How the profit motive can save forestsGland, Switzerland: It has not been a good year in Southeast Asia, where the forests caught fire and the markets caught 'flu. I do not claim a connection between these two disasters, or that solving environmental problems will solve the world's financial problems. But money and the environment are inextricably linked, and I challenge the view that expenditure on improving the environment is at the expense of shareholders.
There are strong reasons for believing that companies that are good at managing environmental issues are well-managed overall and evidence for this comes from new developments in the forestry sector specifically certification by the Forest Stewardship Council (FSC). Certification is an independent way of assessing environmental management and therefore an indirect indicator of overall management quality. Forestry companies that practice responsible environmental management could be the winners in an underperforming sector.
In recent years, many companies have begun to measure their environmental performance. Ethical investment funds have been set up, but mainstream investment managers have often taken the view that while better environmental performance is good for the planet it may be bad for investors. Their duty is to maximize returns for investors, and improving environmental performance uses shareholders' money. Yet there is growing evidence of a connection between good environmental performance and increased profits. At the same time, the idea of fiduciary duty is broadening beyond maximizing returns to incorporate environmental performance.
Innovest, a Toronto-based investment consultancy, has developed an analysis tool called EcoRise 21 to predict environmental performance by assigning a "green rating" from AAA to C. When applied to more than 300 Fortune 500 companies, those gaining the highest rating outperformed their competitors by as much as 5 per cent. That may be because companies concerned to minimize environmental impact reduce waste and energy use and cut costs. So a successful environmental management system is a good indicator of quality management.
Another aspect of fiduciary duty involves assessing liabilities. The vast cost implications of failing to assess liabilities were shown in the Indonesian fires and the Exxon Valdez disaster. Failing to look at companies' environmental status means exposing investors to possibly huge liabilities. So good environmental management can add to profits and reduce liabilities.
The forest products sector has performed poorly in recent years. The reasons are complex, but some points are clear. Forest management and tree harvesting are usually profitable, so underperformance is likely to come at the processing stage.
The top ten players worldwide account for 21 per cent of market share. With a single world-class paper mill costing around US$1billion, integrated operations are very capital intensive. High-income economies have seen low growth in paper and paperboard product consumption, and in a commodity business, price competition is acute.
Many companies have responded by building bigger plants and investing in emerging markets, both of which have the potential to lower production costs and increase sales. They are also involved in more mergers, acquisitions, and strategic alliances to reduce costs. All these strategies help build competitive advantage, but they cannot address the other problems of the sector its basis in a commodity business, and growing challenges from environmental campaigners over its right to operate.
Southeast Asia shows why environmentalists are worried about forests. The Indonesian fires were environmental catastrophes, with millions of hectares of forest destroyed and the survival of some of the world's most endangered species threatened. Preliminary estimates put the price of lost tourism, productivity, health effects, and legal costs at US$20 billion.
Owners of many of the Indonesian forests burned them to be replaced by plantations. These may seem like artificial forests, but they are symptomatic of other problems facing the world's forests: loss of quality. Unlike naturally occurring forests, plantations are usually all the same species of the same age. Natural forests feature a rich diversity of species, helping to prevent soil erosion, limit the spread of fire, regulate climate, and store carbon.
The first goal of environmentalists is often government regulation, but this has frequently failed. In Indonesia, it appears that many fires were started precisely because new laws were being introduced and landowners wanted to clear land before they took effect. Concessions to grow and harvest trees are government market mechanisms to control forests, but these, too, have often failed. Some of the richest natural forests are in poorer countries.
A vicious cycle has operated: concessions are let for unrealistically low sums, which chokes funding to government forestry departments. The result is that poorly funded forestry departments supervise underfunded forestry concessions.
International forestry agreements are being debated, but the 1992 Earth Summit in Rio de Janeiro offered only non-legally binding principles for `global consensus'.
For all these reasons, WWF, the international conservation organization, and other environmental groups have encouraged the development of market-based solutions, and supported certification by the FSC to promote improved forest management. The FSC is a non-profit organization representing environmental groups, social organizations and forest product companies. Its certification is the only internationally applicable, independently verified forest management scheme, creating a "chain of custody" allowing wood to be traced from forest to point of sale.
Growing consumer demand for products from responsibly-managed forests means that FSC labelling confers a market advantage to companies using it. The scheme also addresses forest management directly, with widely agreed environmental best practice, and it is market-led and needs no state funding. FSC also offers the possibility of premium pricing.
FSC-based certification only began in 1994, but growth has been rapid. WWF aimed to see 10 million hectares certified by the end of this year but the target was reached six months early. The new target is 25 million hectares by 2001.
Any investment portfolio that includes the forest product sector should incorporate FSC-based certification as a criterion. Clearly, it cannot guarantee superior financial performance. But it points to good management and a company likely to enjoy a secure right to operate, keen to achieve premium prices and greater market share, with a forward-thinking grasp of market realities. Quite apart from these financial factors, it will help secure the biodiversity of forests on which we all depend.
*Chris Elliott is Director of WWF's Forest for Life Campaign