In January, the United Nations’s Intergovernmental Panel on Climate Change — a group of scientists and government officials from 113 countries — issued its much-anticipated fourth report on global warming. In it, the panel not only indicated that global warming is worsening, but that the rise in temperatures is likely caused by human activity. How likely? The panel said it’s at least 90 percent sure humans are responsible.

In the contentious battle over global warming, 90 percent may be as close to a dead-certain lock as you can get. Equally as certain is that businesses — the primary generators of greenhouse gases — will be held accountable for what the report calls the “unequivocal” change in the planet’s weather.

The reckoning has already commenced. In the 2007 proxy season, investors filed 42 global-warming resolutions with U.S. companies — nearly double the number filed three years ago. At the same time, coalitions of eco-minded institutional investors have started to confront corporations considered slow to address their own carbon emissions. In February, a group of powerful institutional investors posted a list of 10 offending businesses, including ConocoPhillips, ExxonMobil, and Wells Fargo — then sent the dishonor roll to various news outlets, including CFO.

Such lists can harm reputations and trigger expensive campaigns to counter the attack. Risk consultants believe these shareholder complaints are merely the opening shots in a coming war on corporate CO2 emitters. They point out that Congress, after years of inaction, finally appears ready to tackle global warming. The most likely outcome? A federally enforced limit on the amount of CO2 companies can emit. Businesses that fail to make their numbers could pay a steep price. Under a cap-and-trade system — the centerpiece of many current bills — laggards would have little choice but to buy costly offsets from companies that have exceeded their emission-reduction requirements. Under other proposals, excessive emitters would be hit with a penalty, known colloquially as a carbon tax, that will prove difficult to pass along to customers.

Businesses face other regulatory pressures as well. The European Union now appears ready to impose its own carbon tax on imports from industrialized countries that have failed to ratify the Kyoto Protocol (read: the United States and Australia). In a recent interview, French president Jacques Chirac described a carbon tax as “inevitable.”

Closer to home, a growing number of states — notably California, New Mexico, and Massachusetts — are setting aggressive greenhouse-gas reduction targets for utilities and other sizable producers of CO2. “Each company is going to have to deal with some sort of [CO2] regulation,” says Peter Breitstone, managing principal and CEO of Aon’s Environmental Services Group. “We know that it’s coming.”

Indeed, it appears that corporations will be grappling with their carbon output for decades. In some cases, product lines may need to be altered. Automakers, for example, claim it could cost as much as $3,000 per vehicle to build cars that will meet California’s expected emissions requirements. Other businesses will end up selling operating units that generate excessive greenhouse gases. Corporate officers will also have to deal with increasing numbers of climate-related lawsuits and the unsettling prospect that damages may not be covered by general liability or directors’-and-officers’ policies (see “Up in Smoke” at the end of this article). Dan Anderson, professor of risk management and insurance at the University of Wisconsin, goes so far as to say: “Greenhouse-gas emissions will be one of the critical business risks of the 21st century.”

The Carbonists’ Manifesto

To date, most greenhouse-gas regulations require gradual, yearly reductions in overall emissions. Typically, the rules aim to cut the discharges to below 1990 levels (a benchmark that protects businesses that have slashed carbon emissions in recent years). Failure to meet such targets will force companies to buy offsets — which could run into millions of dollars — or face hefty fines.

California’s much-trumpeted new law, signed by Gov. Arnold Schwarzenegger in September, will bring the state’s CO2 emissions back to 1990 levels by 2020 (a 25 percent reduction). Past that, the plan calls for an 80 percent reduction below 1990 levels by 2050. The scheme specifically targets large emitters, which must meet mandatory caps beginning in 2012. As part of the plan, the state’s public utilities recently barred California power producers from purchasing electricity from coal-fired plants.

As with almost all CO2 legislation, California’s law does not mandate specific ways to cut greenhouse gases. Left to their own devices, many companies have zeroed in on energy consumption as the surest way to cut carbon emissions. Management at Baxter International, a pharmaceutical and medical-devices company, for example, began addressing the company’s CO2 emissions in the 1990s as part of an overall plan to lower the company’s environmental footprint. By curbing the company’s power consumption, Baxter reduced associated greenhouse-gas emissions 27 percent (per unit of production value) from 1996 to 2005. Last year, Baxter upped its original goals, looking to reduce its greenhouse-gas emissions a further 20 percent by 2010.

The CO2 scheme has generated great publicity for the Deerfield, Illinois-based company, but Baxter has also reaped financial gains from a broader environmental program. In 2005, the company reported $23 million in benefits derived from its efforts (which include water usage and energy reduction) — with $62 million in accrued benefits over the past five years. “There is a dollar savings,” says Art Gibson, vice president, environment, health, and safety. “But this also positions us for what we knew would be a tougher regulatory environment.”

Undoubtedly eager to shape that landscape, several other high-profile companies are touting their own solutions. In January, a coalition of four environmental groups and 10 CEOs, including General Electric’s Jeffrey Immelt, sent an open letter to President Bush and Congress. In it, the group — the U.S. Climate Action Partnership (USCAP) — offered a detailed plan to combat global warming that includes federal targets limiting greenhouse-gas emissions, along with funding for new technologies. They also called for the U.S. government to get involved in the next round of international negotiations governing greenhouse gases (the Kyoto Protocol expires in 2012).

In announcing the plan, the CEOs noted that legislators need to act immediately. Any delay in CO2 legislation, the chief executives warned, increases the chance of “even steeper reductions in the future.”

Skeptics point out that while USCAP set forth a fairly bold working plan, the scheme is nonetheless sympathetic to business concerns. The proposal, for example, would credit companies for CO2 reductions taken ahead of any regulations. That’s critical for corporations that have started to curb discharges voluntarily. “If we can get documented emission reductions that go beyond a regulatory standard,” says Tom Catania, vice president of government relations at Whirlpool Corp., “we see that as an asset down the road.”

In fact, businesses like Whirlpool may be able to sell those credits to companies that exceed future mandated levels. At the very least, corporations don’t want to be penalized for having acted preemptively. They argue that businesses that have already lowered CO2 emissions will find it difficult to make further reductions. “A key focus for us is credit for early actions,” acknowledges Dawn Rittenhouse, director of sustainable development at DuPont, a company that has reduced its global greenhouse-gas emissions by 72 percent since 1990.

The USCAP plan also calls for assistance to industries that would be especially burdened by carbon targets — presumably utilities, oil companies, and automobile manufacturers. In addition, the scheme also champions a national policy that would govern carbon emissions. That sort of federal mandate would likely supersede the current welter of state and municipal laws — and would undoubtedly place fewer restrictions on businesses. “As with the Clean Air and Clean Water Acts in the 1970s,” says John Kostyack, senior counsel at the National Wildlife Federation, “business would rather have one set of rules that would preempt state rules.”

Accounting for Carbon

If Congress does act, corporations can expect some sort of cap-and-trade system. Under the bill most likely to pass — a bipartisan proposal introduced in January by senators John McCain (R–Ariz.), Barack Obama (D–Ill.), and Joseph Lieberman (I–Conn.) — companies with high CO2 emissions could purchase offset allowances from climate exchanges in other countries or a newly created agency, the Climate Change Credit Corp., in order to meet 15 percent of their targets. The price of the offsets is not known, but experts say it could be expensive.

It could also be complicated, given the difficulties in certifying and disclosing CO2 reductions. Currently, businesses can report their greenhouse-gas inventories to a handful of registries, including EPA Climate Leaders, the Chicago Climate Exchange — a voluntary market for trading climate credits — and the California Climate Action Registry. Other regional programs have cropped up of late, too.

The problem is that each registry has slightly different requirements. What’s more, the formats are not necessarily in sync with major greenhouse-gas reporting standards, which also proliferate and include the Greenhouse Gas Protocol, the G3 Reporting Framework, and the Global Framework for Climate Risk Disclosure (which was released in October by a group of institutional investors). While good starting points, these frameworks don’t always lead to the same results. “There are some similarities in the major moving parts,” says Melissa Carey, a climate-change policy specialist at Environmental Defense (a member of USCAP), “but all the [environmental] accounting standards are different.”

It will take time for regulators to settle on one reporting standard. Meanwhile, the hodgepodge could create a problem down the road when companies attempt to claim credit for their shrinking carbon footprints.

United Technologies Corp., for example, now manufactures a jet-engine cleaner called EcoPower, which works six times faster than previous cleaners. That means the engines get washed more often, leading to improved fuel efficiency. Hawaiian Airlines estimates EcoPower will cut carbon-dioxide emissions on its Boeing 767 planes by nearly 8 million pounds each year. The question: Who gets to claim that reduction — UTC, Boeing, or Hawaiian Airlines? And what about the fuel provider, which will no doubt detail any decrease in fuel sold in its own CO2 report?

Smokestacks and Mirrors

The same holds true for businesses that restrict corporate travel, or those, like DuPont, that manufacture carbon-friendly products. While such efforts represent a budding business opportunity, they also pose an accounting issue. Catania, of Whirlpool, which manufactures a host of energy-efficient appliances, says there has been a “regular dialogue” among companies, energy providers, and policymakers about so-called double counting of reductions.

Those conversations could become more heated if businesses face monetary fines for going over mandated CO2 limits — or have to pony up for climate allowances. Says Rick Bennett, vice president of environmental health and safety at UTC: “There is a big battle looming over who gets the credit.”

Large carbon emitters that lose out may have no choice but to rethink their business models or product mixes. Automakers top that list. In its 2005 annual report, Ford indicated that if substantial increases in gas-mileage standards were imposed or if state greenhouse-gas regulations were not overturned, the company may be forced to take various “costly actions that would have a substantial adverse effect on our sales volume and profits.” The company went on to note that it might have to curtail production of high-margin vehicles like luxury cars, restrict engine offerings, and increase production of fuel-efficient cars.

Carbon concerns are beginning to color all sorts of corporate decisions. For example, before Whirlpool acquired Maytag for $2.7 billion in 2006, Catania says the company ran projections to see what effect the purchase would have on the company’s stated CO2 reduction goals. At Exelon Corp., Phillip Barnett, senior vice president, corporate financial planning, says the power producer examines the carbon footprint of a potential acquisition during due diligence. “It’s part of the evaluation of risk and opportunity,” he says, “part of our economic analysis.”

In some cases, carbon due diligence can lead to surprises. In 2004, DuPont sold off its fiber business, which included Invista, a nearly $7 billion specialty fibers operation. Rittenhouse says the unit was divested, in part, because of the operation’s large carbon footprint. More recently, the potential acquirers of Texas utility TXU, including Kohlberg Kravis Roberts, agreed to terminate the applications for 8 of the power producer’s 11 proposed coal plants in Texas. Those plants would have had to pay at least $917 million a year in environmental compliance costs, according to Ceres, a network of investors and public-interest groups focused on sustainability issues.

Sweat Suits

Going forward with such controversial deals is sure to bring out the lawyers. In fact, attorneys of all stripes are already queuing up to sue businesses over global warming.

In Mississippi, a group of local residents has filed a class-action lawsuit against oil companies, utilities, and coal producers. The suit claims that the defendants’ carbon emissions contributed to global warming, which spawned Hurricane Katrina, which then destroyed the litigants’ homes. Don Goldberg, a senior attorney at The Center for International Environmental Law, predicts that U.S. corporations may also be sued over climate change by foreign entities. Those suits — from indigenous peoples, island nations, and other parties — might be linked to violations of international environmental treaties or human-rights laws.

States are also getting in on the act. In the first such case, eight states sued five utilities for allegedly pumping 650 million tons of carbon dioxide into the atmosphere. The case was dismissed, but observers expect a slew of others. The attorney general of California, for one, is currently seeking damages from the Big Six automakers for allegedly contributing to global warming and thus harming the state’s ecosystem. Says Carey: “States are doing things because the federal government hasn’t.”

Some observers believe it will be difficult for states to pin the climate rap on individual companies. “We’re talking about a global situation,” says a spokesperson at the Insurance Information Institute. “Establishing causality is about as tenuous as it gets.”

Risk experts point out that early litigation in some other celebrated state lawsuits was also laughed off as ludicrous. “Some lawyers say it’s legally impossible to make the connection between global warming and corporate liability,” notes the University of Wisconsin’s Anderson. “But I heard this sort of argument in the tobacco and asbestos cases.”

John Goff is technology editor at CFO.

Up in Smoke

Because insurers typically exclude pollution-related liabilities from general liability, umbrella/excess, and directors’-and-officers’ policies, corporations would likely have to rely on internal cash flow to pay damages stemming from climate-related lawsuits. A case pending before the U.S. Supreme Court, however, could get companies off the hook.

In the suit (Massachusetts v. Environmental Protection Agency), 12 states, 13 environmental groups, two cities, the District of Columbia, and American Samoa are attempting to get the EPA to regulate carbon-dioxide emissions. The plaintiffs argue that CO2 is a pollutant and therefore falls under the agency’s regulatory purview as defined by the Clean Air Act. The EPA challenges the assertion.

Here’s the kicker. If the Supreme Court rules in favor of the EPA — that is, if it rules that CO2 is not a pollutant — the liability for paying damages could shift. “In that case,” says one insurance executive, “the pollution exclusions arguably would not still apply.”

It’s unclear if the EPA would commence regulating corporate CO2 emissions if the Court decides against it. But if the EPA wins, insurers may lose. Indeed, if the Court rules that CO2 is not a pollutant, insurers might be left to cover huge monetary awards handed out in global-warming lawsuits.

Based on the current docket, there won’t be any shortage of those. “The lawyers are getting creative,” says a spokesperson at the Insurance Information Institute. — J.G.

Tomorrow’s Forecast: Materially Adverse

In the spirit of transparency, companies are increasingly disclosing information on climate risk. According to research by Friends of the Earth, which examined the 2005 annual reports of 112 oil-and-gas, auto, insurance, and petrochemical companies, nearly half reported on climate change, compared with 26 percent in 2000. And many filers indicated the effect of future carbon mandates. “Most companies that describe the regulations say this could materially affect their operations,” says Michelle Chan-Fishel, who conducted the research. Progress Energy, for example, classified any future climate regulatory actions as “a business risk to our operations,” and added that further requirements to reduce CO2 emissions “could be materially adverse…if associated costs of control or limitation cannot be recovered from customers.”

Here’s how respondents broke down the financial risks posed by climate change (of companies that reported on climate change):