This report offers a high level perspective on the world’s biggest natural capital risks for business, investors and governments.
To provide a business perspective, it presents natural capital risk in financial terms. In doing so, it finds that the world’s 100 biggest risks are costing the economy around $4.7 trillion per year in terms of the environmental and social costs of lost ecosystem services and pollution.
Many of these natural capital costs are found in the developing world, but the resulting goods and services are being consumed by resource intensive supply chains around the planet – thus it is a global challenge for a globalized world.
Although internalization of natural capital costs has only occurred at the margin, 3 billion new middle class consumers by 2030 will cause demand to continue to grow rapidly, while supply will continue to shrink. The consequences in the form of health impacts and water scarcity will create tipping points for action by governments and societies. The cost to companies and investors will be significant.
This research provides a high-level insight into how companies and their investors can measure and manage natural capital impacts. While it has limitations, it should act as a catalyst for further research into high risk areas, and mitigation action. For governments it should spark further debate around the risks their countries face, and whether natural capital is being consumed in an economically efficient manner. The scale of the risks identified suggests that all actors have the opportunity to benefit.
2. Executive Summary
Trucost has undertaken this study on behalf of the TEEB for Business Coalition.1 Findings of this report build on TEEB’s The Economics of Ecosystems and Biodiversity in Business and Enterprise2 and the World Business Council for Sustainable Development’s Guide to Corporate Ecosystem Valuation3 by estimating in monetary terms the financial risk from unpriced natural capital inputs to production, across business sectors at a regional level. By using an environmentally extended input-output model (EEIO) (see Appendix 2), it also estimates, at a high level, how these may flow through global supply chains to producers of consumer goods. It demonstrates that some business activities do not generate sufficient profit to cover their natural resource use and pollution costs. However, businesses and investors can take account of natural capital costs in decision making to manage risk and gain competitive advantage.
Natural capital assets fall into two categories: those which are non-renewable and traded, such as fossil fuel and mineral “commodities”; and those which provide finite renewable goods and services for which no price typically exists, such as clean air, groundwater and biodiversity. During the past decade commodity prices erased a century-long decline in real terms4, and risks are growing from over-exploitation of increasingly scarce, unpriced natural capital. Depletion of ecosystem goods and services, such as damages from climate change or land conversion, generates economic, social and environmental externalities. Growing business demand for natural capital, and falling supply due to environmental degradation and events such as drought, are contributing to natural resource constraints, including water scarcity. Government policies to address the challenge include environmental regulations and market-based instruments which may internalize natural capital costs and lower the profitability of polluting activities. In the absence of regulation, these costs usually remain externalized unless an event such as drought causes rapid internalization along supply-chains through commodity price volatility (although the costs arising from a drought will not necessarily be in proportion to the externality from any irrigation). Companies in many sectors are exposed to natural capital risks through their supply chains, especially where margins and pricing power are low. For example, Trucost’s analysis found that the profits of apparel retailers were impacted by up to 50% through cotton price volatility in recent years.5 Economy-wide, these risks are sufficiently large that the World Economic Forum cites ‘water supply crises’ and ‘failure of climate change adaptation’ along with several other environmental impacts among the most material risks facing the global economy.
This study monetizes the value of unpriced natural capital consumed by primary production (agriculture, forestry, fisheries, mining, oil and gas exploration, utilities) and some primary processing (cement, steel, pulp and paper, petrochemicals) in the global economy through standard operating practices, excluding catastrophic events. For each sector in each region (region-sector), it estimates the natural capital cost broken down by six environmental key performance indicators (EKPIs), and a ranking of the top 100 costs is developed from this. It also estimates the 20 region-sectors with the highest combined impacts across all EKPIs to provide a platform for companies to begin to assess exposure to unpriced natural capital, both directly and through supply chains. In doing so it allows investors to consider how their assets may be exposed. It also highlights sector-level variation in regional exposure to impacts to identify opportunities to enhance competitive advantage. It does not attempt to assess the rate at which these costs may be internalized, and whether sectors are able to adapt, but attempts to give a high-level view of where natural capital risk lies, and what this could mean for business profitability in a more sustainable regulatory environment.