Bringing rivers, forests and bees on the balance sheet

This story first appeared in an earlier version of the Luxembourg Times magazine, which is on sale in newsstands across the country.

On increasingly common hot summer days, supermarkets fight to keep their refrigerators cold behind blinds or glass doors. But the battle seems futile, given that so much of the food they are selling is packaged in plastic. This generates more carbon emissions, which in turn raises temperatures, and makes it even harder to preserve food.

But what if companies had to account for the environment on their balance sheet? Treating forests, rivers and biodiversity like an asset would make them just as mindful of the value of nature as of the value of their supplies and their sales.

The idea stems from a young field of economics known as natural capital accounting (NCA), which argues nature should be treated as a capital asset from which companies derive a value.

“It’s about realising these are assets we can all look after and if we do, they will keep on giving for your business,” said Ece Ozdemiroglu, founder at EFTEC, a consultancy that helped about 50 firms prepare natural capital accounts and plan a strategy to prevent the deterioration of natural assets.

Food producers rely on land, water companies on rivers and pharmaceutical firms on biodiversity. Accounting for these raw materials will reveal the firm’s dependency on the natural capital assets they own and the ones that nobody owns, like air or water. Resources like plants, animals, air, water, soils and minerals all count as natural capital, according to the Natural Capital Protocol, the international framework that leads the movement. Accounting has been used to identify risks, benefits and opportunities since Babylonian and Egyptian times, and accounting for nature fits that profile.

The appetite for the new discipline is in line with the rise of environmental taxes and stricter rules against pollution. But while most such regulation is about controlling activities, NCA can change a business strategy before the firm has any negative impact yet, its proponents say.

A supermarket in London during a heatwave, keeping refrigerators cold behind blinds © Photo credit: Luxembourg Times

The appetite for the new discipline is in line with the rise of environmental taxes and stricter rules against pollution. But while most such regulation is about controlling activities, NCA can change a business strategy before the firm has any negative impact yet, its proponents say.

With traditional accounting, oil producers do look at the impact of the environment on their accounts, for instance when registering write-downs for cleaning up an oil spill. Car makers will do the same, when writing down the cost of a flooding in their factories. But these accounting entries reflect the damage after it occurs.

The EU in an April consultation raised the question as to whether financial accounting standards are suitable for sustainable investments. Companies that rely heavily on oil and gas, for instance, might see their value rapidly diminish as fossil fuels are being phased out. But the existing impairment and depreciation rules do not fully price in such potential future losses.

A sign in a supermarket in London during the heatwave © Photo credit: Luxembourg Times

The EU in an April consultation raised the question as to whether financial accounting standards are suitable for sustainable investments. Companies that rely heavily on oil and gas, for instance, might see their value rapidly diminish as fossil fuels are being phased out. But the existing impairment and depreciation rules do not fully price in such potential future losses.

In contrast, a farm using natural capital accounting will try to maintain the quality of soil, water, air and pollinating insects instead of optimising crop yields with heavy use of fertilisers and pesticides. But that requires a shift away from the traditional capitalistic view that natural resources are freely available despite the fragile balance of ecosystems. Raw materials entering the manufacturing of products are either seen as substitutable, or their renewal is seen as being somebody else’s responsibility, especially now that supply chains are increasingly complex.

“What is the value for society of foxes that are killed because of a parking lot being built? Perhaps it’s not that important, but the day there are no more foxes there is a biodiversity issue,” said Thierry Philipponnat, head of research and advocacy at NGO Finance Watch. “Same for bees: the value of one bee may not be much, but the value of all bees is enormous given their role in pollination.”

Owning is Caring

Using Natural Capital Accounting, companies would identify natural assets on their balance sheet, just like they record the value of machinery, building and infrastructure they own, a process which enables them to plan for their replacement. If business can identify and value the resources they own, the proponents of the system say, they would become custodians of their ecosystem and invest in their maintenance and protection. Depreciation would be turned on its head. While manufactured assets can see their value fall in line with their estimated useful life, natural resources should not depreciate in value at all, because they cannot be replaced.

“With natural capital we’re saying it will depreciate if you don’t look after it. So if you want to continue to receive the benefit from nature, you need to avoid depreciation,” said Ozdemiroglu.

Olam Food Ingredients, one of the largest global suppliers of cocoa, coffee, cotton and rice has started dabbling into the method to understand how its business depends on nature, taking into account its entire supply chain of farmers. At a later stage, it aims to apply it to the entire group.

“Products from coffee to edible nuts rely on healthy biodiverse environments,” said Rishi Kalra, Managing Director of Olam. “It is a fact that the health of ecosystems, land, water resources, air and biodiversity has a direct correlation to operations, profitability and economic prosperity.”

Food companies might be buying raw ingredients from all over the world and need to be aware of the risks in their supply chains. Switching suppliers when resources run out comes at a cost. “We need to get out of this mentality of using resources in one place, and [then] when they are finished we just go somewhere else,” said Ozdemiroglu.

The accounting exercise is easier for companies that are closest to the environment, for instance because they own natural assets such as land. Yet measuring biodiversity loss will always be a complex issue, despite the fact that sectors like agriculture, fisheries and forestry depend directly on healthy ecosystems.

Flows of benefits

A natural capital income statement too can reflect the impact of a firm’s operations and its dependence on natural assets by recording flows of benefits produced for the business and society more widely. For example, a positive flow, which avoids environmental damage, would come from planting trees that store carbon, switching to a low carbon fuel or making production waste free. By contrast, a loss would be recorded when releasing carbon or discharging pollutants into water.

“Nature … has been degraded and we haven’t been paying for that,” said Michael Lewis, head of sustainable finance research at German investor DWS, which has about €760 billion assets under management.

Forestry England, a publicly-owned business, knew that the value from its forests does not just come in the form of timber, the visitor car park and the café. Trees also clean air, regulate the local climate, water and reduce flooding risk. But the company could not show that in its annual accounts – until it started using natural capital accounting, which showed the public benefits of having the forests in place were much larger than the financial returns. The Duchy of Cornwall, the estate of prince Charles, is another example of a company that started looking after their soil, after using NCA found that it was releasing carbon and losing diversity.

There is increasing interest in NCA, especially from land-based businesses such as farms, water companies and forest estates. Yet there’s only a very small number that applies the system and publishes the results. Most companies use them as an internal tool only, Ozdemiroglu says.

Using NCA might seem like another daunting accounting task, but firms already have the information needed from their corporate social responsibility and ESG reporting. And NCA is the best tool to bring to light the trade-off between short-term financial results and long-term environmental impact.

While there is no regulatory requirement for businesses to submit natural capital accounts, or even a common standard, Ozdemiroglu is hopeful that showing the hidden value of natural capital assets can become mainstream one day: “It’s not going to happen overnight or in the next accounting year and it doesn’t have to happen with all companies at the same rate.”