Carbon Principles Announced

Only a month later, three big banks on Wall Street have responded. On Monday, Feb. 11, Citigroup, JPMorgan Chase and Morgan Stanley have adopted the “Carbon Principles,” a set of guidelines for advisors and lenders to evaluate carbon risks associated with new investments in the U.S. electric power sector. This framework comes after nine months of dialogue with leading environmental organizations, including Environmental Defense and the Natural Resources Defense Council. Seven of the nation’s largest coal-burning utilities also were consulted and have written statements of support for the guidelines.

While banks have been stepping up their commitment to address climate change in recent years with a huge increase in support of renewable energy investments, they have largely shied away from acknowledging any material risks associated with their continued financing of carbon-intensive energy sources like coal. In fact, some of the same companies that advocate policies to combat climate change also are the largest global financiers of the coal industry. Under the “Enhanced Diligence” framework called for by the Carbon Principles, it now will be more difficult for U.S. electric utilities to build new, conventional coal-fired power plants.

The evaluation process calls on utilities to see if cost-effective demand reductions can limit the overall need for new generating capacity. Moreover, consideration should be given to renewable energy and low-carbon distributed energy sources as an alternative to building new, large baseload power plants. Finally, any new coal-fired generation should take into account whether carbon emissions can be economically captured and stored, rather than released to the atmosphere. Only after these other options have been ruled out should banks consider financing of new, conventional coal-fired power plants.

The Carbon Principles leave some key questions unanswered, however. One is whether they will extend beyond the United States eventually to serve as a litmus test for new power generation around the globe. Another question is what price on carbon will be assumed for this Enhanced Diligence framework. If the assumed carbon price is too low, it may not have much affect on final decisions regarding new power plants.

On Tuesday of this week—just one day following the Carbon Principles announcement—Doug Cogan, lead author of RiskMetrics’ climate change study, sat with Pamela Flaherty, Senior Vice President of Corporate Citizenship at Citigroup, on a panel at the RiskMetrics Governance Conference. Citi was the top-scoring U.S. bank in the study and a driver of the Carbon Principles. In discussing her company’s wide-ranging climate change initiatives, Flaherty commented, “Our journey has not been one of taking a score card and checking it off… It’s been about finding those points where we can make a difference for our business and clients.”

Clearly, banks’ role as the primary financiers of the country’s most carbon-intensive industries is a place to start to “make a difference.” While the Carbon Principles will not preclude new coal-fired power plants from bank lending portfolios, they do ensure a more rigorous evaluation process in evaluating the risks associated with financing carbon-intensive projects. It will be interesting—and telling—to see whether other banks and utilities follow suit and sign on to the Carbon Principles in the weeks and months ahead.

*This commentary expresses the views of the author alone and does not purport to represent the views of RiskMetrics Group or its clients.