing the carbon footprint of their portfolio. Over time, however, the S&P/IFCI Carbon Efficient Index has outperformed its underlying broad benchmark by a significant margin, suggesting that investments in companies with more carbon efficient operations may have some potential for generating alpha within the emerging markets.

Year-to-date through February 29, 2012, the S&P/IFCI Carbon Efficient Index has gained 18.27% on a total return basis, outperforming the 17.90% return of the S&P/IFCI LargeMidCap Composite by 37 basis points (bps). Likewise, since its December 10, 2009 public launch, the 23.43% cumulative return of the S&P/IFCI Carbon Efficient Index has outperformed that of the S&P/IFCI LargeMidCap Composite by 427 bps.

While past performance is not a guarantee of future results, it is important to note that the level of performance noted above has been relatively consistent and not heavily concentrated in any particular period. Over the 27 monthly
periods since the index launch, there have been just eight months in which the S&P/IFCI Carbon Efficient Index has underperformed its benchmark. Furthermore, in five of these eight periods, the underperformance has been by 11or fewer bps.

Likewise, over the 19 monthly periods in which the S&P/IFCI Carbon Efficient Index has outperformed the benchmark, the monthly alpha has been less than 25 bps on ten occasions, between 25 and 50 bps on seven occasions and greater than 50 bps on just two occasions. The largest monthly differential has been 78 bps. Furthermore, outperformance has been demonstrated in 2010, 2011 and year-to-date through February 2012.

It may be impossible to draw any firm conclusions regarding the source of the alpha generation, particularly over a relatively short time period. However, the index design, which ensures that the country and sector weights of the S&P/IFCI Carbon Efficient Index mirror those of the S&P/IFCI LargeMidCap Composite at each annual reconstitution, does suggest that obvious sources of variation such as sector or country weight differences are most likely not the cause.

Note: A version of this article first appeared in the July-August 2011 issue of Environmental Finance magazine. 

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Water scarcity costs* are a useful business tool to quantify water risk and compare exposure to water stress among companies in supply chains or investment portfolios. Take RWE Npower Plc's power station in Essex, Tilbury B. The plant has a capacity of 1,063 megawatts (MW) and is located in an area that is very short of water. Water scarcity costs for the plant could total more than £51 million annually, based on the power station's estimated water use in 2010. In comparison, EDF Energy Plc's Sizewell B, a nuclear pressurised water reactor and the largest power station on the east coast in Suffolk, is likely to be less exposed to water shortages than Tilbury B. Our research found that the Sizewell plant, which has the capacity to generate 1,191 MW, could incur water scarcity costs totalling £1.7 million per year. Rising water stress in the east could increase the plant's scarcity costs to almost £2 million a year by 2025.

Water shortages could lead to higher electricity tariffs

Different fuel and cooling technologies are a big driver of variations in the water intensity of individual power plants, and the costs of their combined water consumption can have ripple effects on electricity users. Trucost applied water scarcity costs to the estimated water consumption of a further seven power plants, based on average water use for the different processes used in 2010. Together with Sizewell B and Tilbury B, the power stations account for 94% of electricity generated in the east. If all nine power plants analysed in the region were to internalise water scarcity costs and pass them through in higher power prices, median industrial electricity prices could increase by 5.7% from 2011 levels.

Tilbury B power station has switched from coal to operate on 100% biomass fuel between 2012 and 2015, which could increase water use. With the switch in fuels at Tilbury B and higher future water scarcity costs for Sizewell B and RWE Npower's Great Yarmouth power station in 2025, Trucost believes that water scarcity costs for all nine power plants analysed could push up future power prices by more than 6%. RWE Npower might continue operating the Tilbury biomass plant beyond 2015, but if it reverts to an earlier plan to replace the biomass plant with a less water-intensive combined cycle gas turbine (CCGT) alongside a small open cycle gas turbine (OCGT), the average industry-wide electricity price rise driven by water scarcity costs could be limited to less than 6%. Such a move, however, could increase GHG emissions from the plant and lead to higher carbon costs instead.

Chart 1 below shows the estimated range in water scarcity costs per cubic metre (m³) per MWh across the nine power plants in 2010, and potential changes in exposure to water stress if Tilbury B generates power from biomass or CCGT/OCGT. The analysis does not take account of planned changes in fuels or cooling technologies at the other plants analysed.

Chart 1: Average and ranges in exposure to water stress at a plant level – 2010-2025

Trickling on to balance sheets

The water scarcity costs could be incurred in several ways, including through higher water pricing by water utilities, and higher fees/rates for water abstraction. But the majority of these costs are likely to be internalised through lower power generation capacity or changes in licensing conditions for water withdrawals, restrictions on water discharges, and through infrastructure or maintenance costs. Other sectors could see water scarcity lead to production or supply chain disruptions, or feed through in high and volatile commodities prices.

Low-carbon, high water?

Infrastructure that locks in high levels of resource dependence and pollutants could face higher-than-forecast costs, and factoring these risks into capex and procurement decisions is becoming more important to maintain future cash flows and returns on investment. No more so than in investments made now to develop low-carbon infrastructure. According to the U.S. National Renewable Energy Laboratory, low-carbon technologies such as carbon capture and storage could make power generation more water intensive. Understanding exposure to water stress in investments, operations and supply chains is vital to set course for a resilient, water- and carbon-efficient economy.

The joint research project on How Water Shortages in Eastern England Could Increase Costs for U.K.-Based Utilities was in collaboration with Michael Wilkins of Standard & Poor's Ratings Services and Aled Jones and Candice Howarth of the Global Sustainability Institute at Anglia Ruskin University. The full research is available to download at Credit FAQ and features in S&P's CreditWeek Special Report - Water: The Most Valuable Liquid Asset?, 7 March 2012

* Water scarcity costs reflect the financial impact of each cubic metre of water extraction on freshwater replenishment, ecosystem maintenance, and the return of nutrients to the water cycle. Trucost estimates this by modelling standardised cost data relative to water scarcity, to reflect local water use as a percentage of annually renewable freshwater resources.  This study assumes 95-100% take-up of water availability in the catchments analysed. Calculations are based on process water (cooling water is excluded, in this instance).  

How would you define socially responsible investment (SRI)?

Lauren Smart: I actually prefer to talk about sustainable investment because I think the market has moved beyond the strict confines of "socially responsible investing" which is linked with ethical investing and negative screening of companies that don't meet ethical criteria. Sustainable investment, however, is much broader, more aligned with mainstream financial considerations and is where I think the market needs to be and has been moving towards in the last few years. This is more about long term financial security of a business which is only possible if the company manages itself in a sustainable manner. This means that companies and investors need to think about issues that may not have been considered financially material traditionally or in a very short-termist approach such as environmental, social and governance (ESG) factors. What we have seen over recent years though is that these "ESG" factors can be financially material and therefore should be considered as part of good financial analysis. For example, BP had a long history of accidents and bad environmental governance. Analysts that had taken notice of this may have recognized that there was a chance of a catastrophic accident, as we saw, and the financial repercussions of this for BP and its shareholders have been significant. Similarly, there have been a number of instances recently where companies have reported profit warning due to rising price of cotton (linked to drought). Having a better understanding of their resource dependencies and their exposure to price rises from factors such as water scarcity can help them reduce their profit risk. Forward thinking companies are better managing these risks and are therefore more future proofed, likely to be better able to exploit new markets, avoid the worst of commodity price volatility and should ultimately be a better investment in the long term.

Emerging Markets ESG: What distinguishes SRI from mainstream investment?

Lauren Smart: This links to my previous point. I think that we are seeing a convergence in sustainable investment and main stream investing. Some of the principles of sustainable investment are being considered by the mainstream even if they don't classify it as that. For example, most mainstream mining analysts would look favourably at a mining company that manages its resources well and has good social and health initiatives in the local communities it operates in because it is more likely to keep its license to operate, be more successful in competitive situations and have a healthier and more productive work force. There is still a long way to go though and there are many ESG indicators that mainstream analysts could be looking at that would add value to their investment analysis. There is also more that needs to be done from ESG research houses to make their analysis more relevant to main stream investors, to demonstrate the links to financial returns and enable them to integrate research into their valuation models. This is why Trucost translates all its environmental risk research into financial terms, to enable investors to understand what the potential financial implication might be to a company from their natural capital dependencies and integrate that into their valuation scenarios.

Emerging Markets ESG: Which extra-financial theme - environmental, social or governance - is the most challenging for emerging market companies to manage?

Lauren Smart: I think the challenges vary in different markets so it isn't possible to say one is more challenging than another. It also depends on the sector, but broadly there is a need for greater disclosure of ESG indicators from Emerging Markets companies as they still lag the rest of the world in terms of their disclosure, which presents an investment risk due to the black hole of knowledge. Of course, it is impossible to disclose ESG indicators unless the data is being routinely collected in a systematic way which usually requires some management accountability, so in itself to have disclosure on issues, indicates that they are on the agenda of the company and they are beginning to manage them. This is new to many of the companies in the emerging markets so can be difficult for them to start doing. Many of Trucost's clients therefore ask to use our modeled data for companies who do not disclose so they can understand what the potential scale of risk in their portfolio is and with which companies. Some investor clients also engage with high impact non disclosing companies to encourage them to improve their transparency. The quality of disclosures also needs to improve but there are some positive signs and some countries, like South Africa, are actually quite advanced in reporting due to initiatives by the JSE and things like the King Code of corporate governance principles... so it's not all negative!

Emerging Markets ESG: Which extra-financial theme - environmental, social or governance - is the most challenging for investors in emerging market companies to analyze?

Lauren Smart: A key trend we have identified is a desire from investors to understand the risk they may be exposed to through the supply chains of companies which are increasingly being moved to the emerging markets. This presents a set of risks that can be very difficult to unpick as there is often a lack of visibility in company supply chains, however, this is also where the greatest risk for a company and an investor frequently comes from. Sectors such as food and clothing production and retail are particularly exposed. We are working with clients, such as Puma, to understand their supply chain and their natural capital requirements such as cotton, wheat and leather and map those requirements to their suppliers' geographies and possibility of future price increases from factors such as water price rises. This insight enables companies to understand their supply chain and operational risk from natural resource requirements, identify and mange where in the world and from which suppliers their greatest environmental impacts are occurring, inform future business strategy such as sourcing and then define successful business models for a resource constrained future. It is evidence of this type of foresight that investors are looking for from companies.

Emerging Markets ESG: Emerging markets have a huge environmental footprint. What role do emerging markets play in Trucost's business, operations and strategy?

Lauren Smart: Emerging markets are a strategic priority for Trucost. We have expanded rapidly in the emerging markets recently and expect that to continue this year. We are working for clients in China, Brazil, South Africa, India and other parts of Asia and have local partners such as Syntao in China. We have also opened an office in Hong Kong from which we will service Asia. We also have a large number of clients who are based outside of emerging markets who are interested in understanding the environmental risk they are exposed to through their investments in the emerging markets so Trucost is working hard to further build out our data and research in the region. It an exciting area!

First published on Emerging Markets ESG

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"Companies that actively manage environmental risks - and take advantage of associated opportunities - increasingly seem to outperform those who don't in the stock market. That could be a very good thing, both for shareholders and the planet," said Cary Krosinsky, vice president of Trucost and editor with Nick Robins of Sustainable Investing: The Art of Long Term Performance, in a recent Newsweek article on green rankings.

In other words, green companies tend to perform better in the stock market and are worthy of investment consideration. Krosinsky spoke recently at the University of Virginia Darden School of Business at the invitation of the student club, Darden Capital Management, which provides students the opportunity to manage $6.2 million in funds, including the Rotunda Fund, a portfolio of stocks from companies that maintain sustainable business practices.

According to Krosinsky, what he terms "sustainability investing" was long thought to be a screen of sorts to weed out "sin stocks," such as tobacco. "Now, sustainability investing counts companies' positive works," he said. Krosinsky discussed a 2009 performance study, which showed that companies that mind their environmental, social and governance (ESG) business factors exceed the S&P 500 by as much as 4.8 percent.

Dean Krehmeyer, executive director of Darden's newest Center of Excellence, the Initiative for Business in Society (IBiS), remarked, "ESG metrics offer one important way to track how businesses are creating value for society and enable comparability for identifying best-in-class organizations that exemplify long-term thinking."

Darden Professor Rich Evans also believes that sustainability investing holds a distinct opening for investors.

"With above average risk-adjusted performance over the previous three years and below average fees, funds that focus on sustainable and socially responsible investing (SRI) present a unique opportunity for investors," said Evans.

Evans teaches a case on sustainability investing in his Second Year course, "Investments." In 2012, his research will continue to focus on how investors make decisions when managing portfolios.

Choosing the right stocks begins with analyzing the information companies report. These days, the green information is a little easier to find.

"Sustainability reporting, or adding ESG metrics to investor analysis, is becoming more mainstream," said Erika Herz, Darden manager of sustainability programs and managing director for the Alliance for Research on Corporate Sustainability (ARCS), an organization that advances research and convenes scholars addressing sustainability issues in business.

She believes that sustainability reporting sheds light on short-term earnings, but also a company's long-term value. "Good governance is a proxy for a strong future," Herz added.

The students who run Darden's Rotunda Fund, with support from Darden Professor and Faculty Advisor Yiorgos Allayannis, also consider ESG metrics when making investment decisions. Valued at $750,000, the fund uses both a sustainability thesis and an investment thesis to identify stocks that the students believe have the best potential to perform.

"With the shift away from defined benefit plans and towards defined contribution plans, people have an increasing say in their asset allocation decisions. We believe that the growth of SRI shows how people are looking to put their money towards investments that make a positive contribution to society," said Class of 2012 MBA student Peter Lee, manager for the Rotunda Fund. "Through the Rotunda Fund, we're aiming to show how investing for good can be a legitimate investment strategy that can generate attractive returns."

A potential advantage for shareholders, sustainability investing also provides incentives for companies to act greener and increase transparency.

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The report., Expect the Unexpected: Building Business Value in a Changing World, examines the environmental and social changes that will bring both risk and opportunities for businesses in the search for sustainable growth. 

Ranging from climate change and ecosystems decline to the growing middle class and urbanization, these megaforces are expected to significantly affect corporate growth over the next 20 years, says KPMG International.

KPMG used Trucost data to identify the external environmental costs of 11 key industry sectors (including upstream supply chain).  Based on this data, KPMG found that the external environmental costs of the 11 sectors rose by 50% between 2002 and 2010, from US$566 billion to US$854 billion.

The research finds that "external environmental costs could account for a considerable proportion of earnings (EBITDA) and thus represent significant business value potentially at stake: across the 11 sectors, the average environmental costs per dollar of earnings would have been approximately 41 cents in 2010."

KPMG also examined the readiness of businesses to deal with this risk. "The two sectors perceived as being at highest risk from sustainability megaforces, but least ready are Food Producers and Beverages...the Automobiles and Telecommunications & Internet sectors are perceived as being the least at risk and the most ready."

Regardless of the sector of operation, there is little doubt that those companies that achieve the fastest success in decoupling growth from natural resource dependency and environmental decline stand to achieve competitive advantage in today's resource contrained and environmentally conscious era.

Those in the Food Producers and Beverages sectors appear to have the most significant first mover opportunity.

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In his introduction to the 38 chapters that comprise the new book Evolutions in Sustainable Investing: Strategies, Funds and Thought Leadership, Cary Krosinsky writes, "This book in effect charts the history of SRI (socially responsible investing)." It isn't, in reality, quite the case; the book pays little attention to the earlier days of the SRI industry, which culminated with the shareowner action that is widely considered to have been a major turning point in ending apartheid in South Africa and in the formation of the Global Sullivan Principles of Social Responsibility.

Furthermore, the book devotes relatively little space to the traditional SRI pillars of shareowner activism and community investment. While there is some discussion of the former in the chapters devoted to specific asset management firms, neither subject earns a chapter of its own. In fact, neither is even listed as a subject in the book's index.

Addressing the negative screening practices of traditional SRI -- the "unsophisticated screens" which, he argues, accounts for 90 percent of the trillions of dollars invested in "a socially responsible manner" in the US -- Krosinsky writes, "Take a purely values-based approach, and you risk missing the very same practical opportunities in eco-efficiency and innovation, where the sustainability we require will come from."

Instead, the beginning of the history compiled by Krosinsky and his associates can perhaps be located in the 1987 report by the Brundtland Commission, which famously defined sustainability as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs."

The basic thesis of the book, and the overarching rationale for sustainable investing proposed by it, is as straightforward as it is compelling: due to such factors as population growth and climate change, the world is entering an era of resource scarcity. Companies that recognize the risks associated with the realities of the new era, and exploit the opportunities for innovation that adaptation to scarcity requires, will have positioned themselves to outperform their lagging peers.

Likewise, investors who take into account the realities will benefit from a sustainable investment strategy that, in the words of Nick Robins, Head of the Climate Change Center of Excellence at HSBC, has as one of its features a "forward-looking, prospective methodology which we argue will systematically add value over time."

In one of the book's chapters, Krosinsky described the framework that is necessary "to judge companies that are looking to succeed in a changing world while positioning themselves best from a risk standpoint." Expanding upon the traditional environmental, social, and corporate governance (ESG) criteria, Krosinsky instead proposes investment criteria that incorporate five factors: in addition to ESG, he includes traditional financial criteria and quality of management.

"Investing and measuring without the framework offered in this chapter," Krosinsky writes, "Inevitably ignores some or all the risks that are critical to a company's success."

Of course, the approach to sustainable investing espoused by Krosinsky depends upon effective measurement, which is not surprising; he is, after all, a Senior Vice President at Trucost, a leading environmental research firm that maintains the world's largest database of corporate greenhouse gas (GHG) emissions.

The quality of ESG research has improved considerably since Paul Hawken, the author of Natural Capitalism and a contributor to Evolutions in Sustainable Investing, wrote in a 2004 paper on SRI, "Over 300 different criteria are employed today versus only five 20 years ago. But the granularity of the screening misses the most important screen of all, the business model or intention."

The improvement occurred thanks in large part to the efforts of firms such as Trucost. In a chapter of the book devoted to the environmental metrics compiled by Trucost, Senior Vice President James Salo describes the approach that sustainable investors must take. Focusing on the most important area of environmental performance for each asset; understanding such drivers of value as operational efficiency, capacity for innovation, and reputation; and the monetization or benchmarking of environmental performance "have a strong potential to drive investment outperformance in the long term," Salo writes.

The book's chapters provide informative commentaries on the histories of several sustainable asset management firms, dating back to the early 1990s when Wall Street dismissed sustainable funds as being insufficiently diversified. But once it establishes the groundwork for a contemporary definition of effective sustainable investment, the book comes fully to life as it investigates the nexus of investment opportunity in an era of resource scarcity: emerging markets.

No fewer than six of the book's chapters address sustainable investment in Asia, Africa, and India. While challenges to the uptake of the practice in these regions remain considerable -- the prevalence of state-owned companies in Asia, widespread poverty in Africa and India -- efforts are underway to improve the ESG reporting of companies, and increasing investment by institutional investors committed to sustainability should help improve the long-term performance of companies located in these frontiers of investment.

In a chapter on sustainable stock indexes, Graham Sinclair of AfricaSIF, the African sustainable investment forum, describes how guidelines from the Johannesburg Stock Exchange (JSE) have led to increased ESG disclosure by listed companies. In 2010, JSE began requiring its more than 450 companies to produce integrated reports, which combine financial data with reporting on ESG issues.

In Brazil, BM&FBOVESPA, the Brazilian Stock Exchange, launched a Corporate Sustainability Index that "reflects the real business sustainability of listed companies and incorporates the evolution of sustainability practices and theoretical benchmarks," Sinclair writes.

Earlier this year, after Evolutions in Sustainable Investment went to press, BM&FBOVESPA announced that it will recommend that listed companies either produce a sustainability report or explain why they do not.

This writer found it enlightening that Krosinsky described Hawken's 2004 paper as "a landmark piece well worth reading." It may be a sign of either a maturing industry or a growing global crisis, or both, but Krosinsky envisions when rational investors in the mainstream will have to invest sustainably. Hawken, on the other hand, set financial considerations aside for the most part, arguing that SRI research should identify companies whose products and services "are helpful to the world we inhabit."

In an era marked by corporate governance scandals and impending resource scarcity, the two approaches no longer seem mutually exclusive. As sustainable investment research becomes more sophisticated, the strategy's potential for long-term outperformance increases. The same research should help the traditional values-based investor more accurately identify those companies whose operations contribute to a more sustainable world.

Krosinsky may well disagree with the notion of a potential convergence of traditional SRI with sustainable investing. After all, in a chapter entitled "On Performance," he demonstrates that ESG funds outperform their benchmarks, while SRI funds do not. But as Hawken argued in his 2004 paper, "What does it matter if one fast food company is singled out as 'best in class'...if you are going the wrong way, it doesn't matter how you get there."

This article originally appeared on SocialFunds.com.

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UK manufacturers across sectors see raw materials shortages as one of their top five risks in 2012, according to findings of a survey by the manufacturers' organisation, EEF. It sees effective resource management as a significant economic and environmental challenge. The stakes are high. The World Economic Forum warned last month that the world is heading for a "peak metals" scenario that could put US$2 trillion (1.7% of GDP) of economic output at risk in 2030, unless major global economies respond to shortages in the supply of steel and iron.

The transport industry consumes 16% of global steel production. Differences in the materials efficiency of production suggest that the industry has potential to make more from less. We looked at two global automobile manufacturers, luxury car producer BMW Group - owner of BMW, Mini and Rolls-Royce Motor Cars - and India-based Tata Motors - the maker of commercial and passenger vehicles including Jaguar Land Rover - to see how efficiently they're using steel.

Each company disclosed the quantity of steel used to manufacture their vehicles. On average, Tata Motors used 0.28 tonnes of steel to produce each vehicle, while BMW used more than three times as much (see Table 1).

Table 1: Steel use by car producers in 2010

Considering BMW manufactures its luxury cars to high European safety standards, more steel-intensive vehicles raise the importance of recycling to use raw materials more efficiently. BMW is also investing in lightweight alternative materials such as carbon fibre reinforced plastics.

Iron ore is the main component of steel and its price has risen more than 900% over the past 10 years and fluctuated sharply since January 2010. In 2000 the cost of iron ore was US$12.50 per tonne. Fast forward 12 years and the price has increased more than tenfold to over US$130 per tonne, after peaking at nearly US$190 in early 2011. The high and fluctuating cost of iron ore and potential loss of market share is driving many steel manufacturers to switch production methods by using new electric furnaces (EAF). These are cheaper to run and include a higher proportion of recycled steel than traditional basic oxygen furnaces (BOF). This highlights room for cost savings to be made by savvy suppliers to car manufacturers.

Iron ore prices jumped despite world iron ore production rising from 1,049 mn tonnes to 2,400 mn tonnes, a 129% increase, with some warning that excess supply could lead to a cutback in mining. As iron ore consumption is expected to increase at 2% p.a and is currently growing at 10% p.a, sharp swings in commodity prices are just one of the factors push resource efficiency up manufacturers' agendas. Building new markets and diversifying into new supply chains were among opportunities spotted by manufacturers in EEF's survey. Driving demand for products that are made using fewer raw materials could help make higher car ownership and economic growth in emerging markets more sustainable.

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¹ http://annual-report.bmwgroup.com/2010/gb/en/facts-and-figures-2010/management-report/review-of-operations/production.html

² http://www.tatamotors.com/investors/flash-figure-details.php?id=105 

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Companies and investors are caught between expectations of lower demand growth for energy and raw materials and uncertainties about supply-side risks. Commodities prices have fallen from their peak in 2011 as expectations of a recession in the Eurozone and a slowdown in economies such as China have hit markets and crop production has recovered. However, some inventories remain tight and fuel and commodity prices are still higher than the average for the five-year period to the end of 2010¹. Average food prices in 2011 were the highest in 20 years.

Supply and demand trends are likely to keep global food prices strong - futures wheat prices for the end of this year are currently more than one-tenth higher than existing prices.²  The recovery in wheat and grain production could help replenish depleted stocks caused by floods and droughts in some producing regions and help meet growing demand for food, feed and biofuels, rather than fully reverse the sharp rise in prices between 2010 and 2011.

High prices for oil and fertilisers such as potash, will feed through into agricultural commodity prices going forwards. The costs of the environmental impacts of production, such as greenhouse gas emissions and water use, could also increase input costs. Environmental costs are increasingly being internalised through regulatory or market measures, and the food industry is particularly vulnerable to the costs of the physical impacts of resource depletion, pollution and climate change.

A recent report by McKinsey & Company into resource trends over the next 20 years shows a potential  50-450% rise in commodities prices if externalities from greenhouse gas emissions and water use were priced. McKinsey points out that rising prices for food and water are increasing input costs for consumer packaged goods (CPG) companies, which also face rising energy and materials prices.

With Trucost's help, McKinsey assessed how the price of a common basket of consumer packaged goods (CPG) might change if it were to reflect the cost of environmental impacts. Trucost data show that pricing environmental costs for water and greenhouse gas emissions could increase wheat prices by more  than 400%. External costs for water use vary by region. For instance, the four top wheat producing countries are China, India, Russia and the United States of America. Different levels of water use per tonne of crop produced and levels of water scarcity in surrounding basins drive variations in water costs in each country. Chart 1 shows how more intensive water use for wheat production in India, combined with greater water scarcity, results in an embedded water cost that is more than 800 times higher than that in Russia.

Chart 1: Wheat production and external water costs in top 5 countries

Food value chains could incur costs through changes in Government subsidies, higher water pricing, changes to abstraction or irrigation licenses or lower productivity. For instance, lost crops due to drought in Argentina could cut export revenues by US$6 billion. Production in parts of China and India could be hit by low rainfall, while other areas face floods and storms caused by ongoing La Niña weather conditions. However environmental costs are internalised, uncertainties and fears of tail risks - low probability events that have a significant impact on prices - are likely to keep markets volatile. Exposure to fluctuations in commodity prices could increase if trading of agricultural commodity derivatives is curbed in response to accusations that it has contributed to food price spikes.

Companies that transform value chains and business models to improve resource efficiency and manage exposure to risks from the interdependence between food, energy and water will be well positioned for an era of greater price volatility.

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¹ IndexMundi commodity price data

² FactSet, 24 January 2012

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Last year marked the second year of steady expansion for the top three U.S. car firms - General Motors (GM), Ford and Chrysler - after a severe downturn during the global crisis in 2008. The U.S. car industry seems to be on a steady path to recovery, helped by President Obama's financial stimulus. GM is in pole position on sales, reporting 234,351 vehicles sold last month, 12% more than Ford and 70% more than Chrysler.

The bailout had green strings attached - manufacturers had to make more effort to sell fuel efficient vehicles to cut carbon dioxide emissions and oil dependence. Market forces and regulatory drivers are building momentum to do this. Improving the energy and carbon efficiency of vehicles in use will be a priority this year, as manufacturers struggle to meet demand for fuel efficient cars and a new U.S. fuel economy standard to cut greenhouse gas (GHG) emissions and improve energy efficiency comes into force. 

Competing on the carbon efficiency of production is also important to cut exposure to rising input costs and develop more sustainable value chains. So which U.S. carmaker has the most carbon-efficient production?

Based on the companies' latest carbon disclosures and Trucost calculations of their supply chain GHG emissions, Chrysler is the top polluter, with 351 tonnes of GHG emissions, measured in carbon dioxide equivalents (CO₂e), per US$ mn revenue. GM is next, with 345 tonnes per US$ mn, leaving Ford as the most carbon efficient of the three, with less than 310 tonnes of CO2e/US$ mn.¹

Chart 1: Carbon efficiency of automakers production and supply chains

Ford takes the chequered flag on its wider environmental performance. Its more environmentally-efficient production also lessens its financial risk. Trucost estimates that if the company had to internalise its environmental costs, they would amount to 2.3% of its revenue - 8% less than for GM or Chrysler.

Trucost calculates that Ford's supply chain contributes 87% of its total emissions. The carmaker has engaged with 30% of its direct (tier 1) suppliers on carbon impacts, and found variability in supplier readiness to measure and report GHG emissions. Engagement also delivered valuable insight into risk management opportunities for the broader automotive supply base. Ford is expanding engagement to wider production, information technology and logistics suppliers. With a US$65 billion value chain, encouraging better measurement and management of materials and carbon could have a significant impact on the company's raw material and environmental footprint. Ford could be better equipped to manage growth sustainably than the two competitors analyzed.

Stronger management of sustainability in value chains could help make supply chains more resilient. Potential risks were highlighted last year, when environment-related events disrupted the supply chains of several manufacturers. For instance, the earthquake and tsunami in Japan and floods in Thailand affected Toyota's operations and parts suppliers, causing a fall in production and loss of earnings.

Could 2012 be the year that potential game changers in the auto sector re-map upstream environmental risks and switch to low-carbon growth?

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¹ Environmental data was normalized to 2010 revenues for methodological reasons, as latest environmental data available covers the financial year 2010: http://www.gmsustainability.com/ ; http://corporate.ford.com/doc/sr10.pdf and http://www.chryslergroupllc.com/en-us/sustainability/Documents/ChryslerGroup2010SR.pdf

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Our 2012 State of Green Business report, our fifth annual, has just been published. I'm not going to mince words: Things aren't going as well as we'd hoped. For the first time since we began doing our assessment, in 2008, several of the indicators have taken a downward turn.

Each year, we take the pulse of sustainable business through the lens of 20 indicators of progress, or lack thereof. The indicators measure such things as carbon emissions, e-waste recycling, green office space, vehicle fleet emissions, toxic emissions, energy efficiency, employee commuting, corporate reporting, and a dozen other things. For each, we provide the metric, an analysis, and our take on whether we're making progress ("swimming"), holding our own ("treading"), or going backwards ("sinking").

For the first time, we saw a significant decline in progress-not just in one indicator, but several. Cleantech investments, energy efficiency, green office space, packaging intensity, toxic emissions, and toxics in manufacturing -- all of these trend lines leveled off or reversed course in 2011. Only one indicator -- green power use -- markedly improved.

What's to blame? Simply put, sustainable business is suffering a recessionary hangover.

For much of the past few years, many of our indicators moved in positive directions. Combined with the commitments we were seeing, as well as our surveys of sustainability leaders in large corporations -- which told us that their budgets, staff, and goals were holding steady or growing during the recession -- we concluded that the economic turmoil, at least in the United States, wasn't putting a damper on companies' efforts to improve their environmental performance. The results could be seen each year in the continued progress measured by the GreenBiz Index.

We were, shall we say, irrationally exuberant.

The reality is this: Much of the progress we saw in our 2010 and 2011 reports were lagging indicators based on work done with pre-recessionary budgets. As the economic realities have set in, environmental progress has stagnated, or worse.

That's not the full story. Despite our efforts to normalize many of the indicators to Gross Domestic Product in order to avoid spikes and drops resulting from economic booms and busts, we believe that less economic activity doesn't always lead to lower environmental impacts. In some instances -- electricity power plants, for example -- industrial operations must operate at baseline levels that don't always move in lockstep with the economy.

It's not all bad news. This year, like all years, we find many promising developments in the world of corporate sustainability, as more companies make more commitments related to their products or operations. As we have in the past four reports, we pick 10 promising trends, from the rise of sustainable consumption, to the growing engagement of chief financial officers in companies' sustainability initiatives, to the fact that clean technology, contrary to the political narrative, is alive and well, even flourishing. There is much reason for hope.

Indeed, that's where the cognitive dissonance sets in: We report on so many promising developments each week, so many companies that are engaging more thoughtfully and holistically than ever with what it means to integrate sustainability into their operations, products, and services. We watch as clean technologies become competitive, as markets for organic foods and efficient vehicles reach into the mainstream, as companies achieve zero-waste factories and replace toxic ingredients with safer ones.

But for all of the good work being done, it's simply not good enough.

Can we simply pass this off as a byproduct of a bad economy, and cross our fingers that progress will accelerate when times get better? Or is it time for companies to dig deeper, and for their employees and customers to get more engaged? What will it take to make real progress?

There's a lot at stake here. We continue to be optimistic, though perhaps more cautiously than in the past.

Download report: The State of Green Business 2012