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Joseph Mariathasan: Reporting on natural capital

‘You can only manage what you can measure’ is an oft-repeated phrase. Can it be applied to the natural world? There are certainly concerted attempts to do so as part of the drive towards environmental investing.

Defining ‘natural capital’ and then putting a price on it is proving to be controversial, and not only among those who would be perceived to be right-wing commentators. George Monbiot, a columnist at left-leaning UK newspaper The Guardian, declared in a column earlier this year that putting a price on nature was “morally wrong, intellectually vacuous, emotionally alienating and self-defeating”.

Trying to put the natural world into a framework of economics is fraught with difficulties because economics is not a science but a methodology and framework for analysis, which is ultimately dependent on explaining human behaviour rather than absolute facts.

Generating a capital value for forestry, for example, can be based on assuming discount rates such that, whatever positive figure is used, it will give low valuations to income generated in 100 or more years hence.

For current consumption of material goods this may be valid, but human beings would like to believe our grandchildren and generations beyond would still be able to enjoy the beauty of a forest whatever the present value may be today.

Natural capital

Despite the difficulties, assessing value for the natural world could produce figures to help better decision making, and therefore such attempts are to be applauded. But for such measures to be credible there has to be consistency in the measurements and a good idea of the uncertainties associated with each. Like any scientific measurement, what matters almost as much as a value itself is the error margin associated with that value. There can be a reconciliation between the views of critics such as Monbiot and advocates of calculating natural capital if there is also a good analysis of what the error margins are in any calculation.

Case study: Yarra Valley Water

A good example of what sort of analysis can be produced is an integrated profit and loss statement and balance sheet produced by Australian utilities company Yarra Valley Water. The company worked with GIST and Trucost to prepare an integrated profit and loss account for the 2014-15 financial year.

Traditional financial accounts recorded a profit of $50m (€44m), but the integrated P&L account reported a profit of $446m, made up of $374m in financial value addition, $53m of natural capital impacts, $13m in human capital, and $6m in social capital.

To arrive at these figures, the companies first had to decide on the scope of what should be included. This included the maintenance contractor, for example, but most of the sewage was compartmentalised differently as it was treated by another company. Decisions also had to be made about which programmes to include in terms of social capital assessment.

Parameters were then selected for each slice of capital to capture the potential impacts. Examples included land clearing, pollutants discharged into waterways, water extraction, and greenhouse gas emissions. Each was quantified and required a separate analysis to determine the environmental impact an economic value.

The primary purpose of the analysis was to provide management information that would help the company in future decision making. That objective seems to have been successfully achieved.

But Yarra Valley admits that many people feel uncomfortable seeing all the externalities aggregated into dollars: “They rightly highlight that not everything can have a monetary value put against it.”

 Yarra Valley Water

Source: Yarra Valley Water

This presents a major divide that must be crossed before the evaluation of externalities will be accepted by the majority.

A more serious hurdle that still exists is the question of objectivity. If 1,000 firms did the same analysis independently for Yarra Valley, what would be the mean and standard deviation of the reported profit? If the standard deviation was $2m on the reported $446m, the figure would have credibility for external investors. If the standard deviation was $200m, it would be impossible to make meaningful comparisons with other corporations, although management may still find it of use.

Integrated profit and loss reporting is a worthwhile endeavour, but there is still a lot of work to be done before investors will feel comfortable. 

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