Strategic Responses to the EU Emission Trading Scheme

An Empirical Study in the Oil and Gas Industry


Master's Thesis, 2011

142 Pages, Grade: 1.1


Excerpt

Table of Contents

Abstract

Acknowledgements

Table of Contents

List of Tables and Figures

List of Acronyms and Abbreviations

1 General Introduction
1.1 Purpose of the Research
1.2 Research Interest
1.3 Research Question
1.4 Research Objectives
1.5 Dissertation Structure

2 Background on Climate Change Regulations and the EU ETS
2.1 Why Climate Change is addressed by Companies
2.2 Climate Change Regulations
2.2.1 The Kyoto Protocol
2.2.2 The European Emission Trading Scheme
2.3 Chapter Conclusion

3 Literature Review
3.1 Conceptual Studies
3.1.1 Dunn (2000)
3.1.2 Hoffman (2002)
3.1.3 Schaltegger, Burrit and Petersen (2003)
3.1.4 Boiral (2006)
3.2 Empirical Studies
3.2.1 Levy and Kolk (2002)
3.2.2 Skjaerseth and Skodvin (2003)
3.2.3 Pacala and Socolow (2004)
3.2.4 Pinske and Kolk (2007)
3.2.5 Hoffmann (2007)
3.2.6 Jeswani, Wehrmeyer and Mulugetta (2008)
3.2.7 Kim (2008)
3.2.8 Lacombe (2008)
3.2.9 Pinske and Kolk (2009)
3.2.10 Rogge, Schneider and Hoffmann (2010)
3.2.11 Okereke and Russel (2010)
3.3 Analysis of the Literature Review
3.3.1 Strategic Responses to Climate Change, GHG and EU ETS
3.3.1.1 Influencing Factors
3.3.1.2 Strategic Responses
3.3.2 Literature Gap
3.4 Chapter Conclusion

4 Empirical Approach
4.1 Research Setting
4.1.1 Industry Selection
4.1.2 The Oil and Gas Sector
4.2 Research Approach
4.3 Research Design
4.3.1 Data Sampling
4.3.2 Data Collection
4.3.3 Data Analysis
4.4 Quality of Research: Validity, Reliability and Limitations
4.5 Chapter Conclusion

5 Results
5.1 Carbon Emissions of Case Companies
5.2 Influencing Factors
5.3 Strategic Responses
5.3.1 Corporate Responses
5.3.2 Managerial Responses
5.3.3 Operational Responses
5.3.3.1 Compensation
5.3.3.1 Innovation
5.4 Additional Case Study Findings
5.5 Future Implications and Challenges
5.6 Chapter Conclusion

6 General Conclusion
6.1 Dissertation Purpose and Research Question
6.2 Key Findings
6.3 Theory Contributions
6.4 Managerial Contributions
6.5 Limitations
6.6 Further Areas of Research
6.7 Critical Appraisal

Glossary

Bibliography

Appendices

Abstract

Emitting half of the greenhouse gases in industrialised countries, the oil and gas sector plays a central role in global GHG emissions. Environmental regulations such as the EU ETS emerged to fight climate change by reducing GHG emissions. Although those regulations increasingly affect oil and gas companies, specific implications of the EU ETS on business strategies are widely unknown. Therefore, this dissertation explores strategic responses to the EU ETS and analyses the impact of the regulation on the oil and gas sector.

A strategic response framework, derived from the literature review, provides the basis for the analysis and is consequently adapted to the research findings. Empirical case studies of BP and Shell, combine secondary data and expert interviews to identify and further outline specific responses to the EU ETS.

The research findings indicate that the EU ETS significantly impacts business strategies of oil and gas firms. The resulting strategic responses are mainly influenced by regulatory pressure, economic factors and competitive implications. Responses in various corporate, managerial and operational areas could be identified. From a corporate perspective, oil and gas companies support the EU ETS, as a trading scheme for carbon is preferred to other options, such as carbon taxes. Managerial responses comprise the introduction of environmental risk management systems, incorporating a carbon price into investment decisions, and the establishment of carbon trading teams, mitigating the costs of the EU ETS. Operationally, oil and gas firms responded directly by engaging in carbon trading and investing in Carbon Capture and Storage technologies. While, process improvements and lower emission generating products such as natural gases and biofuels are responses triggered by the EU ETS, investments in renewables are not affected. Additional findings of the research are the high probability that carbon and investment leakage will take place as well as the significant impact, the EU ETS might has on M&A and outsourcing decisions, depending on the carbon price.

Acknowledgements

Dublin, 20th of August 2011 Simon Hecker and Marc Noy

List of Tables and Figures

Table 1: Categorisation of Strategic Responses

Table 2: Literature Review Overview

Table 3: Climate Change Activities of Case Companies

Table 4: Overview of Managerial Responses of Case Companies

Figure 1: Strategic response model derived from the literature review

Figure 2: Carbon emissions of case companies (2001-2010)

Figure 3: Carbon emissions of case companies by business segment (2010)

Figure 4: Strategic response framework for the oil and gas sector85

List of Acronyms and Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 General Introduction

The general introduction clarifies the purpose of the research (1.1), outlines the research interest (1.2), and provides the research questions (1.3). This chapter further presents the research objectives (1.4) as well as the dissertation structure and methodology (1.5).

1.1 Purpose of the Research

The purpose of this dissertation is to empirically explore different strategic responses that emerge within organisations in order to comply with carbon emission regulations such as the European Union Emission Trading Scheme (EU ETS). It further provides conceptual insights about strategic responses under environmental and regulatory uncertainty. Hence the study endeavours to contribute to the understanding of the strategic behaviour of organisations to climate change regulations by using an exploratory approach.

1.2 Research Interest

“As a member of the general public, you can hardly open the newspaper, watch the news, or go to the movie theatre without running into some mention of what has become the most notable environmental issue of the decade: CLIMATE CHANGE” (Hoffmann & Woody, 2008, p. 1) .

The external costs caused by the world’s biggest organisations would “wipe out more than one-third of their profits if they were held financially accountable” (Jowit, 2010, p. 1). Costs of use, loss and damage to the environment caused by the 3000 largest publicly listed companies have been estimated to US$ 2.15 trillion with no end in sight. Those costs will grow even further, reaching US$ 28.6 trillion in 2050. Major driver of this cost increase are carbon emissions (PRI Association & UNEP Finance Initiative, 2010).

The growing awareness of society that companies are not paying for most of the use, loss and damage of the environment put governments and other interest groups into action. Increased efforts to hold companies responsible for their external costs, to both, reduce public financial obligations and environmental damage at the same time. Climate change policies and in particular new carbon emission regulations based on the Kyoto Protocol are either already introduced or at least planned in Europe, the US and China. The European Union, pioneering with this practice, implemented a greenhouse gas (GHG) trading system, the EU ETS in 2005 in order to curb its Carbon Dioxide (CO2) emissions. This trading scheme is separated into three phases and considered as “the most notable policy development” (Pinske & Kolk, International Business and Global Climate Change, 2009, p. 3) in fighting climate change. Phase III of the EU ETS, an advancing step towards full auctioning of carbon allowances, will be implemented in 2013 (2013-2020) and is considered to have significant financial impact on organisations in certain industries. The basic idea of the ETS scheme is that firms operating in emission intensive industries have to buy allowances equivalent to CO2 emissions caused by their installations. Firms with excess emission allowances can offer their surplus on the market. In the same way, firms can purchase allowances if their abatement costs are above the EU allowance market price (Hoffmann V. H., 2007).

Of the targeted industry sectors, energy intensive industries will be most affected by the scheme, namely, the electricity industry, oil and gas producers, steel and aluminium manufacturers (Hoffmann & Woody, 2008). Climate change was long considered as a corporate social responsibility and companies developed strategies basically to improve the corporate image. Initial corporate responses were the instalment of “easy-to-implement activities that involve some basic technological and behavioural changes [such as] measures to improve energy efficiency and reduce energy consumption” (Pinske & Kolk, International Business and Global Climate Change, 2009, p. 91). Mostly, those responses were less strategic and more functional as they concerned “the integration of climate change in corporate day-today practices” (Pinske & Kolk, International Business and Global Climate Change, 2009, p. 91).

However, “although for many companies becoming responsive to climate change does not go much further than [easy to implement] operational improvements” (Pinske & Kolk, 2009, p. 91), various authors (e.g. Porter & Reinhardt, 2007; Enkvist & Oppenheim, 2008; Hoffman & Woody, 2008; Jowit, 2010) argue that carbon emission regulations will increasingly influence business strategies. According to Enkvist and Oppenheim, carbon regulations “have [a] fundamental impact on key issues of business strategy such as production economics, costs competitiveness, investment decisions, and the value of different types of assets” (Enkvist & Naucler, A cost curve for greenhouse gas reduction, 2007, p. 45). As further argued by Pinske and Kolk, “climate change can have a considerable influence on the value proposition of a company, inducing it to fundamentally reconfigure business activities to simultaneously reduce climate impact and enhance the competitive position” (Pinske & Kolk, 2009, p. 3).

Various strategic responses to reduce carbon emissions and to comply with the regulatory framework can be identified (Pinske & Kolk, 2009, p. 91). A preliminary literature screening showed, that the exact composition of such strategic responses is widely unknown and only addressed by a limited number of studies today. Given the relevance of the topic, this is surprising as further development in the area of strategic responses can be expected in the next years. As stated by Pinske and Kolk, “[…] on-going government, stakeholder and shareholder pressure will encourage companies to explore the full range of options, and adapt their climate change strategy in response to changes in external and company specific factors” (Pinske & Kolk, 2009, p. 91). Especially, the oil industry with the combustion of oil-based fuels for transportation, electricity generation and heating accounts for more than half of greenhouse gas emissions in industrialized countries and faces significant challenges (Kolk & Levy, 2001).

The preliminary literature screening further revealed that from the industries affected by the EU ETS, the power sector was partly analysed recently. However, empirical research on the oil and gas industry is widely missing. Consequently, a study on strategic responses to the EU ETS in the oil and gas sector seems to be not only up to date, but also of high academic relevance.

1.3 Research Question

As outlined above, GHG regulations and the EU ETS in particular are believed to have significant impact on key strategic areas of oil and gas companies whereas specific responses are unknown. Therefore, this dissertation explores new areas of research when analysing the strategic responses to the EU ETS in the oil and gas industry in-depth. Subsequently, the resulting research question is:

“How do multinational oil and gas companies strategically respond to the EU ETS?”

In this dissertation, initial empirical evidence for this question is provided by identifying, categorising and analysing strategic responses to the EU ETS. Specifically, respective current strategic reactions are identified, which can be attributed to EU ETS, cluster them into distinct categories, and analyse their impact on the organisation.

1.4 Research Objectives

Related to the research question, the analysis aims to establish a greater understanding of the impact the EU ETS has on strategies of oil and gas companies and the resulting responses to those impacts. Specifically, the exploratory research objectives are as follow:

Research Objective 1: To develop a comprehensive framework for the oil and gas sector which incorporates relevant strategic responses available for oil and gas companies to limit possible negative effects of the EU ETS.

Research Objective 2: To identify the current and future implications of the EU ETS on the strategy of firms’ within the oil and gas sector by particularly focusing on Phase III.

1.5 Dissertation Structure

In chapter one, the general introduction is presented, clarifying the general purpose of this dissertation in the broader context of climate change. Afterwards, background information on climate change regulations such as the Kyoto Protocol and EU ETS are given in order to outline the importance of those regulations for organisations. Chapter three presents the literature review. It focuses on conceptual and empirical studies, discussing and analysing the topic of strategic responses to climate change policies and GHG emission regulations. Subsequently, in chapter four, the research methodology will be outlined. As a result of the literature review a case study approach was adopted incorporating secondary as well as primary data sources. The research results are presented and analysed in chapter five. This chapter provides detailed insights into industry and company specific strategic responses to the EU ETS. Additionally, future implications are outlined. Finally, chapter six gives detailed conclusions on the researched topic.

2 Background on Climate Change Regulations and the EU ETS

This chapter provides a basic introduction to climate change policies and corporate environmental management. It discusses the emergence of climate change issues as economic factor and the development of the regulatory environment. Firstly, general motivations for companies to reduce GHG emissions are described (2.1). Secondly, this chapter will further outline the specific characteristics of climate change regulations such as the Kyoto Protocol and EU ETS (2.2).

2.1 Why Climate Change is addressed by Companies

Economists see environmental issues as a problem of externalities. An externality is a cost (negative externality) or benefit (positive externality) that is experienced by someone other than the party who produced it (Turner, Pearce, & Bateman, 1999, S. 79). Thus, global climate change is a negative externality today. In the words of Sir Nicholas Stern, global warming is “the greatest market failure the world has ever seen” (Stern, 2007, p. 177). Starting to realize the deteriorating effects companies can have on the environment, governments began with the development of environmental regulations aimed to reduce these “externalities” by the mid of the 20th century.

By the late 1980s, some organisations started to consider environmental impact reduction not only as a threat to business but also as a potential source of competitive advantage. So called “corporate environmental management practices” emerged which aim to “harmonize environmental and bottom line goals by integrating impact-reducing product and process design into company’s core strategic vision” (Goldstein, 2002, p. 496). As a result of integrating environmental considerations into a corporate strategy, firms were able to save costs and increase profits due to reduced waste and energy use. Additionally, tighter environmental regulations that need to be integrated in environmental management can encourage innovation.

2.2 Climate Change Regulations

As the major international effort to reduce the effects of climate change, the Kyoto Protocol was signed and national carbon regulations are based on its specifications. Therefore, the Kyoto Protocol is described (2.2.1), before outlining the EU ETS as part of the broader Kyoto concept (2.2.2).

2.2.1 The Kyoto Protocol

“Since climate change is a global environmental problem, it has been necessary to adequately address climate change at a global level” (Kim, 2008, p. 3).

In 2005, the Kyoto Protocol, an international regulatory agreement to limit GHG emissions, which was adopted in 1997, came into force. Ratified by 163 countries, the Kyoto Protocol sets binding emission targets for participating developed countries to reduce their emissions of GHG by 5.2 % in 2012 based on the level of GHG emitted in 1990 (UNFCCC, 2007).

As a cornerstone in global climate change policy, the Kyoto Protocol determines the goals for emission reductions and imposes legal as well as financial penalties for failure of compliance. Moreover, it provides market mechanisms to support countries and organisations, to achieve their emission reduction targets in an economically efficient way. The protocol is split into three flexible emission reduction mechanisms known as ‘Kyoto mechanisms’ namely, Joint Implementation (JI), Emission Trading (ET) and Clean Development Mechanisms (CDM)[1]. It further provides developed countries considerable flexibility to engage and support the developing countries to meet their obligations for emission reduction (UNFCCC, 2007). In order to meet the Kyoto commitments, the European Union Emission Trading Scheme was established in 2005. This GHG trading scheme, therefore, is the regional application of the Kyoto Protocol obligations and sets emission limits to specific industries within the EU.

2.2.2 The European Emission Trading Scheme

Commonly recognised as the most important piece of legislation targeting CO2 emissions, the EU Emission Trading Scheme was established in 2005 in order to meet the obligations of the EU member states under the Kyoto Protocol (Grubb, Betz, & Neuhoff, 2007). It is largely based on a cap-and-trade[2] system pioneered in the United States for managing sulphur dioxide (SO2) emissions (James & Fusaro, 2006).

The EU ETS was established by Directive 2003/87/EC of the EU parliament and became effective in 2005 (Federal Environment Ministry, 2003). In 2010, it was the largest regulatory mechanism for greenhouse gas emissions in existence, covering over 2 billion tonnes of CO2 (Federal Environment Ministry, 2003). As the EU emission trading scheme is a highly complex system, a basic idea of how it operates is needed before it is sensible to proceed with the analysis.

National emission caps are established through a National Allocation Plan (NAP), which is a request by a member state for a total quantity of permits. The EU Commission decides if the NAP fulfils criteria set out by the Emission Trading Directive, most importantly whether the request is aligned with the member state’s Kyoto target. Once this is established, individual states are free to allocate permits to industrial operators covered by the scheme (Federal Environment Ministry, 2003). Several types of allocation methods can be applied. One particular option for allocating permits is the so-called “grandfathering”, where permits are distributed for free according to historical emissions. Another option is a permit auction where firms can bid for a pre-determined quantity of permits (Escalante, 2010). There is a general consensus that auctioning is preferable to grandfathering, since it reduces economic rents (Hepburn, Grubb, Neuhoff, Matthes, & Tse, 2006). The resulting trading after initial allocation allows firms to benefit from differences in abatement costs. Companies, which are able to reduce emissions, can sell excess permits to companies whose abatement costs are higher than their options to reduce emissions (Turner, Pearce, & Bateman, 1999, S. 182). Polluters are required to hold the amount of permits equivalent to their emissions. Companies that have surplus emission permits can sell them privately or in established trading markets. Those that are short of permits consequently need to buy them. If they fail to do so, they have to pay a fine (Escalante, 2010).

The standard carbon credit is called a European Union Allowance (EUA). However, EUAs can be substituted with Certified Emission Reductions (CERs) offered by the United Nations and with validated abatement projects in developing countries (European Parliament, 2004). The price of the carbon permits aims to encourage firms to reduce carbon emissions by acting in their own self-interest to minimize costs. However, the EU ETS does not guarantee that reductions will actually take place at individual companies. Only if the benefits of cutting carbon emissions such as investments in clean-energy will be higher than the added costs of carbon permits, companies will chose to reduce CO2 (Escalante, 2010).

Since the EU ETS is an artificial market with “no natural demand for carbon credits, the playing field depends entirely on the legal and regulatory framework” (Obermayer, 2009, p. 10). Therefore, “the UNFCCC and EU have to provide stability and build faith in the system” (Obermayer, 2009, p. 10) in order to ensure that private investments tackle climate change. The EU ETS was split into three phases designed to gradually establish and pre-test the regulation: Phase I (2005-2007), Phase II (2008-2012) and Phase III (2013-2020):

Phase I (2005-2007)

- Trial period to set up a basis of price, market mechanics and emissions data.
- CO2 emissions of more than 10,000 facilities were capped at 2.1 billion tonnes per year
- Majority of industry players receives free allocation

Phase I of the EU ETS ran from 1 January 2005 to 31 December 2007 and established the largest carbon trading system worldwide, but was considered as a trial phase. The trial phase was confronted with a lot of criticism. The period was characterized by a significant over-allocation of permits, which basically did not generate any incentive for firms to reduce CO2 emissions.

Another measure, which created unintended effects, was the decision to grant emission allowances for Phase II based on the carbon dioxide emitted in Phase I. This created incentives for some CO2 emitting plants to remain in operation to increase free allocations for Phase II, even when a closure of those plants was cheaper and more socially efficient (Grubb, Betz, & Neuhoff, 2007). Furthermore, the fact that permits could not be taken into Phase II resulted in a decline of the carbon price from approximately €35 a tonne, to nearly zero at the end of Phase I (Escalante, 2010). Consequently, the carbon price as signal for investment decisions did not act as intended. As Phase I was supposed to be a testing period intended to build the infrastructure for the carbon market, the results can be regarded as successful since valuable information for future phases were provided (Buchner & Ellerman, 2007).

Phase II (2008-2012)

- “Linking Directive“ introduced the “Clean Development Mechanism” and the “Joint Implementation-projects” to offset emissions

- Non-EU members, Norway, Iceland, and Liechtenstein joined the EU ETS

The second Phase, running from 2008 to 2012, incorporates substantial improvements but also faces controversial debates about its success. Companies are now able to balance missing CO2 permits with emission reductions in countries outside the EU, by so called “Clean Development Mechanisms” or “Joint Implementation-projects”. These options are intended to keep the costs for emission reductions at a lower level as well as to incentivise investments into developing countries for a sustainable economic development. The amounts of emissions that can be transferred in those ways are determined on a national basis; in Germany companies are allowed to transfer up to 22 % of the permits per installation (Buchner & Ellerman, 2007).

However, major criticism of Phase II was about so called “windfall profits” in the energy sector became public. Initially, national governments allocated free permits to power companies, which in turn, added the market price of those permits to their costs and passed them on to consumers by raising electricity prices (Sijm, Neuhoff, & Chen, 2006). Profits from this practice are estimated to be between €23 and €71 billion for European power companies (Point Carbon, 2008).

The carbon price of Phase II ranged between €13 and €20 (see appendix 2: The development of the CO2 spot price over time). Reduced output in energy-intensive sectors as a result of the recession as well as the market perception of future fossil fuel prices were identified as major price drivers and therefore responsible for the volatile carbon price development (The Committee on Climate Change, 2011). However, other factors such as institutional decisions, energy prices and weather events, macroeconomic and financial market shocks also influenced the carbon price development (Chevallier., 2011).

Phase III (2013-2020)

- Establishment of an centralized EU cap – national allowances will be allocated to individual EU members
- Limited use of offsets - reduced access to project credits from outside the EU
- Unlimited banking of permits between Phases II and III
- Auctioning as the preferred means of allocation

Phase III is planned to run from 2013 to 2020 and aimed to result in greater emission reductions, greater regulatory certainty and more predictable market conditions (Department of Energy & Climate Change). The third Phase of the trading scheme is expected to “deliver two-thirds of the EU’s unilateral 20 % emissions reduction target by 2020 on 1990 levels. This equates to a 21 % reduction by 2020 compared to the 2005 verified emissions baseline under the EU ETS” (Department of Energy & Climate Change).

Central elements of Phase III will be an “EU-wide cap on emissions, which will annually decrease by 1.74 % of the average level of the Phase II cap. [Further an] increase in auctioning levels is planned at least 50 % of allowances will be auctioned from 2013, compared to around 3 % in Phase II” (Department of Energy & Climate Change). These measures are intended to increase the environmental effectiveness and economic efficiency of the EU ETS. Another change compared to Phase II is the limitation of “project credits under the Kyoto Protocol from outside the EU to no more than 50 % of the reductions required in the EU ETS“ (Department of Energy & Climate Change). This reduction from 226 % in Phase II to 50 % in Phase III, aims to focus emission reductions to take place within the EU.

Further important changes incorporated in Phase III are shown in the following overview (Department of Energy & Climate Change):

- Industrial sectors will be allocated allowances for free on the basis of product benchmarks. The benchmarks will be set on the basis of the average of the top 10 % most greenhouse gas efficient installations in the EU.
- Sectors deemed at significant risk of relocating production outside of the EU due to the carbon price. They will receive 100 % of the benchmarked allocation for free.
- Sectors not deemed at significant risk of carbon leakage will receive 80 % of their benchmarked allocation for free in 2013, declining to 30 % in 2020 and 0 in 2027.

Experts agree that the EU Emission Trading System plays a key role in the global efforts to reduce greenhouse gas emissions. It is regarded as motor to establish a global CO2 market. “The enormous efforts to plan the policy, provide a market framework for trading, establish links with project-based credits from the UN and drive a process of improvements around its three trading phases” (Chevallier, 2011, p. 4) eventually seem to pay off. However, as a significant GHG reduction depends on the EU ETS ability to create an effective price-signal as well as the political willingness to enforce also unpopular measures, the success of the ETS in not guaranteed.

2.3 Chapter Conclusion

It can be concluded that, today, climate change is an important aspect of business strategies in various industries and seems widely integrated into the environmental management of companies. Existing as well as upcoming GHG regulations, such as the EU ETS Phase III, even increase its significance, especially for energy intensive organisations. However, as the EU TS has only been implemented recently, the actual effects are unknown and also its successfulness depends heavily on the political willingness to enforce also unpopular measures.

3 Literature Review

This literature review represents a synthesis of available research on strategic responses to environmental regulations. It consists of 15 academic studies from various authors in order to establish the context of strategic responses to climate change regulations. A focus is put on greenhouse gas and carbon management (a summary of all articles can be found in appendix 3: Summary of literature review articles). Strategic responses to the EU ETS in general and in the oil and gas market in particular are analysed. The chapter is separated into four parts: Firstly, conceptual papers, studies and books are presented (3.1). Secondly, empirical studies (surveys and case studies) on strategic responses to climate change issues are highlighted (3.2). Thirdly, the literature review findings are analysed (3.3). Finally, the chapter conclusion is given (3.4).

3.1 Conceptual Studies

In the following, relevant conceptual studies are presented. Conceptual studies are used to build the fundamental concept and to identify important variables relevant for further research. Therefore, papers of Dunn (3.1.1), Hoffman (3.1.2) and Boiral (3.1.4) as well as the book chapter of Schaltegger, Burrit and Petersen (3.1.3) are chosen.

3.1.1 Dunn (2000)

Dunn analysed emerging business strategies to address climate change. The author identifies three key drivers, affecting the strategic responses of organisations to climate change issues, which help to explain variations in corporate climate strategies: Technology, Economics and Policy. Dunn argues that especially government policies can have significant impacts on the strategic responses. The introduction of new climate change regulations by local and global governments, at first, led to resistant actions of companies across energy intensive industries during the 90s in order to prevent the introduction of new environmental policies. However, against these resistance responses various companies such as British Petroleum (BP), Boeing, Hewlett Packard, IBM, Intel, Shell and Whirlpool joined the Business Environmental Leadership Council in 2000, an organisation supporting the Kyoto protocol to address climate change and lower carbon emissions actively. Dunn concludes that resisting and supporting responses follow the same objective, to influence government policies to the company’s favour, firstly individually and then through resisting or supporting trade associations. Further, “business responses to climate change include a range of internal and external control measures” (Dunn, 2000, p. 6). As control measures, Dunn identifies the installation of GHG inventory and managements systems, the introduction of GHG reduction targets and internal emission trading systems as well as increased R&D activities and investments into areas such as energy efficiency, renewables and fuel switching. According to the author, in recent years a special focus was put on internal emission trading systems. As an example, BP and Shell put internal cap and trade systems for all their business units into place. As emission trading motivations Dunn identifies: Demonstrating environmental leadership, learning-by-doing, hedging and managing risk as well as revenue increase.

3.1.2 Hoffman (2002)

In the paper “Examining the Rhetoric: The Strategic Implications of Climate Change Policy”, Hoffman outlines factors influencing strategic responses to climate change regulations and identifies four key influencing variables.

The first variable is capital asset management. Given the huge investments into plants, equipment and technology, new environmental regulations will add some extra costs to those investments. As a response, affected companies try to influence policies and regulations. Dependent on the volume of those investments, firms “pushed for flexible time tables for climate controls to be mandated, allowing users and developers of technology extended time horizon to plan for, develop and perfect substitutes” (Hoffman, 2002, p. 331).

Secondly, market competencies play an influencing role. “All companies differ on their core competencies and their resulting opportunities for using climate change controls to their own advantage” (Hoffman, 2002, p. 331). Therefore, a company’s’ own market competencies can impact the strategic responses of organisations. Especially, cost and risk management, capital acquisition, market demand, strategic direction, and human resource management are affected.

As a third variable, Hoffman identifies global competitiveness. Generally, the Kyoto Protocol “does not push for the early entry in developing countries” (Hoffman, 2002, p. 333), which put the Western World at an economic disadvantage. As a response, western companies lobbied for “joint implementation provisions in the Kyoto treaty, which promote technology transfer to the developing world while assuring domestic companies an economic return on such transfers” (Hoffman, 2002, p. 333).

Fourthly, the ability to manage institutional change impacts strategic responses of organisations. For example, “companies that are more adept at managing key constituents such as the government, the press and the public will find greater opportunities in managing the strategic elements of climate change” (Hoffman, 2002, p. 333).

Hoffman separates between resistant and proactive strategic responses. In early 2000 the author observed that most companies reacted resistant to global climate change initiatives by joining organisations such as the Global Climate Coalition, the Western Fuels Association and the American Petroleum Institute, which were associations, trying to block climate change controls. However, BP/Amoco as one of the first companies changed their strategy and emphasised the need for climate change controls. Moreover, they invested $160 million in the solar market and therewith put pressure on competitors. Shell shortly followed the example of BP, investing $500 million into solar energy and other renewables projects.

3.1.3 Schaltegger, Burrit and Petersen (2003)

Schaltegger, Burritt and Petersen outline general strategic options to react to climate change related threats and opportunities. They differentiate between four strategies depending on the level of the potential threat and opportunity of the climate change issue or policy: Defensive, Indifferent, Innovative and Offensive.

In general, the first reaction of organisations is to react in a defensive way, called defensive strategy. This strategy incorporates resistance and retreating actions such as lobbying, which was widely applied by the automobile and oil industry prior to the introduction of carbon emission regulations in the late 90’s. Retreat can be considered as a final option and means to “close down operations and move to another region where resistance is thought to be weaker” (Schaltegger, Burritt, & Petersen, 2003, p. 183).

Secondly, indifferent strategies can be applied. This strategy is characterized by ignored impacts. The business is re-evaluated or costs are reduced.

As a third strategy, companies can implement an innovative strategy. According to Schaltegger, Burritt and Petersen, this comprises the anticipation of new policies and the introduction of a differentiation strategy, since companies accept the change.

An offensive strategy can be considered as the fourth response to new climate regulations. Companies can use either a market penetration or a market enlargement strategy. However, this response often demands environmental friendly attributes of the firms’ products and services.

3.1.4 Boiral (2006)

In the paper “Global Warming: Should Companies Adopt a Proactive Strategy?” Boiral analyses two fundamental aspects of climate change: corporate environmental management and strategic responses.

Firstly, the author analyses the impacts of the Kyoto Protocol on organisations in general. Summarising, the author concludes that the resistance to controls defined in the Kyoto Protocol is decreasing.

Secondly, Boiral investigates the underlying reasons for companies to apply different environmental management strategies and their respective values. Generally, organisations can choose between a proactive strategy and a wait-and-see approach. “The adoption of a proactive strategy helps companies anticipate the implementation of standards or quotas and avoid having these measures become insurmountable barriers to markets in the near future” (Boiral, 2006, p. 328). In more detail, the author separates the proactive responses into three categories: Managerial actions, technical actions and socio-political actions. Managerial actions “are based on the environmental involvement of managers and the integration of environmental preoccupations into organisational practices” (Boiral, 2006, p. 326). This includes the integration of ISO 14001 standards to promote GHG reduction within firms, clear setting of environmental related objectives and programs, as well as the establishment of employee commitment through training to foster GHG reduction actions. Technical actions comprise renewable energy investments or the acquisition of GHG trading permits as well as the investment in clean development mechanism projects. Socio-political responses “are intended to enhance the image of an organisation, its legitimacy and political gains” (Boiral, 2006, p. 326). Specific actions are lobbying or the greening[3] of products in order to improve the company’s image and advance the corporate social responsibility (CSR) perception.

3.2 Empirical Studies

This sub-chapter outlines the most relevant empirical studies related to the topic of strategic responses and climate change issues. It entails surveys as well as case studies implemented by the following authors: Levy and Kolk (3.2.1), Skjaerseth and Skodvin (3.2.2), Pacala and Scolow (3.2.3), Pinske and Kolk (3.2.4 and 3.2.9), Hoffmann (3.2.5), Jeswani, Wehrmeyer and Mulugetta (3.2.6), Kim (3.2.7), Lacombe (3.2.8), Rogge, Schneider and Hoffmann (3.2.10) as well as Okereke and Russel (3.2.11). The empirical studies are structured according to their date of publication.

3.2.1 Levy and Kolk (2002)

Levy and Kolk focus on strategic responses of oil companies to climate change regulations. The authors adopt the two-dimensional typology model of Gladwin and Walters (see appendix 5), to empirically classify the strategic responses. The model organises strategic responses into four categories: Resistant, Proactive, Avoidant and Compliant. As axes, the level of cooperation and assertiveness are chosen. Levy and Kolk define cooperative as “support for mandatory emission controls and investments in renewable energy technologies” (Levy & Kolk, 2002, p. 288). Assertiveness allows companies to support or oppose regulatory policies. As a result of the research, the authors identify divergent responses of oil and gas companies to climate change regulations. According to the findings, this divergence can be attributed to the following reasons: The home country effect, individual company differences and convergence pressure.

The home country effect: The authors state that “MNCs’ home countries could create divergent pressures on their strategies” (Levy & Kolk, 2002, p. 289) due to local economic and physical resources, national economic and industrial policies, as well as cultural values and institutional norms.

Individual company differences: As economic factors not necessarily account for the differences in strategic responses, the authors conclude that “different competencies and market positioning of companies” (Levy & Kolk, 2002, p. 291) lead to different responses.

Convergent pressure: Levy and Kolk argue, “European companies, while investing in renewables, have maintained the vast majority of their assets in traditional businesses” (Levy & Kolk, 2002, p. 293). Therefore, the authors believe, that “the trend toward convergence is not driven by any fundamental change in the external environment” (Levy & Kolk, 2002, p. 291). However, “considerable uncertainty still remains concerning the magnitude and timing of climatic impacts if not their direction and cause” (Levy & Kolk, 2002, p. 291).

Levy and Kolk further found out, that that firms “with prior experiences in renewable technologies were most reticent in investing in renewables in response to climate change. As a result, they concluded, “institutional frames provide strategic guidelines derived from historical and home country experiences […]” (Levy & Kolk, 2002, p. 296).

3.2.2 Skjaerseth and Skodvin (2003)

Skjaerseth and Skodvin analyse the sources of climate change strategies of different companies in the oil and gas sector. In their study, the differences among the climate strategies of the three multinational oil companies, namely Shell, ExxonMobil and Statoil are analysed. Furthermore, the study outlines reasons for choosing different strategies. The sources of different strategy choices are based on two models, the ‘Corporate Actor model’ and the ‘Domestic Politics Model’.

The ‘Corporate Actor Model’ focuses on three key factors that can shape the climate strategies of organisations: environmental risk, environmental reputation and organisational learning. Environmental risk follows the logic that the more carbon intensive the fossil fuel portfolio of an organisation, the higher the risk of being affected by regulatory policy changes. Environmental reputation influences the degree of companies’ proactive responses, as they need to retain or obtain a certain image. The company’s capacity for organisational learning also influences the degree of an organisational proactive response.

The ‘Domestic Politics Model’, on the other hand, assumes that companies are defined by state-society relationships. It entails the societal demands for environmental protection, the government supply of environmental policy as well as the political institutions linking demand for and supply of environmental policy.

Related to the case companies, they argue that Shell took a proactive strategy towards climate change. Exxon on the other hand, incorporated a reactive strategy as it counteracted regulations and did not invest into renewable opportunities. Statoil applied an intermediate strategy as it used elements of proactive and reactive strategies.

3.2.3 Pacala and Socolow (2004)

Within their paper, Pacala and Socolow introduce an approach called ‘Stabilization Wedges’. The authors state that a significant reduction of carbon emissions could be achieved by scaling up technologies based on existing know-how. Instead of a single carbon-free technology that solves the climate change issue on its own, a portfolio of less ambitious options will jointly achieve a carbon emission reduction. Overall, they identify several technology wedges that are currently able to significantly reduce carbon emissions and can be applied by organisations to the strict carbon emission reduction policies. Those wedges can be achieved by increasing energy efficiency, fuel switching, Carbon Capture and Storage, nuclear energy and renewable energy investments. In addition, they identified 15 different sub-options all leading to reduced carbon emissions. The options comprise improved fuel economy, reduced reliance on cars, more efficient building, improved power plant efficiency, storage of carbon captured in power, hydrogen and synfuels plants, nuclear fission, wind and photovoltaic electricity, renewable hydrogen, bio-fuels, forest management and finally agricultural soils management.

3.2.4 Pinske and Kolk (2007)

In their 2007 paper, Pinske and Kolk analyse how multinationals respond to new policy changes in the area of emission trading.

The authors identified ‘Compliance’ to the EU ETS as the most cited response in their study. This is especially valid for firms with eligible installations that are highly exposed to carbon emissions. Those companies are enforced to consider their GHG discharge in order to avoid non-compliance penalties. In this context, Pinske and Kolk also concluded that “[emission] trading is merely for compliance and not for speculation” (Pinske & Kolk, 2007, p. 446). Based on the findings, the authors developed a framework combining two dimensions: Expected institutional constraint and opportunity recognition. As a result, four different scenarios for strategic responses emerged (see appendix 6).

The first response of multinationals to new policy changes is to ‘Conform’ to institutional pressure and to accept the institution as it is. “In this scenario a firm expects to be constrained by the institution, but does not see many opportunities in changing the institution and merely abides by existing rules and norms” (Pinske & Kolk, 2007, p. 449). This has been the case for large energy consumers in oil and gas, chemicals, metals, and pharmaceuticals in response Phase I of the EU ETS.

As a second strategic response, companies can chose a business area or field of operation, which is not affected by the new environmental policy regulations and therefore, allow continuing business as usual. This response is called ‘Institutional Evader’. It is rather passive and companies or parts are simply not affected by trading schemes.

By the third response, called ‘Institutional Entrepreneur’, companies try to “seize the opportunity to change the institution in a way that alleviates the pressure that it feels and improves the institution’s efficiency, at least with regard to its own interest” (Pinske & Kolk, 2007, p. 449).

The fourth response alternative is called ‘Institutional Arbitrageur’. Companies gain “from the unintended consequences that go with building a new institution by using the institution for purposes it was not created in the first place” (Pinske & Kolk, 2007, p. 450). An example would be the banking sector, which could benefit from emission trading even though it is only slightly affected by the EU ETS.

Pinske and Kolk conclude that multinationals are likely to use a mix of those responses, mainly influenced by industry, location and timing.

3.2.5 Hoffmann (2007)

Hoffmann analyses the effects of the EU ETS on technology investment decisions that reduce carbon emissions in the German electricity industry. Technology investment decisions are referred to as “the choice of top management whether to build up such technologies, either by internal development or external acquisition” (Hoffmann V. H., 2007, p. 465). A special focus is put on three aspects relevant when considering strategic responses: Technology alternatives, risk management and timing.

Firstly, Hoffmann focuses on the investigation of technology investments. As part of technology investments, the author considered investments into R&D, Portfolio and Retrofits. The study shows that R&D efforts are largely unaffected. However, Hoffmann identifies an increased interest in the R&D activities related to Carbon Capture and Storage technologies. R&D investments into renewable energy sources, on the other hand, seem not affected. Portfolio investments include general technology and fuel choices. According to the findings, “the overall regulatory conditions and fuel price developments have not resulted in fundamental portfolio changes” (Hoffmann V. H., 2007, p. 470). Retrofit activities, on the other hand, seem to be highly influenced by the EU ETS, mainly due to relatively low investments costs combined with fast payback.

Secondly, Hoffmann analyses strategic responses within a company’s risk management activities. The author focuses on three dimensions, namely: Organisation, management tools and choice of investment. Hoffmann observes two key changes. Firstly, the evaluations of investment risk under the EU ETS “has become a high-priority topic on the executives’ agenda” (Hoffmann V. H., 2007, p. 470).

Secondly, specialists have been assigned to evaluate the risk related to investment decisions and environmental policy changes, with tools put in place “to calculate the risk associated with technology investment decisions” (Hoffmann V. H., 2007, p. 470). The choice of investment is mainly driven by high regulatory uncertainty, resulting in a “diversified energy mix rather than focusing on specific low carbon technologies” (Hoffmann V. H., 2007, p. 472).

Thirdly, Hoffmann studies the timing of investment decisions “in the light of regulatory uncertainties stemming from the EU ETS” (Hoffmann V. H., 2007, p. 472). The author finds out that “investment decisions under the EU ETS face the additional complexity of a changing regulatory scheme which requires investors to align the timing of investment decisions and planning process with developments of the EU ETS in order to reduce risk” (Hoffmann V. H., 2007, p. 473).

Hoffmann concludes, “actual technological changes induced by the EU ETS seem to be moderate at best when comparing them to the objectives of the EU to reduce its carbon emissions by 60% to 80% by 2050” (Hoffmann V. H., 2007, p. 473). Furthermore, Hoffmann advises to put a higher focus on low emission technologies in order to respond to the increasingly stiff environmental regulations.

3.2.6 Jeswani, Wehrmeyer and Mulugetta (2008)

Jeswani, Wehrmeyer and Mulugetta analyse the corporate responses to climate change issues across different sectors and countries. Therefore, the authors compare the responses of the nine most energy intensive and GHG emitting industries in Pakistan and the UK.

In their study, Jeswani, Wehrmeyer and Mulugetta find out that industry response can significantly vary among sectors, industries and countries. As key influencing factors, regulatory pressure, social demand, market positioning and economic conditions as well as the accessibility to alternative technologies are identified.

Jeswani, Wehrmeyer and Mulugetta base the findings on a research framework (appendix 7), “which defines the criteria for categorization of business strategies on climate change […] using the existing literature” (Jeswani, Wehrmeyer, & Mulugetta, 2008, p. 49). The framework distinguishes between four basic strategies to respond to climate change activities voluntarily or as response to policy changes. Those responses are: Indifferent, Beginner, Emerging and Active. In addition, the authors identify two components: operational and management activities, which represent the corporate strategic response alternatives in respect to climate change policies and GHG reductions.

Operational responses include: Improved maintenance, changes in process technologies/modification, input materials, or product specification, installation of energy-efficiency equipment, encouragement of employee initiative related to energy efficiency and GHG reduction, participation in Kyoto flexible mechanisms (ET, JI or CDM), participation in voluntary programs as well as networking, research alliances, or agreements with other companies. Management activities comprise management commitment/involvement, installation of environmental management systems, increased focus on creating awareness of energy-efficiency opportunities within organisation and target setting for reduced consumption. Benchmarking energy cost and usage to establish targets, enhancement of organisations awareness of climate change impacts associated with their activities (GHG inventory prepared, GHG audit conducted, and policy statement on climate change), GHG reduction targets setting and responsibility allocation as well as public GHG data reporting are also attributed to managerial activities.

3.2.7 Kim (2008)

Kim analyses the corporate responses to climate change related to market strategies. Overall, the author identifies three key political response strategies to climate change: Supportive, defensive and neutral. Supportive responses contain “active engagement in policy making in support to climate change legislation” (Kim, 2008, p. 4). Companies involved in supportive actions generally consider climate change as an important threat to the environment and support environmental friendly government policies and regulations knowing that additional manufacturing and process costs are likely to occur. Firms using a defensive approach are “basically opposed to setting emission targets, but appear to prefer a voluntary approach to reduce emissions” (Kim, 2008, p. 5). Based on the firm’s own resources and capabilities, this could mean lobbying for or against government policies. When using a neutral strategy, companies apply a ‘wait and see’ strategy until they are forced to conform to regulations and laws.

Next to key political strategies, Kim highlights three operational response strategies available for organisations: Emission trading, process improvement and product development. Emission trading is considered as an important response “likely […] to be a crucial pillar of future global or national climate change policies as an instrument to reduce GHG emissions” (Kim, 2008, p. 8). The author argues that firms which “have already built expertise in measuring and trading [emissions] can create a competitive advantage, if GHG reductions are mandated at the global or national level” (Kim, 2008, p. 9). Process improvement mainly aims at increasing energy efficiency and the use of renewable fuels. Product development targets the creation of energy efficient products (products with lower carbon emissions).

Referring to the resource-based view, Kim concludes that “informal tactic knowledge, trading skills, organisational culture committed to reducing carbon emissions can be valuable resources and capabilities that create a competitive advantage” (Kim, 2008, p. 9). Especially, for global firms dealing with different local regulations, it is important that carbon regulations are implemented on a global scale. Additionally, the author argues that by taking “an environmental leadership in climate change by supporting for regulation to control GHG, firms would increase their reputations and establish favourable relationships with external stakeholders, which will enhance profitability” (Kim, 2008, p. 9).

3.2.8 Lacombe (2008)

Lacombe investigates the economic impact of the EU ETS on the refining industry in Europe. Based on a literature review as well as technical and policy reports the author developed a list of options to reduce greenhouse gas emissions at refineries.

The first option Lacombe identifies is process optimization without changing the infrastructure of the refinery. Especially, the reduction of waste flared can lower GHG emissions. S

As second option, the efficiency optimisation of heat as well as power production and usage can lead to lower carbon emissions. This can be done by fuel switching from oil to natural gas or refinery gas, making use of combined heat and power (CHP), switching entirely to the grid for power generation, developing better catalysts, improving the distribution of steam as well as improving the reflux circulation in reaction chambers and distillation towers. Thirdly, the introduction of CO2 Carbon Capture and Storage techniques is a key option to reduce emissions.

According to the findings, refineries optimized the production mix by taking the emission-intensity of the different crude oil products into account. Moreover, companies showed efficient responses, by “preparing for further abatement investments and by undertaking the lowest hanging fruits among their abatement options through operational changes” (Lacombe, 2008, p. 113). However, Lacombe attributes this trend largely to the rising cost of energy and not to the introduction of the EU ETS in particular. Moreover, the author states that interviewees perceived the price of allowances as not high enough during Phase I to lead to significant operational changes. Lacombe describes the introduction of EU ETS as an interesting experiment in adaptation to institutional change, because “it has forced companies to adhere, understand, and interact with a new market that was created de novo by the regulator” (Lacombe, 2008, p. 118). Lacombe further argues that the first trading period was “instrumental in allowing the refining sector to build the capabilities needed to respond efficiently to the carbon price signal in the long run” (Lacombe, 2008, p. 123). The author argues that the internal and external constraints that this first phase revealed will shape the future outcome of the scheme.

3.2.9 Pinske and Kolk (2009)

In their 2009 paper, Pinske and Kolk focus on the strategic options for businesses in response to global climate change issues.

Generally, the authors state that responses to climate change are “divergent, mainly influenced by a joint influence of external, industry and company-specific factors” (Pinske & Kolk, 2009, p. 92). As outlined by appendix 7, external factors include the physical impact relevant to types and location of operations, government policies and regulations as well as stakeholder pressure. Industry-related factors comprise the industry structure related to the technological and competitive situation, industry growth and the concentration level. Company-specific factors are the economic situation and market positioning, the position within the supply chain, historic involvement with (technological) alternatives, the degree of (de)centralization, the degree of internationalization of top management, the availability and type of internal climate expertise, the corporate culture and managerial perceptions as well as the internal capacity to anticipate risks, spread vulnerabilities and to manage stakeholders. The degree of influence of each component on the company has significant influences on the firm’s responses to climate change.

Further, companies can choose between two key strategic responses to respond to new climate change policies: Firstly, pursuing product-or process-oriented improvements, called Innovation. Secondly, emission trading called Compensation .

[...]


[1] See Glossary

[2] See Glossary

[3] See Glossary

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Details

Title
Strategic Responses to the EU Emission Trading Scheme
Subtitle
An Empirical Study in the Oil and Gas Industry
Course
International Business
Grade
1.1
Authors
Year
2011
Pages
142
Catalog Number
V180583
ISBN (eBook)
9783656039334
ISBN (Book)
9783656040781
File size
4639 KB
Language
English
Tags
strategic, responses, emission, trading, scheme, empirical, study, industry
Quote paper
Simon Hecker (Author)Marc Noy (Author), 2011, Strategic Responses to the EU Emission Trading Scheme, Munich, GRIN Verlag, https://www.grin.com/document/180583

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