Accounting for Natural Capital: How do You Actually Go About it?

By Richard Mattison, Chief Executive, Trucost

With so much interest in natural capital at the moment and a growing number of initiatives – not to mention the inaugural World Forum on Natural Capital taking place in Edinburgh this November. I am often asked: What is it all about?

There are many reasons why companies would want to account for their natural capital impacts... I’ll get to those later, but first I’ll explain how you actually go about it.

I’ll start by describing how we helped Puma and Parent Company Kering publish the world’s first EP&L statement in 2011 - if you are interested in this topic, you are likely to be aware of it.

First, we had to measure Puma's operational and supply chain impacts, back to raw materials, in traditional sustainability metrics (tonnes of GHG emissions, waste disposal and air pollution, cubic meters of water consumption, and hectares of land use).

Puma had already addressed its operational impacts and had been promoting the reporting of environmental performance data with strategic suppliers for some time.

This provided a great starting point. But which other suppliers, or suppliers of suppliers, did we need to engage with to measure material environmental impacts?

The key to unlocking this problem is provided by environmentally extended input-output (EEIO) modeling; an economic technique that identifies the interdependencies of different branches of an economy – the development of which won Wassily Leontief the 1973 Nobel Prize in Economics.

EEIO modelling identified "hotspots" of environmental impact across Puma's supply chain tiers around which we were able to pinpoint high impact suppliers for engagement. It also provided baseline data for lower impact areas of the supply chain. Following our engagement with Puma's high impact suppliers, we combined these data with PUMA’s previously collected data to improve the modelled baseline and deliver a complete environmental footprint.

The final stage was to apply natural capital valuations to the footprint data in order to create the EP&L statement. In order to stick to my promise to keep this overview concise, I’ll describe how we arrived at one of the key valuation metrics: water.

You might question the relevance of economically costing water use for Puma – surely water is a resource that is already paid for? Unfortunately, the local ecosystem goods and services provided by water - along with local water availability - are often not reflected in market prices. Inaccurate pricing of water leads to perverse market incentives and presents risk to water-intensive business inputs derived from vulnerable regions. For example, 11 of the 31 dry regions of mainland China provinces create 52 percent of China’s industrial output and 40 percent of agricultural products. As the name suggests, these are the driest provinces with water resources comparable to those of the Middle East.

The World Economic Forum cites "water supply crises" among the most material risks facing the global economy. Understanding the non-market value of water helps to shift the focus from a supply-side approach of water management, to one that also recognizes the need for demand management. It also helps companies to identify risk from more accurate water pricing – and optimize operations and supply chains in line with rising costs.

We derive valuation coefficients for water using the Total Economic Value framework. To determine a local natural capital value for water for each of Puma's supplier geographies, a relationship between non-market economic value and scarcity was derived.

Puma's EP&L provided a strategic tool for the company to get ahead of the trend toward external natural capital costs being internalized by regulators, up to the point when products are sold. The next step was to extend the analysis to the product level.

In much the same way as the operational EP&L was created, we used EEIO modelling to identify high impact focus areas and supplemented these data with primary data from Puma's suppliers and secondary data from regional Lifecycle Assessment studies and academic literature.

Natural capital accounting at the product level identifies opportunities to holistically reduce natural capital costs. Puma was able to reduce the natural capital cost of its more sustainable InCycle Cotton t-shirt by 31 percent compared to its conventional cotton t-shirt. This was primarily achieved by switching conventional cotton for organic cotton which avoids GHG intensive fertilizers, sourcing cotton from land with lower value ecosystem services and introducing Puma's innovative “I’m Half the Bag I Used to Be” packaging.

Critically, the Product EP&L highlighted Puma's ultimate success in decoupling natural capital benefits from retail cost.

Trucost is now working with many companies to help them apply natural capital valuations to their business models in order to reduce environmental and social impacts where it counts. We provide data that can be incorporated directly into existing financial and operational systems to identify the net benefits of different technologies, procurement strategies or product lifecycles.

Three billion new middle class consumers by 2030 will cause demand to continue to grow rapidly through a period where we will face ever-increasing resource constraints. The consequences in the form of health impacts, water scarcity and lost ecosystem services will create tipping points for action by governments and societies.

Companies best positioned to compete in the future will be those that are able to decouple growth from unsustainable dependency on vulnerable natural resources. Natural capital accounting enables companies to do just that by identifying opportunities to optimize operations, supply chains and product portfolios in line with resource availability and environmental cost.

Richard Mattison will be speaking at the World Forum on Natural Capital, as will Jochen Zeitz, former CEO of Puma, held on 21^st and 22^nd  November in Edinburgh. Discounted Early Bird rates are available until Thursday 12^th September at http://www.naturalcapitalforum.com/