Achieving net zero requires a shift to renewable sources of energy. There is another way that not many people talk about – energy efficiency. Unfortunately, improving the energy efficiency of products is not sexy enough (unlike a solar power plant!) to be talked about but is a crucial lever for net zero.
There have been gradual improvements in the inefficiency levels of many products. Our cars guzzle lesser fuel. Our refrigerators, air conditioners, washing machines, dishwashers use less electricity. All this should lead to lower carbon emissions. But it doesn’t. Why? As the fuel cost decline, we compensate it by buying larger cars. Instead of using one air conditioner, we use two. We use larger refrigerators and higher capacity washing machines.
This phenomenon is attributed to the Jevons paradox. The theory, named after the 19th-century British economist William Stanley Jevons, posits that efficiency gains often increase demand.
One possible way to manage the situation is communication and bringing in a culture of sustainable consumption.
Stranded assets are becoming a reality. Take the case of thermal coal. It is widely recognised that thermal coal is no longer a growth opportunity. This is coupled with the fact that debt financing grew sharply and leverage ratios have skyrocketed. A bulk of financing for thermal power plants has come from debt. With thermal power plants being rapidly replaced by renewable energy plants, many power plants will become defunct. Given that there is a large amount of debt associated with these plants, the lenders are in a quandary.
So, what happens to these power plants? Creating a climate “bad bank” could be better than running down these power plants.
The idea of a bad bank has gained currency with the Non-Performing Assets (NPA) of Indian banks. A ‘bad bank’ is a bank that buys the bad loans of other lenders and financial institutions to help clear their balance sheets. Over time, the bad bank resolves the bad assets. Like the concept of bad banks, there can be climate bad banks that cater to assets impacted by climate issues.
There are four ways in which resolution can occur:
On Balance Sheet Guarantee: Here, the bank protects part of its portfolio against losses, typically with a second-loss guarantee from the government.
Internal Restructuring unit: A separate unit is created in this scheme, and the assets are placed within it. This ensures sufficient management focus and incentives are aligned to the restructuring of assets bringing about efficiencies.
Special Purpose Entity: This is an off balance-sheet solution. Here the unwanted assets are offloaded into a special purpose entity (SPE). This way the assets are taken off the balance sheet.
Bad Bank Spinoff: In the spinoff, the bank shifts the assets off the balance sheet and into a legally separate banking entity.
Creating a bad bank is desirable action. Without a bad bank, the fossil fuel assets may be sold off to opaque unlisted entities. These entities may have little or no intentions of running or responsibly closing these assets.
Governments have many policy options to curb carbon dioxide (CO2) emissions and slow down global warming. There are a wide range of estimates of costs that these policies will impose on governments and taxpayers. If the government doesn’t do anything or do much, society will inevitably pay the price. According to a study by the Institute of Policy Integrity, climate change could cost the world some $1.7 trillion a year by 2025, increasing to about $30 trillion a year by 2075.
The social cost of carbon (SCC) is the monetary value (say, dollars) of the economic damages that would result from emitting one additional ton of greenhouse gases into the atmosphere.
The social cost of carbon is a tool that helps policymakers determine whether the costs and benefits of a proposed policy to curb climate change are justified. A higher SCC generally means that the benefits of a particular climate policy to cut CO2 justify its cost; a low SCC makes a policy seemingly cost more than the benefits it ultimately delivers.
Estimating the dollar amount of SCC requires information that links social, economic and physical features into one framework. This information is then fed into computer models. These models integrate four types of information:
Predict future emissions: These are based on population, economic growth, and other factors.
Model future climate responses: Future emissions are estimated and based on these estimates, the impact is assessed regarding increased temperature and sea-level rise.
Assess the benefits and costs: What will be the impact of climate change on agriculture? What will be the cost of adaptation to sea level rises? What will be the impact of additional warming on energy use? What will be the impact on worker’s productivity?
Convert to present value: Since benefits and costs are likely to accrue over time, policy decisions need to be taken today. Hence you discount the future costs and benefits to today. At what discount rate? It is the discount rate that indicates a willingness to spend today to protect future generations.
Simulation of the three models is run hundreds of thousands of times using different values for uncertain variables and parameters. As a result, many estimates of SCC emerge. SCC is usually represented as a range rather than a single number. An average of all the estimates is taken at a particular discount rate to deliver a representative SCC. A representative computation is shown below:
Source: Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis , 2016
We can get a sense of SCC by seeing that it was estimated that India’s country-level social cost of carbon emission the highest at $86 per tonne of CO2 in the world. This means that the Indian economy will lose $86 by emitting each additional tonne of CO2. Next in scale is the US, where the economic damages would be $48 per tonne of CO2 emission and Saudi Arabia at $47 per tonne of CO2 emission.
The concept of Social Return on Investment (SROI) emerged from the work done by the Roberts Enterprise Development Foundation (REDF). Originally intended for large social enterprises, over time it has been fine-tuned to meet the requirements of various types of organisations. SROI is an outcomes-based measurement tool that helps organisations to understand and quantify the social, environmental and economic value they are creating. In effect, SROI captures the triple bottom-line of people, profits and planet.
Every business needs to periodically measure its performance. One of the ways of measuring the company’s performance is the accounting rate of return. This is simply the profits that the company has earned divided by the investment that it made in the business. Companies are also impacted by externalities – things that take place outside its factories. These externalities are not captured in the accounting rate of return.
Externalities are best understood by examples. For example, if the factory’s chimney releases smoke it has harmful consequences on the people and farms nearby. This is beneficial and is called negative externality. On the other hand, if the company builds a road to its factory then it makes it easier for people in nearby areas to commute. This is positive externality. Every social and sustainability action of a company will have an impact in terms of externalities. To measure the performance of a company’s social and sustainable actions we use the metric – social return on investment or SROI as it is popularly called.
In practice, there are two ways of calculating SROI depending on the level of measurement. When the measurement is undertaken at the company’s level, it is based on both social and economic benefits and considers economic as well as social investments. On the other hand, when the measurement is undertaken at the project level it is simpler to look at only social costs and benefits and relate them to social investments.
Thus, the company level measurement is defined as: SROI=(Economic profit + Social profit)/(Economic investment + Social investment). Here social profit is social benefits less social costs
And, the project level measurement is defined as: SROI = Social profit/Social Investment.
THE PRINCIPLES OF SROI
There are seven principles of SROI that support the application of SROI. These are:
Involve stakeholders: Stakeholders are the ones who are most impacted by the change being brought about. They should be informed and identified and involved during the entire process.
Understand what changes: There are two types of outcomes of any change process—intended outcomes and unintended outcomes. It is necessary to have sufficient proof of the changes that have been brought about.
Value the things that matter: Value all things that matter. Where direct measures are unavailable, suitable proxies should be used.
Only include what is material: Materiality requires an assessment of the criticality of that piece of information to the decision at hand. If this is information is excluded would the decision-maker make a different decision?
Do not over-claim: Only that portion of benefits should be claimed that the organisation is responsible for creating.
Be transparent: All inputs and outcomes must be documented and made available to the stakeholders.
Verify the result: The results of SROI should be vetted by an independent assurance agency for it to be credible.
THE SROI MEASUREMENT PROCESS
Unless one follows a systematic process to arrive at SROI, the outcome is unlikely to be credible and reliable. The following steps are recommended for arriving at a credible and reliable SROI.
Step 1 – Map the stakeholders: It is important to establish the boundaries of the SROI measurement. First, one needs to figure out the outcomes of social intervention. Second to figure out who the stakeholders of the social project are. It may be worthwhile to list the stakeholders. Finally, one needs to understand how to involve the stakeholders in the project.
Step 2: Mapping the outcomes:This is undertaken by means of impact maps. To understand an impact map, let us take the example of a company constructing a farm pond. The farm pond provides benefits to agriculture, humans, and animals. For agriculture, benefits may be in terms of increased yields and/or more crops in a year. For humans, more water is available for drinking. bathing and cooking. Milch animals may yield more milk. Although there may be lots of benefits, most of them will add little value to the impact. These need not be considered. As the accountants will tell you these fail the materiality test. Once the benefits are identified these need to be converted to monetary terms.
One of the interesting things about outcomes is that they often depend on circumstances. For example, a water project in an arid area is more valuable than one where water is relatively easily available.
Step 3 – Evidencing the outcomes and giving them a value: Step 2 provided a qualitative measure of the outcome of the social project. However, it is also important to put a monetary value to the outcome. This involves (i) developing outcome indicators; (ii) collecting outcomes data; (iii) establishing how long outcomes last; and (iv) putting a value on the outcome.
Step 4: – Establishing the impact: The outcomes that we measure should be auditable. Hence it is essential that outcomes are not over claimed. Also, we need to figure out how much of the impact is because of one’s own activity and how much of it would have taken place anyway or how much of the outcome would have occurred without our intervention and how long will the benefits last. This requires measurement of three key metrics:
Deadweight is a measure of the amount of outcome that would have happened even if the activity had not taken place. It is calculated as a percentage.
Attribution is an assessment of how much of the outcome was caused by the contribution of other organisation’s or people.
Drop-off is used to account for how the outcomes, in future, are likely to be less than current measurements. It is only calculated for outcomes that last more than one year
Step 5 – Calculating the return: Now all the inputs and outputs have been measured, SROI can be calculated using formula listed in the section Social Return on Investment.
Step 6 – Conducting a sensitivity analysis: Relying on a single SROI number can be dangerous. Many assumptions are made while computing SROI. Hence it makes sense to test the robustness of SROI to these assumptions.
ADVANTAGES AND DISADVANTAGES OF SROI
Like any measurement SROI also has its advantages and disadvantages. All the advantages and disadvantages of economic ROI apply to SROI as well and some more.
Advantages
It is simple and easy to calculate. Requires only two pieces of information—profits and investment—numbers that are already available in financial statements.
It measures profitability by scaling social profits to the investment made. Thus, companies are comparable on SROI.
Disadvantages
SROI measurement is impacted by the point of time when the measurement is undertaken. Thus, in a multi-year project, SROI could be different in each of the years. This causes confusion.
Profit (the numerator) is impacted by accounting choices. Different depreciation policies could lead to different profit numbers even though there is no change in the underlying business.
Measuring social costs and benefits often requires measuring shadow prices—making it complicated to apply in practice. For example, where water is conserved in a water-scarce area, the value of water conservation depends upon the extent of water scarcity. Higher the water scarcity, higher would be the value of water.
Measurement of deadweight, attribution and drop off poses significant challenges as there are no direct measures. Estimates must be made based on prevailing local conditions. Such measurement errors could have a significant impact on SROI.
References
SROI Network, ‘A Guide to Social Return on Investment’, London: Cabinet Office, 2012
