The Quest for an Environmental Metric

In the Gulf of Mexico, near Crystal River, Florida, manatees swim in the shadow of a huge coal-fed power plant owned by Progress Energy Corp. These enormous "sea cows," which can weigh up to 3,000 pounds each, hate the cold, and they consistently herd where the plant discharges millions of gallons of warm water daily into the Gulf and its estuaries. Experts say manatees are quite content to frolic in the tepid water.

To be sure, these endangered sea mammals seem happy about the effect of the power plant on their home. But measuring the total impact of coal-fired facility on the environment and local economy is more complicated. Indeed, identifying a metric that quantifies the symbiotic relationships between a power plant and manatees might be a bit too esoteric an undertaking for busy finance executives. Yet many corporate managers have been on the lookout for ways to measure such intangible gains and losses for a while now.

Their goal, in most cases, has been to measure "sustainability," a catch-all term used to describe the way companies manage profits, people, and the environment to keep the business viable over the long term. But factoring environmental and social variables into the next five-year plan is new territory for most companies, not to mention documenting sustainability efforts.

Nevertheless, companies in the United States and around the world are increasingly issuing sustainability reports that highlight answers to such questions as whether cuts in air emissions add or detract from profits or if their worker-safety programs increase productivity.

The story of the Crystal River plant is an interesting footnote to sustainability reporting — and not only because the manatees treat the effluent it produces as a haven. Nearly two decades ago, the plant owners used an unorthodox metric to assess the facility's impact on nearby estuaries. Called "emergy," which is shorthand for "embodied energy," the metric provides managers with a way to quantify variables once considered too qualitative to measure accurately.

Today, as the nascent practice of sustainability reporting becomes more popular, and managers search for a standard set of guidelines, emergy may be poised for a comeback. "Sustainability reports are all over the map with their metrics, and include a significant amount of qualitative statements," notes Jason Makansi, research director for Pearl Street Capital, a hedge fund. Like many others, he's trolling for more quantitative data.

Who Wants to Know?
Hedge funds aren't the only investors searching for better ways to measure business risk linked to environmental and social issues. Managers of socially responsible investing (SRI) funds are also keen to find new and improved metrics. Further, the influence of such funds — which screen for sustainability criteria — is growing annually. In 2004, SRIs accounted for $2.6 trillion of assets under management, or 11.3 percent of the total managed assets market.

More tellingly, asset managers that don't solely cater to the SRI crowd have also been keeping tabs on the way corporations approach these issues. Witness Citigroup Asset Management (CAM), which was acquired by Legg Mason on December 1. The company manages more than $430 billion of assets, of which about $1 billion is rigorously screened for sustainability criteria.

Further, CAM operates a social-research department that evaluates portfolio companies for risks related to environmental and social issues. The intent is to identify potential negative earnings effects posed by such things as product and environmental liability, employee lawsuits, and failed responses to emerging societal issues that affect business.

While social-research director Mary Jane McQuillen stresses that economic value is CAM's top criteria, her charge is to focus, for example, on worker-safety initiatives and benefit programs to gauge whether a company can retain top talent. She might also study environmental lawsuits for their potential drag on a company's earnings.

In some cases, McQuillen grills CFOs to make sure they're reading emerging issues — like health matters, for example — that help shape their industries. For instance, when McQuillen recently questioned the finance chief of a large consumer food-products company, the executive "eloquently" addressed the market risk associated with consumption of the company's products as it related to the rise in obesity and Type-2 diabetes in the general public. The CFO also discoursed on how the human body processes sugars and starches and the nutritional makeup of the company's products.

Talk of gastronomical enzymes is a far cry from what most CFOs typically discuss with asset managers. But the fact that such discussions exist may be a sign that that business is ready to revisit the unconventional world of emergy analysis.

Dial "M" for Emergy
The basics of that analysis emerged in the mid-1980s. At the time, Florida Power Corp. (since merged into Progress Energy) was slapped with an environmental lawsuit that claimed that the hot water being discharged from its Crystal River plant was spoiling the Gulf's ecosystem. The utility called in Howard Odum, the University of Florida professor who had earlier developed the emergy metric, to assess whether building a cooling tower to process the hot water was environmentally sound.

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