Enabling Environment Srinivasan Sunderasan Enabling Environment A Worm’s Eye View of Environmental Finance Srinivasan Sunderasan Verdurous Solutions Private Limited Mysore, Karnataka India ISBN 978-81-322-0881-5 ISBN 978-81-322-0882-2 (eBook) DOI 10.1007/978-81-322-0882-2 Springer New Delhi Heidelberg New York Dordrecht London Library of Congress Control Number: 2012954782 © Springer India 2013 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, speci fi cally the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on micro fi lms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. 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While the advice and information in this book are believed to be true and accurate at the date of publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for any errors or omissions that may be made. The publisher makes no warranty, express or implied, with respect to the material contained herein. Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) Foreword The term environmental fi nance may not be commonplace yet, but Srinivasan Sunderasan’s book E nabling Environment brings light to this developing and press- ing fi eld. The term was fi rst coined in 1992, by Richard L. Sandor, and describes fi nancial investments, infrastructure, and devices that work with and preserve the environment. However, two decades later, most countries’ economic policies continue to be at odds with an environmentally green agenda. We stand at a point of economic and historic upheaval. Many developed coun- tries’ economies are in disorder or depression, continually increasing their needs for nonrenewable energy and therefore continuing to create large amounts of nonrecy- clable and harmful waste. Developing countries, on the other hand, feel they should build their infrastructure, policies, and economies around the same principles that have landed developed countries in their previously mentioned precarious situation. Though this may appear a bleak outlook, it provides us a unique opportunity. Developed nations can incorporate the principles of environmental fi nance as they begin to reevaluate and restructure their economic policies. Developing countries, who are building their economic framework, can craft it around environmental fi nance theories, while becoming the new benchmark or standard for sound environ- mental and economic practices. To halt this slide down the slippery slope of environmental degradation requires the brakes of reason that come from informed thinkers such as Al Gore, James Hansen, and others. Dr. Sunderasan adds his voice to this growing crescendo by developing a strain of thought that draws on established economic theory and is yet eclectic in its approach. Devising solutions to these demanding problems can no longer rely on political diktat nor be sought by appealing to the social consciousness, but must rather draw on the irrepressible market forces that can be unleashed by Adam Smith’s invisible hand . Dr. Sunderasan in his pioneering collection of essays proposes a range of proactive policy measures and market-based instruments that can alter patterns of behavior to achieve desired outcomes. The power of Dr. Sunderasan’s solutions is rooted in their ability to merge the individual interest with those of the larger community – of positively internalizing what are strong negative externalities. v vi Foreword Dr. Sunderasan skillfully explores many areas of environmental fi nance, such as the green index, providing incentives to governments and businesses to increase green productivity and reevaluating measures of energy expenditure and even the social and psychological changes that should be made to bridge the inter- and intragenera- tional environmental gap. In putting together this book, Srinivasan Sunderasan has done a remarkable job of focusing the lens of reason on what may be the most pressing issue of our time and initiating a new line of discourse to stimulate discussion among thinkers, policy makers, organizations, and market participants. Anyone wishing to enter the fray to restore our environmental heritage will fi nd this book to be an invaluable guide. Professor of Finance and Dr. A. Abraham Director MBA, Arab Open University, Kuwait August 2012 Prefatory Note It has been a summer of discontent! Citizens in debt-ridden and shaky economies of the Eurozone, namely, Greece and Spain, have taken to the streets to disapprove of proposed austerity measures, pension and healthcare cuts, and longer working hours and other such measures which are collectively seen as a way out of the crisis for the domestic economy, the Eurozone, and for the global economy in general. It is dif fi cult to point a fi nger at the guilty, for the voting public brought the populists into of fi ce who, in turn, drained the treasury. The very same voting public continues to back those who promise lesser austerity and more populism – even if the latter are faced with fewer options save eschewing pro fl igacy and following a path of fi scal consolidation. While the political leaders who led to this impasse have probably gone into a comfortable retirement, it is today’s common person and the persons belonging to the generations to come who bear the pain of lost jobs, of lost bene fi ts, and, ultimately, of lost hope. It is common people who make choices which eventu- ally lead to distress; it is common people who are expected to put up with a host of unpleasant circumstances in pulling themselves out of crises. Yet, there are few, if any, mechanisms other than periodic referendums or elections that engage individu- als in decisions of global import, monetary, fi scal, environmental, or otherwise. Practically speaking, it is individuals who make consumption-related choices on ways of living, traveling, or in preferring products or services over others. This col- lection of articles on environmental fi nance is an attempt to highlight the role of these everyday persons in aggregating individual effort toward collectively achiev- ing positive global outcomes, effective transfer of technology and resources, and sustainable livelihoods for the present and for the future. Given that global negotia- tions among political leaders, policy makers, and activists routinely get bogged down on issues relating to responsibilities for past actions, and to intergenerational and intragenerational equity, it is possible for each individual to take moral owner- ship of the natural environment and to make positive contributions toward restoring it to its pristine state. This collection of topical research work covers speci fi c aspects and issues within environmental economics and fi nance, ranging from the politics of fossil fuel prices through stock-market valuations of green(er) companies, option-based payments vii viii Prefatory Note for ecosystem services, and behavioral models for inducing environment-friendly conduct. Owing to familiarity and convenience of access, data from India are employed to illustrate, but the concepts outlined could be applied globally. Each article tackles a real issue offering plausible, practicable solutions, without making idealistic and unreasonable assumptions. Speci fi c investment or consumption choices, incentive structures, and behavioral patterns are discussed. This book is based on extensive research and on the author’s personal experi- ence, thus providing a technical overview for each issue being discussed and yet retaining focus on the practical economic and fi nancial facet of the issue in question. Enabling Environment is built on a theoretical foundation, draws on relevant experiences from across countries, and offers solutions and instruments that can directly be implemented in the real world. The collection is a singular blend of economic theory and empirical fin ance – and hence should appeal to researchers and academics as well as main-street investors. It leads seamlessly from economic theory into exploiting the investment opportunities available, while contributing to superior environmental outcomes through this transition. The introductory chapter discusses the concept of individual transferable emis- sion quotas as an equilibrating mechanism. The political irrelevance of fossil fuel subsidies is demonstrated in the following chapter followed by an analysis of the value of independent assessments and disclosure of environmental performance of fi rms across industry sectors. “Goodwill capital” emanating from superior environ- mental performance is quanti fi ed and read in conjunction with the generation of superior investor returns. The design of an innovative green stock-market index as a genuine re fl ection of the “greenness” of the economy is outlined. From encouraging pro-environmental behavior, the focus shifts to internalizing externalities as a means of adaptation. Implied valuation of a ton of carbon is com- puted from a set of projects submitted under the Kyoto Protocol/UNFCCC Clean Development Mechanism (CDM). Furthering the discussion on carbon valuation and trading, a synthetic basket currency, “CERO,” is proposed with a view to enhancing the ef fic iency of international carbon markets. A “real-option” model is developed as a means of encouraging agroforestry on private lands to encourage sequestration and to deliver other ecosystem services. The collection of articles ends with a section on social incentives and societal norms involved in encouraging pro-environmental consumption choices. Mysore, India Srinivasan Sunderasan August 2012 Contents 1 Rainmakers ................................................................................................ 1 Measures of Responsibility ......................................................................... 2 Real People and Real Issues ....................................................................... 3 The Abstractions of Per Capita Measures .............................................. 4 Equilibrating at the Retail Level ............................................................ 5 Exploiting Existing Instruments, Institutions, and Structures .................... 6 Layout of This Book ................................................................................... 7 References ................................................................................................... 8 2 The Irrelevance of Political Populism ..................................................... 11 Introduction ................................................................................................. 11 Overview of Price Controls and the Political Process ................................ 12 Anecdotal Evidence and Motivation for the Study ..................................... 13 Econometric Model ..................................................................................... 15 Response of Domestic Retail Prices to Changes in International Oil Prices ...................................................................... 16 Transfer of Changes in Retail Fuel Prices to the General Price Level .............................................................................................. 16 In fl uencing Policy and Winning Elections .................................................. 18 Discussion: Statistical Results in Perspective ............................................. 20 The Ability to In fl uence Pricing Policy ................................................. 21 The In fl uence of Pricing Decisions on Electoral Outcomes .................. 21 Conclusions ................................................................................................. 22 References ................................................................................................... 26 3 The Persistence of Green Goodwill ......................................................... 29 Introduction ................................................................................................. 29 Voluntary and Mandatory Disclosure and Market Response ...................... 31 Environmental Compliance and Stakeholder Involvement ......................... 31 Consumers and Community ................................................................... 32 Government Regulation ......................................................................... 32 Investors ................................................................................................. 33 ix x Contents Data and Methodology ................................................................................ 34 Discussion ................................................................................................... 39 Conclusions and Recommendations ........................................................... 40 References ................................................................................................... 41 4 Broad-Basing “Green” Stock Market Indices ........................................ 43 Introduction ................................................................................................. 43 Index of Environmentally Responsible Business ........................................ 44 Investor Commitment to Sustainability of Business Operations ................ 44 Broad-Basing Green Indices ....................................................................... 45 Shades of Green: Certifying Green Production and Product ...................... 46 Aligning Pro fi ts with the Planet .................................................................. 47 Conclusion .................................................................................................. 48 Appendix ..................................................................................................... 49 References ................................................................................................... 57 5 Implied Valuation of Environmental Externalities ................................ 59 Introduction ................................................................................................. 59 Literature Review: Internalization of Externalities ..................................... 61 The Kyoto Protocol ..................................................................................... 62 Methodology, Data, and Findings ............................................................... 63 Group 1: Project Assets in Place ............................................................ 64 Group 2: Project Assets Not in Place ..................................................... 64 Discussion, Conclusion, and Recommendation .......................................... 67 Appendix ..................................................................................................... 68 References ................................................................................................... 80 6 Optimal Pricing Instruments for Emission Reduction Certi fi cates ................................................................................................. 83 Introduction ................................................................................................. 83 Background ................................................................................................. 83 Statistical Predictability .............................................................................. 84 The Optimally Designed Pricing Currency ................................................. 88 Alternative 1: CER Exporter Country Currency Basket ........................ 89 Alternative 2: Basket Comprising CER Exporter Countries’ Import Partners’ Currencies ................................................................... 91 Basket Construction .................................................................................... 92 Discussion, Conclusion, and Recommendation .......................................... 95 References ................................................................................................... 98 7 Giving Local People a Cause to Keep Their Trees Standing ................. 101 Background ................................................................................................. 101 Direct and Indirect Valuations .................................................................... 103 Bene fi t Transfer Mechanisms ..................................................................... 104 Real Options and Ecosystem Valuations ..................................................... 107 Timber Harvest ....................................................................................... 107 Bushmeat ................................................................................................ 109