If companies are not made accountable for the full cost of the carbon that they emit,
then they will carry on generating carbon at a level which is optimal for their own shareholders, but not optimal for society.
So reporting accounting on reporting on carbon emissions has the effect of raising awareness of this as an issue.
Professor Richard Barker is not only one of the most popular professors on the MBA program,
he's also a member of the International Accounting Standards Board and a leader of the Natural Capital Accounting Movement.
Following my conversation with Korsak in part one of this two part episode on The Future of the Planet,
I spoke to Richard to learn whether the solution to the carbon bubble might come from an unlikely source.
The financial accounts. We're going to kick off by starting off with this concept of the carbon bubble, which, as I've explained,
we had previous conversation with the cost class cause Paris has done a lot of work
on this area and he was explaining to us that there is this idea that it would be
impossible for all of the natural resources which are currently on oil and gas
companies books to be extracted and burned and still remain below two degree warming.
And it's something like only 20% of those that are currently on their accounts could, in fact be extracted.
And so there's this idea that perhaps they are sort of shockingly overvalued by by that account.
And I the reason we must talk to you is obviously you've really become such
an expert in natural capital accounting and obviously accounting in general.
And so to understand from your perspective, does this carbon bubble exist?
Is it real? And what do companies do to kind of response rates?
There's a lot of questions in that, but we can take a look. Okay. So I think it is real.
I think it's very disturbing and there's lots of elements to it.
And I think the past tends to be taken as a guide to the future.
So what's worked well in the past tends to be assumed to be a good guide to what will work in the future.
And oil and gas companies have been very, very successful in the past, extracting and selling for for burning fossil fuel.
And that's what they do. That's what they're good at, and that's what they're set up to do.
That's the culture of the firm. And they are currently making a lot of money out of doing it.
It is a hugely profitable industry with no obvious current substitute,
and so the incentive to carry on doing what we're doing and the absence of an
alternative is deeply troubling at a time when business as usual is not sustainable.
So from your perspective, what if you were in that position?
What would you be trying to do now?
Well, I think in principle, what they ought to be doing is recognising themselves to be an energy business, because we will always need energy.
But to understand the energy business will need to change dramatically.
So if we if we ultimately come to that, as you describe,
we can't carry on burning fossil fuel and we can't carry on looking for more to find because we've already found more than we can safely burn.
But that's what they're doing. I mean, that's silly. That's just sort of inherent in the in the nature of the business.
And I guess it's a very difficult thing to do to shift from something you do very
well and very profitably to something where you're not sure you have the technology,
you're not sure you're going to be the fund or dominate the market and so on and so forth.
And so it's it's a transition you'd rather not have to make if you couldn't avoid doing so.
And the longer you can avoid doing so, the more you will. And so that's kind of what we're seeing, I think a sort of protracted denial.
And if I'm if I'm an analyst and I'm sitting looking at that at an all company, at what point do I go, you know, how many years towards 2050 or 2030?
Do I wait before I say, actually, this is all shockingly overvalued and none of this is real?
Do you see what I mean? Yeah, I do. So.
So I think it's really important to understand the nature of the incentives of participants in financial markets.
So if you're an analyst or you're a fund manager,
what matters is that you have an understanding of the price as it is now and how it will change in the foreseeable future,
because that's the time horizon over which you will be judged based upon relative performance.
So if everyone in the market is making the same dumb decision, that's okay.
And if you're the sort of the brave person who says, you know what,
we should all be getting out of the oil and gas and nobody else does, you will lose out.
Right.
So it's it's not the case that investors have some sort of inherent personal vested interest in the long run payoff of the stock they're invested in.
Even though someone someone will end up paying the consequence, it doesn't necessarily mean it's the people who are currently holding stock.
So it's a little bit more subtle, I think,
than than trying to get the price right about trying to outperform in your pricing decisions in relation to other investors.
So is there anything that I'm. Well, I guess I'm sure there is because I've had a lecture on this before.
But but what could something like natural capital accounting do to try and change these dynamics?
Maybe should start with what is natural capital accounting for those who don't.
So I always ask people to explain it as if they were just maybe a ten year old.
Yeah, maybe like an MBA.
So if you think about the carbon problem, you can identify, as it were, the source of the problem being one of market failure that.
Carbon emissions historically have not been anybody's private economic problem.
Now, at some level, as long as from a corporate point of view, you can think of the problem as being one of pricing of carbon.
So if companies are not made accountable for the full cost of the carbon that they emit,
then they will carry on generating carbon at a level which is optimal for their own shareholders, but not optimal for society.
So reporting accounting on reporting on carbon emissions has the effect of raising awareness of this as an issue.
So the more you're able to say we the whatever company, the following amount of carbon, if you were to put a price on this,
this is the sort of consequence in society of that one level that's not relevant to that company and reporting to its own shareholders,
because not paying the price of that at another level is incredibly relevant for social policy.
It becomes a social issue if people become more aware of the extent to which this problem exists and of where
the problem resides and what public policy and some would need to happen to be able to resolve the problem,
then you are likely to see direct economic consequences for the company.
You see what I mean? So the fact that carbon is not adequately priced now doesn't mean that that will always be the case.
And the first step in getting towards a satisfactory kind of economic regime in this respect
is to disclose and to report and to quantify actually the price on the nature of the problem.
Does that make sense? Yeah. And how far away is this from being something which because I know you are involved
in some of the policy making around this sort of policy advocacy around this.
How far away is it from being something which when I'm running a business in five years time, I will be doing or thinking?
So the answer to that question varies quite a bit according to the type of natural resource that we're talking about.
So in terms of carbon, we've made a low.
We've not personally, but we've made a lot of progress in terms of a lot of coverage of greenhouse gas emissions in general,
of understanding, quantifying,
reporting, requiring reporting of that of carbon, or indeed that being voluntary mechanisms whereby companies report on a standardised basis.
So we actually have quite a lot of information concerning the nature of the problem for carbon.
We have far less and far less standardisation for other areas like impact on soil or water or deforestation.
So the sort of really impact on ecosystems, oceans and so on,
other really important areas where there is serious and unprecedented rates of degradation of natural resource,
we have fallen well developed standards. So carbon is a sort of leading the way.
Is there a distinction to be made between kind of the sort of voluntary reporting that I've seen on your reporters?
As we use we're carbon neutral now, but we want to be carbon zero.
Yes. Each have the sort of bringing into the financial accounts, which is slightly different.
And then I guess this distinction between management accounting and then.
Yes, what, what goes in the report so that there are various distinctions that are important here, the predominance of practices,
voluntary, voluntary reporting, even this is going to sound paradoxical, but even when it's mandatory.
Right. So if you if you have because if you have a mandatory requirement.
Yeah. To report on something inherently vague. Yeah.
Where there are no standards on and there are no conventions, then in effect you have a standard that requires something voluntary.
Right. So most reporting, whether mandatory or not, is in substance subjectivity currently.
And what we're gradually saying and carbon is the leading example of this or gradually
saying is greater reporting that looks like normal financial accounting works.
Right? If you look at the data on on carbon emissions of greenhouse gas emissions, that's in substance accounting data.
It's quantified, it's standardised, it's historical, it's comparable, it's consistent.
So you tend not to have that in other areas of corporate reporting.
So I think the direction of travel is towards,
I think where non-financial reporting looking more and more like financial report and looking like accounting.
There's another level which is which is if you are able to quantify greenhouse gas emissions,
that's not the same thing as integrating with your financial accounts,
where you also put a number on them, which expresses them in the same unit as the financial accountability for the whole thing together.
When one does that, when you put it all together.
Are there any examples that you can tell us about which they have done this and then have seen a reaction from.
A marketplace where you can pass. There's almost no examples where the end game is being reached.
Right. That's really quite striking. So there's a dramatic increase in what you would call sustainability reports,
integrated reporting or non-financial reporting, whatever you want to call it,
a really dramatic increase, but very little actually in the way of formally linking financial accounting, financial performance to this other domain.
And what do you think it would take to kind of tip that over the edge?
I think investor pressure actually is very important.
So to come back to your earlier question about carbon bubbles and so on.
The more you have corporate financial performance being disclosed and all kinds of
other metrics that look like you ought to be able to line up with the financials, but you can't yet.
And a kind of overhanging sense of we've got a problem here and the stock price correctly, we probably ought to do something about it.
Eventually you get a more sort of market driven pressure, I think, which we're starting to see.
So I think I'd say we're in the early days of that process.
You could argue, you know, if I was going to be so devil's advocate and we've had this discussion.
I mean, that's right. And what where is the what's the limits of the financial statements and what should they include?
What should they not and do? Yeah. Where do you then start and maybe do you see any other frontiers?
So, so again, there's quite a subtle distinction. So the financial statements that the, you know, the shareholders report, as it were,
is a report to shareholders on financial performance that affects shareholders.
Yes, it unambiguously a report to investors is not some sort of wider stakeholder report.
However, if you're an oil and gas company and collectively in your industry, you have more reserves that it's safe to burn at some point or another.
Your investors are going to be worried about that. Right.
And so actually reporting on the future of the industry in a way that isn't directly related to the financial accounts,
is relevant to shareholders with respect to their understanding of your future financial performance.
So now whether you call that financial reporting or not is slightly, by the way, and even, for example,
even if you don't have a tight carbon tax regime currently, you might have in the future.
And the more you are exposed to the risk of that,
the more relevant it becomes to report to your shareholders things that don't currently affect them but might.
Right. So it's quite there's quite a subtle I think the broader sustainability reporting
actually is much more relevant to shareholders than most shareholders currently realise.
So if I, you know, I finished my MBA and I am I'm not quite there yet, but you know, fingers crossed, touch wood.
I finish my MBA and or hypothetically I go into one of these businesses and they say, right, we've had about a single natural couple accounting.
Can you go and do it for me, please? Is that is that feasible right now?
Is there a kind of a resource bank of a place where you can go?
And I mean, yes, I mean, in many ways, yes.
There are standards out there. There are frameworks out there.
There is guidance on that. There's no shortage of material. What there isn't is a single source that has a regulatory authority.
So you can't go somewhere and say this is how it's done and this is what you'll be audited on.
So there's a ton of information, but it's emergent, right?
Right. And so that I think that's one of the things we're involved in,
is trying to bring that into the one standard which hopefully will be coming down the line soon, one hopes, because we don't have time.
So, you know, the development of financial reporting standards really sort of kicked off with the Wall Street
crash and because that's when investors started to realise they needed the sort of information.
And over a long period of time, financial reporting has evolved and it's really in a very mature state now.
We don't have that same length of time to develop, not when interest.
Yeah. And sort of we should all hope that they get developed quite quickly.
Absolutely. Thank you for listening to this episode of the Feature Business Podcast.
Next time I speak to an MBA student and an entrepreneur about the future of banks.
Can they survive the incoming onslaught of fintech innovations?
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