Download Natural Capital - Identifying implications for economies

Climate Change
November 2013
Natural Capital
Identifying implications for economies
This report explains the concepts of natural capital, the future drivers of change and the
mechanisms to factor natural capital into macroeconomics.
Changes to the availability and functionality of natural capital will become increasingly
material for economies, political agendas and corporates, ultimately impacting
investment decision making.
Natural capital factors – air, land, water and habitats – underpin the ability of economies,
corporates and consumers to operate. As the quantity and quality of natural capital
components change, productivity is impacted. We think climate change vulnerability,
expressed through water and carbon risk, is the most important focal point for investors.
By Zoe Knight, Nick Robins and Wai-Shin Chan
Disclosures and Disclaimer This report must be read with the disclosures and analyst
certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Natural
capital
and the
economy
Lakes
Rainfall
Water
Natural Capital
Nature
Hydro
electricity
Transportation
Industrial
processes
Drinking
water
Sanitation
Purification
Human
health and
welfare
Economic
activity
Conservation
Industrial
effluent
Reduced
quantity
Pollution
Scarcity
Damage
Natural capital
management
This report has been produced in conjunction with Professor Paul Ekins
of the Institute of Sustainable Resources at University College London
Source: HSBC
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Summary
Natural capital provides the environmental basis for economic
activity, but is not routinely captured in forecasting. We think that
natural capital factors are becoming a bigger driver of overall
economic productivity and that, increasingly, policymakers will act to
manage change. Ultimately, this will impact the potential return
profile of assets. Our climate analysis shows that water and carbon
risk management are the most pressing issues to be incorporated
into macroeconomic thinking.
Natural capital and economic activity inherently linked
The economic system does not exist independently from natural capital – it exists within it, with air,
water, land and habitat all providing a variety of environmental functions and life-support mechanisms
that enable growth and development. The contribution of these natural capital components to economic
activity and to society more broadly have been difficult to isolate and analyse because of limited data and
insufficient methodology. This is changing. Natural capital imbalances at a local level (water availability)
and on a global basis (carbon) driven by population, economic activity and technology have increased in
prominence. Disruption has become clearer and governments are starting to manage the risks by
implementing policy. Now, investors are driving demand for natural capital metrics and methodology to
take potential risks and opportunities into account at the macroeconomic level.
How does natural capital fit into the macro economy?
We believe that natural capital intersects with the macro-economy – notably output and prices – in three
main ways: first, natural capital contributes to economic value; second, economic activity can depreciate
natural capital; and third, response measures to restore natural capital can have macro-economic effects.
Natural capital contributes to economic value
Natural capital stocks provide a direct contribution to economic output (eg, water in hydro power) as well
as indirectly by providing services for human welfare (eg, clean drinking water). Natures’ replenishment
system also acts as a regulating mechanism (eg, the water cycle can dissipate effluent). But these benefits
are often taken for granted as positive externalities, and so are often over-used and abused.
Changes to the availability and quality of natural capital resource stocks and the flow of services they
provide will impact economic productivity. For instance, a lack of water availability for cooling power
facilities could result in electricity outages, resulting in suboptimal industrial production, or low water
levels in a canal could delay freight traffic. Aside from these factors, surprise events relating to a natural
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capital resource such as too much water in the form of flooding can result in lower-than-expected growth
or inflationary pressures.
Economic activity can depreciate natural capital
Economic activity can result in natural capital depreciation. In the words of economist, Partha Dasgupta,
“ecosystems are capital assets. Like reproducible capital assets… ecosystems depreciate if they are
misused.” The cost of this can now be accounted for. In India, for example, the World Bank estimates that
natural capital degradation costs USD36-124bn annually, equivalent to 2.6-8.8% of 2009 GDP. For
China, the World Bank estimated costs were USD76bn (2.2% of GDP) in 2007. These costs impair
human health, reduce long-run trend growth and undermine overall ecosystem quality.
Responding to natural capital depletion has macroeconomic implications
Investment is required to maintain natural capital stocks and the ecosystem services that flow from them.
Public funding for natural capital is relatively small compared with other sectors. For instance, the EU15
spends just 0.9% of GDP on the environment, compared with 7.5% on health, 5.3% for education and 1.5%
on defence. Private investment from households and business is also mobilised by government policy,
whether through direct regulation, economic instruments or education that shifts social behaviour. The
UNEP Green Economy assessment concluded that 2% of GDP invested in the environment would enable a
superior growth profile. Importantly, countries can also respond to insufficient natural capital domestically
through trade.
We believe that well-designed policy measures to sustain natural capital are positive for long-run
economic prospects, helping to drive resource productivity, a key competitive factor. For example,
HSBC’s co- head of Asian Economics, Fred Neumann, notes that for China a carbon tax would encourage
gains in overall efficiency by spurring the adoption of more advanced technology, boosting productivity
and sustaining China’s growth.
Chart 1: Summary of how natural capital factors permeate into the macro economy
Quantity and quality of natural capital is a driver of economic activity
Economic productivity can be enhanced or
disrupted because of natural capital factors
Managing natural capital can lead to
regulatory, fiscal or monetary responses
Growth boost / drag
Source: HSBC
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Price pressures
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Prioritising the macroeconomic drivers
We believe that the assessment and management of natural capital is becoming more important,
particularly for countries with large and growing populations with relatively scarce natural capital at a
domestic level, such as China and India. Anticipating the prospect of constraints and/or policy responses
to restore natural capital will enable superior investment decision making. In addition to the natural
capital implications for trend growth, we also highlight the way in which investor expectations have been
challenged by natural shocks, such as extreme weather events (e.g. floods and storms). With climate
change, historical patterns of extreme events do not provide a clear guide to future impacts. Ignoring the
natural capital factor could result in nasty surprises in the difference between expected and realised
growth rates and values.
Looking across the G-20 group of economies, (see table 1) we have highlighted a selection of priority
countries for investor attention.
 National water risk: Saudi Arabia and South Africa are already water scarce (<1,000m3/capita), and
Saudi is deteriorating fast; India, South Korea and Germany are water stressed (<1,700m3/capita) and
India is deteriorating fast.
 Sub-national water risk: National averages, however, can hide significant regional water risk, and
we highlight China and India as particularly exposed (see ‘Scoring climate change risk’, 24
September 2013). We have also conducted a case study of Australia (pages 30 to 33), which has high
national per-capita water availability, but exposure to local droughts prompting the use of
conservation controls, water tariffs and compensation packages.
 National carbon risk: China and the USA have the highest emissions, but Australia, Canada, Saudi
Arabia, South Korea and the USA have the highest per-capita emissions. Russia, Germany and the
USA show the best improvement in carbon intensity (CO2/GDP) (Chart 4). We identify the USA as
the economy within the G-8 with greatest distance to target in terms of carbon improvement, and
China as the country with the greatest alignment of factors – air pollution, water, technology and
carbon – pushing on carbon risk.
In short, there are three questions for investors to ask in relation to natural capital and the macro
economy. (1) What are the critical economic exposures to natural capital? (2) Is this natural capital
exposure well-managed? (3) What are the future risks and resulting economic consequences? Without an
understanding of these relationships, investment expectations could be disappointed.
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Table 1: Water and carbon factors are the most important issues to assess from a natural capital perspective
G20
Countries
Argentina*
Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Italy
Japan
Mexico
Russia
Saudi Arabia
South Africa
South Korea
Turkey
UK
US
World
2020 target
emissions
2011 water
Water 2012 CO2 2012 CO2 % change 2012 CO2 % change
% of world
Water availability†
resource, resource % emissions per capita CO2 / cap intensity of
real GDP
CO2 (Optimum is very high
GDP intensity of availability and rising
change
2012 m3/per capita
MtCO2
2003-2012
2002-2011
fast)
GDP 20032012
0.8%
1.6%
2.1%
2.3%
8.4%
4.2%
5.7%
2.5%
0.8%
3.2%
8.8%
1.9%
1.8%
0.9%
0.6%
2.0%
1.2%
4.5%
25.2%
6,771
21,764
27,551
82,969
2,041
3,168
1,302
1,165
8,332
3,002
3,399
3,563
30,195
85
888
1,340
3,083
2,314
9,001
-7.6%
-13.3%
-8.8%
-8.9%
-4.5%
-5.3%
0.3%
-12.3%
-9.6%
-5.4%
-0.4%
-10.6%
1.9%
-23.6%
-8.8%
-4.1%
-11.1%
-4.9%
-7.9%
190
392
500
620
9,208
383
815
1,823
495
406
1,409
496
1,704
615
446
764
318
530
5,786
4.6
17.3
2.5
17.8
6.8
5.8
10.0
1.5
2.0
6.7
11.0
4.1
11.9
21.7
8.7
15.3
4.3
8.4
18.4
33%
-5%
31%
-11%
102%
-16%
-10%
55%
27%
-21%
2%
11%
7%
32%
1%
26%
29%
-16%
-16%
0.45
0.46
0.44
0.49
2.04
0.17
0.27
1.33
1.16
0.24
0.30
0.50
1.74
1.24
1.45
0.71
0.51
0.22
0.43
-48%
-17%
2%
-16%
-14%
-19%
-21%
-9%
-14%
-16%
-5%
-2%
-27%
-8%
-18%
-5%
-6%
-19%
-21%
34,466
31,693
4.9
4.1*
14%
0.64
0%
High, falling
Very high, falling fast
Very high, falling
Very high, falling
Medium, falling
Medium, falling
Low, rising
Low, falling fast
High, falling
Medium, falling
Medium, falling
Medium, falling fast
Very high, rising
Very low, falling fast
Very low, falling fast
Low, falling
Medium, falling fast
Medium, falling
High, falling
Carbon per capita‡
(Optimum is low per
capita and falling fast)
Low, rising fast
Very high, falling
Low, rising fast
Very high, falling fast
Medium, rising very fast
Medium, falling fast
High, falling
Very low, rising very fast
Low, rising fast
Medium, falling fast
High, rising
Low, rising fast
High, rising
Very high, rising fast
Medium, rising
High, rising fast
Low, rising fast
Medium, falling fast
High, falling fast
Source: HSBC, BP Statistical Review. Note: Argentine latest GDP is for 2010. *2020 targets based on IEA World Energy Outlook 2013 reference scenario CO2 from energy, calculated using UN population forecasts
Water Risk† Resource availability: Very low = <1,000m3/cap (water scarce), low = 1,000-1,700m3/cap (water stress), medium = 1,700-5,000m3/cap, high = 5,000-10,000m3/cap, very high = 10,000+m3/cap.
Water availability per capita change: Falling fast = -10%-50%, falling = -10% -0%, rising = 0-10%, rising fast = 10%-50%, rising very fast = 50%+
Carbon per capita‡ Per capita levels: low = under 5 tCO2/ cap; medium = 5-10 tCO2/ cap; high = 10-15 tCO2/ cap; very high = 15+ tCO2/ cap.
Per capita change: Falling fast = -10%-50%, falling = -10% -0%, rising = 0-10%, rising fast = 10%-50%, rising very fast = 50%+
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Chart 3: Water resource change
2000
4000
1600
3000
1200
2000
800
1000
400
0
Canada
Russia
Brazil
Australia
US
Indonesia
Argentina
Mexico
Japan
France
Turkey
Italy
UK
China
S Korea
Germany
India
S Africa
S Arabia
m3 /year/ cap
5000
0
%
5%
0%
-5%
-10%
-15%
-20%
-25%
Saudi Arabia
Australia
India
Turkey
Mexico
Indonesia
Canada
Brazil
South Africa
US
Argentina
Italy
France
UK
China
South Korea
Japan
Germany
Russia
Chart 2: Water availability and use per capita
Water resource per capita (LHS)
Total water withdrawal per capita (RHS)
Source: Aquastat. Black line denotes absolute scarcity, grey line denotes water stress
Source: Aquastat
Chart 4: % change in CO2 intensity of GDP 2003-2012
Chart 5: Absolute CO2 and CO2 per capita
tCO2/ cap
25
MtCO2
10000
5%
0%
8000
20
-10%
6000
15
4000
10
2000
5
0
0
-15%
-20%
-30%
Russia
Germany
US
UK
France
South Africa
Australia
Canada
Italy
China
Indonesia
India
Saudi Arabia
Turkey
South Korea
Japan
Mexico
Brazil
-25%
Source: World Bank, Thomas Reuters Datastream, BP. Note: Argentina is excluded since
its latest available real GDP data is of 2010.
China
US
India
Russia
Japan
Germany
S Korea
Canada
S Arabia
UK
Brazil
Mexico
Indonesia
S Africa
Italy
Australia
France
Turkey
Argentina
-5%
CO2 emissions (LHS)
CO2 emission per capita (RHS)
Source: HSBC, IEA, BP
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Contents
What is natural capital?
Natural capital concepts
Natural capital components
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7
8
Stocks and flows
11
Conclusions
12
Why is it important?
13
Potential trend growth destabilisation
13
Surprise events bring macro volatility
14
Natural capital losses are significant
15
Increased demand for analysis
16
Conclusions
17
How does it fit into the macroeconomy?
18
Natural capital contribution
18
Cost of depletion
20
Investment to maintain the capital stock
22
Increasing policy drivers will become the norm
24
Conclusions
25
What should investors do?
26
Incorporating natural capital
26
1) Identify the natural capital contribution
28
2) Evaluate natural capital management
28
3) Assess future risks and economic consequences
29
Conclusions
31
6
Appendix 1: Data, indices,
accounting, modelling
32
Data monitoring has improved
32
Indices – further development
33
Adjusted net income indices aid natural capital accounting 34
Economic modelling
36
References
38
Disclosure appendix
43
Disclaimer
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What is natural capital?
 Natural capital is water, air, land and habitat
 Natural capital comprises the ‘stock’ of natural resources together
with the ‘flow’ of environmental services they provide
 As stocks depreciate, the ability of natural capital to provide flow
service provision is diminished
Natural capital concepts
The concept of natural capital relates to the
resources (stocks, eg, freshwater) and
environmental functions (flows, eg, water
provision for plant growth) that provide essential
functions to society. For a variety of reasons,
these are often not fully factored into policy
decisions, economic growth projections and
corporate accounting.
Natural capital is resources, together with the
environmental functions they provide and the
ecosystems that support them and are defined as
four categories, water (fresh and marine), air,
land (including minerals and landscape) and
habitats (the summation of water, land and air,
including the ecosystems and plants and species
habitats support).
Previously, when the population was smaller and
industrialisation was lower, nature’s
replenishment cycle was more than adequate so
that natural capital was perceived as unlimited.
Now, more people, increasing economic activity
and extractive technologies are creating
imbalances in natural capital on a regional (water)
and global (air) basis, which creates disruption.
We argue that natural capital degradation and
depletion will become increasingly material for
economies, political agendas and corporates,
ultimately impacting investment decisions and the
value of assets.
Haven’t we been here before?
The concept of resource scarcity in economic
thinking is not new. In 1798, Malthus thought that
the provision of food would eventually be
constrained in the future when the growth rate of
the population outstripped the ability to produce
food given the limited capacity of the earth.
"The power of population is so superior to the
power of the earth to produce subsistence for
man, that premature death must in some shape or
other visit the human race.”
David Ricardo (1817) and John-Stuart Mill (1862)
expanded upon the idea that the economy would
stop expanding, whilst Jevons (1865) warned
about the potential effect that exhausting coal
reserves could have on British competitiveness.
Jevons noted that even with technological
improvements (increased efficiency of the steam
engine) the consumption of coal had increased,
leading to the so-called ‘Jevons Paradox’,
whereby an improvement in resource efficiency
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"It is wholly a confusion of ideas to suppose that
the economical use of fuel is equivalent to a
diminished consumption. The very contrary is the
truth.. ..[E]very. . .improvement of the engine,
when effected, does but accelerate anew the
consumption of coal."
More recently, in 1972 Meadows et al used a
System Dynamics model to simulate the effects of
changes in industrialisation, population, food
production, non-renewable resources and
environmental degradation based upon past
trends. The results found that under most
scenarios the planet’s growth limitation would be
reached within the next century, even with
optimistic efficiency and technology assumptions.
At the time, the ‘Limits to Growth’ concept
gained substantial interest as it coincided with
rising energy prices. A 2008 study ‘A comparison
of the limits to growth with 30 years of reality’
found that the 1972 publication gave reasonably
accurate projections on climate change. The study
noted that forecasts for an increase in global CO2
concentrations were for 380 ppm in 2000 (from
320ppm in 1970); in reality the concentration in
2000 was 369 ppm. Today levels are 395ppm.
Technology can break the link
In reality, technological capabilities and trade
have opened up new channels of economic
activity. Going forward, we expect technological
shifts to continue to have a significant impact
upon production capabilities in a number of
sectors that are naturally capital intensive, such as
energy, industry and transport (please see
‘Disruptive Technologies’, 7 October 2013).
Local shortages create imbalances
Technology, trade and pricing mechanisms will
provide substitutes and solutions for some
industries in some regions. The point here is that
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natural capital is all pervasive, so that significant
localised disruption to a natural capital factor
means change to economic productivity. In some
cases, the financial consequences may be
negligible, but in others the natural capital factor
will result in significant changes to the way value
is created.
Natural capital components
The core natural capital elements, air, water and
land together comprise habitats, but each are
made up of sub-components.
Air: Quality control
Air comprises the stocks of different gases in the
atmosphere. Atmospheric and climatological
processes can affect ecosystems through air
quality, temperature, rainfall and wind. Of the
various air functions, quality has a significant
direct bearing on the economy through pollution
control measures, but air temperature also is a
contributor towards changes in the water cycle as
warmer weather results in increased evaporation.
Chart 6 shows the differences in air quality
between G20 countries, as recorded by annual
mean PM 10 concentrations. The World Health
Organisation recommends that the annual mean
should be below 20 micrograms per cubic metre.
Half the G20 exceed that level.
Chart 6: Air quality varies between countries
PM 10, ug/ cu.m
100
80
60
40
Threshold lev el
20
0
S Arabia
Indonesi
China
Argentin
India
Turkey
S Korea
Mexico
Japan
Italy
Brazil
S Africa
US
German
Canada
Russia
Australia
UK
France
leads to an increase in consumption of the
resource over the long run.
Source: World Bank
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Generally air quality is managed through
regulation such as emissions caps on energy and
industrial facilities and product manufacturers,
with fines payable for breaching them. In
addition, product standards, such as for vehicle
emissions, have been a clear driver of innovation
in the industry. Currently, European auto
manufacturers are subject to the tightest targets.
Chart 7: Target CO2 emission standards for passenger vehicles
gCO2/km
170
162
155
150
130
130
110
oceanic). Water availability depends on the level
of water in reservoirs, interactions with the
atmosphere (rainfall, glacial melt), runoff and
river discharge, and tides and ocean currents.
Water provides environmental services that
directly benefit human welfare and also the
environment more generally. Water can provide a
direct input into economic production
(hydropower, wheat crops) and human welfare
(drinking water) as well as providing a habitat for
life (fish stocks), transport and tourism (canals,
rivers and lakes). Water also provides regulating
functions such as the natural filtering of water
through the dispersion and dilution of emissions.
Regional shortages already exist
China
USA
EU
Source: World Resources Institute, China Environmental Standards Organisation,
Environmental Protection Agency, EU. Emission standards to be achieved by 2015 in
China and EU, 2016 in the USA
In 2013, increasing air pollution has captured the
headlines, particularly in China. Most recently,
the seriousness of the problem has escalated with
a study from the World Health Organisation
demonstrating the link between pollution and
cancer (please see ‘Air pollution causes cancer’
25 October 2013). The policy mechanism to
tackle air pollution is relatively straightforward –
legislation, with fines for breaching standards.
Some 85 countries (representing 83% of global
emissions) have targets in place for reducing
greenhouse gas emissions in response to the
global consensus of keeping temperature rises to
below 2°C. We expect the enforcement of targets
to tighten, which means tighter legislation on
emission standards and pollution control.
Water: Availability and quality
Water comprises both the freshwater resources
within a nation (surface and underground
aquifers) and also marine waters (coastal and
Already, pockets of water scarcity are an
increasing problem. The water cycle is changing
in response to climate change, while increasing
demand for water-intensive activities continues
unabated. The water cycle is intensifying at about
twice the rate predicted by global climate models.
Higher temperatures increase evaporation, so that
8% more moisture is absorbed for every 1°C of
warming. Essentially, dry regions are already
getting drier and wet areas are getting wetter (see
‘Water stress: Analysing the global challenges’,
19 September 2012.
The most water-intensive sectors are agriculture,
energy, mining and utilities. Any disruption to
water supply or quality for these industries means
that production costs will likely increase. This is
already playing out on a case-by-case basis in the
mining industry. For instance, in Chile, which
contributes 34% to global copper production,
more than 90% of copper production came from
water-stressed to water-scarce regions in 2010. So
far, desalination technology is propping up the
mining industry there, but that translates into
higher costs than for other regions.
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Chart 8: Water costs are more where it is scarce
5
0
1.4
1.8
1.4
1.5
1.6
Australia
Peru
Chile
Chilean fresh
water
Transportation, operating cost
Transportation, capital cost
Desalination, operating cost and capital cost
Source: Wood Mackenzie, CRU Group, Mining Council
Chart 8 shows that the cost of transporting water
to a copper mine in Chile makes projects 3.6
times more expensive than projects in Australia.
While clean, unpolluted water is obviously an
important factor for human health and the
environment, water quality is not always relevant
or imperative for every economic sector. Pollution
clearly affects drinking water but is less
detrimental as a power industry coolant.
We think that water is the most tangible natural
capital element to look at for modelling
productivity in the context of economic activity,
and corporates more generally. For countries that
have already been exposed to drought, such as
Australia, and where managing water is already a
priority, detailed regional and usage statistics are
available (albeit buried in the national statistics
offices, or meteorological offices).
We have previously assessed water challenges
from an industry perspective in ‘No water, no
power: Is there enough water to fuel China’s
power expansion’, 19 September 2012, and
‘China Coal and Power: The water-related
challenges of China’s coal and power industries’,
18 June 2013.
Land: Agriculture and carbon risk
Land, importantly, includes fossil fuels and
minerals, which are used as inputs to energy and
10
While small in an economic context, contributing
just 3.14% of world GDP in 2010, agricultural
production is clearly significant from a
humanitarian perspective and employs 30% of the
global workforce. In 2011, 4.9bn hectares of land
were in use for agricultural purposes globally.
This is 37% of the total area of all countries and is
5x the size of the USA.
Agricultural yields are the best expression of how
combinations of natural capital components work
together. Yields are directly impacted by
temperatures during the growing season, water
availability and soil nutrition. Chart 9 shows that
yields have plateaued, while land area harvested is
still growing.
Clearly, disruption to natural capital factors has a
knock-on effect for agricultural productivity,
which can result in inflationary pressures (see
‘Less bread for your dough’ 20 August 2012) if
supply is less than expected. We looked at the
impact of climate change factors in ‘Agriculture:
Double Trouble’ 12 December 2011.
Chart 9: Agricultural land has increased, yields have
plateaued
Area Harvested (LHS)
Ha
180
ton/ Ha
Yield (RHS)
6
160
5
140
4
120
3
100
80
Source: FAO Stat
2012
1
1.8
2002
2
Agriculture: small in value, big in importance
1992
3
1.8
1982
1
1972
4
1962
6
industrial production, soil, which allows
agricultural production, as well as geologies and
landscapes more broadly.
USD/m3
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Chart 10: The carbon budget
(GtC)
1600
1400
1200
1000
800
600
400
200
0
1,560
349
1,210
309
1,000
269
>33%
>50%
Non-CO2 forcings
Remaining budget
Remaining
budget of
269GtC
for >66%
chance of
below 2°C
>66%
Emitted by 2011
779
Carbon
embedded
in fossil fuel
reserves
Source: HSBC, Intergovernmental Panel on Climate Change
Habitats: catch-all category
Habitats vary considerably depending upon natural
conditions involving climate, soil, water and other
locational characteristics. It includes woodlands,
grasslands, wetlands, freshwater (lakes, rivers,
streams, etc), coastal areas (cliffs, sand dunes, etc)
and marine habitats. From a climate perspective,
forest habitat is the issue to focus on because of its
climate regulation properties for CO2.
4150
4100
4050
2010
2008
2006
2004
2002
2000
1998
World
1996
3950
1994
4000
1992
A theme that has increased in prominence in the
debate of climate change risk, and which falls
under the ‘land’ category of natural capital, is
asset stranding of fossil fuels. The current
thinking is that to have a 50% chance of limiting
the rise in global temperatures to 2°C, only a third
of fossil fuel reserves can be burned before 2050.
Legislation is already in place to reduce CO2, but
there is a wide variation in the scope of tackling a
carbon budget with existing initiatives (see
‘Investing within a carbon budget’, 30 September
2013). While the carbon budget is a driver of
action, in the larger short-term incentive, in our
view, is the by-product of fossil fuel combustion
and particularly coal, air pollution.
Chart 11: World Forest area on a steadily declining trend
(million ha)
4200
1990
Fossil Fuels: plenty of reserves but carbon risk
Source: FAOSTAT
Natural capital data is improving
While current data sources to quantify these systems
are by no means comprehensive, they provide
information that is a considerable improvement on
what was available even a few years ago. Generally,
there is more internationally available and consistent
data for issues that are further up the policy agenda,
such as air emissions and water. We expect metrics
to consider natural capital components to become
more widely available as quantification increasingly
becomes the norm.
Stocks and flows
Stocks are the underlying resources
Together, air, water, land and habitats provide a
stock of basic resources that can be used for
economic activity. ‘Goods’ (eg, timber, that are
inputs into production or consumption) are
usually provided by the components (plants,
minerals, etc).
Flows are natures’ services
The ‘services’ (eg, waste recycling) are usually
provided by the processes (eg, biogeochemical
cycling). Service providing processes can be
classified into the following categories.
Source functions are those that contribute directly
to the economy. A resource stock can provide
more than one source function at once; for
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instance, a river can be used for drinking water,
and as a method of transportation.
Sink functions are the capacity of natural capital
to deal with the wastes from human activity, eg,
the dilution of emissions in water, or carbon
sequestration by forests.
The source and sink functions can be in competition
with each other, which might create conflict. For
instance, as well as drinking water, the river might
provide food in the form of fish, and be an outlet for
industrial effluent. The river ecosystem can process
some waste, but there will be a threshold beyond
which the river ceases to be able to provide the
drinking water and habitat functions. Where there
are conflicts, governments have to decide how to
best manage the competing pressures through policy.
Unfortunately economic activity too often produces
negative externalities into the natural capital stock
(greenhouse gases, air and water pollution), which
can undermine the natural capital ability to provide
the necessary regulating services. This can result in a
vicious cycle of environmental degeneration. Table 2
shows examples of the source and sink functions of
natural capital components.
Table 2: Natural capital components and source & sink functions
Air: Properties
Water: Ocean
Land: Soil
Land: Soil
Habitat: Forest
Source
Sink
Oxygen
Transportation
Food production
Plant nutrients
Oxygen
Greenhouse gas
Dilutes shipping waste
Animal waste
Carbon sequestration
Carbon Dioxide
Source: HSBC
Natural capital stocks and flows are of strategic
relevance for several industries and can make
them more or less productive and profitable. For
instance, very energy-intensive industries are
often located near stable and low-cost energy
sources (eg, hydropower), while the construction
of wind turbine blades often takes place in
factories located near ports for ease of transport.
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Conclusions
We believe the priority natural capital
components to assess are water and carbon risk,
which manifests through CO2 emissions. More
specifically, this means incorporating analysis of
how temperature rises translate into changes in the
water cycle in a given region, and how the
management of CO2 emissions in relation to
reduction goals translates into policy change.
Changes in natural capital stocks will, in our
view, affect macro indicators such as GDP and
unemployment, as well as corporate profits. It is
important to keep track of both quantity and
quality of resources and attempt to comprehend
the feedback effects that changes in these would
have on the physical economy. This is especially
important in situations where there is an element
of critical natural capital (for example,
agricultural production, when it is a significant
contributor to exports), falling below a level that
would fundamentally affect or preclude certain
kinds of economic activity.
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Why is it important?
 Trend growth potential may be destabilised in response to natural
capital changes
 Natural-capital-related event disruption impacts economic output
in the short run
 Regulatory changes are being implemented to tackle the issues,
these have longer-term consequences
Potential trend growth
destabilisation
Natures’ cycle of replenishment and evolution
alters the stock of natural capital over time. Now,
the effects of climate change (global average land
temperatures are 0.8°C higher than they were in
1880) in conjunction with population growth and
economic activity, are speeding up imbalances
between the natural capital stock and its ability to
perform environmental functions.
Climate change is the archetypal boiling frog. The
slow, shifting bias of seasonal temperatures
(please see ‘Tackling global warming’, 1 August
2013) is contributing to changes in the water
cycle. The physical effects of climate change
manifest through water availability, so that past
hydrological trends are no longer indicative of
future availability as climate change alters rainfall
trends and destabilises glacial melt. This can lead
to changes to regular events such as the monsoon,
and sudden disruptive ones like floods.
Variation of the Indian monsoon impacts
productivity
India is heavily dependent on the monsoon season,
and among the G20 consumes the largest volume
of water at around 600bn m3/annum, with 90%
used for agriculture. In 2011, agriculture
contributed 14% to the Indian economy and
livelihood to over 70% of the population.
Poor irrigation infrastructure in India means that
60% of agricultural land area is dependent on
monsoon rainfall. The volume of water during the
monsoon season can be measured on a regular
basis so that changing trends can be identified.
Chart 12: Variation in the monsoon correlates with
agricultural activity
Monsoon anomaly
Agriculture (RHS)
%
20
15
10
5
0
-5
-10
-15
-20
-25
GDP (RHS)
% y/y
16
12
8
4
0
-4
1980
1985
1990
1995
2000
2005
2010
-8
Source: Indian planning commission
Rainfall shortfalls during the monsoon season
correlate with agricultural output falls, as shown in
Chart 12. In June 2013, the World Bank explored
what increasing temperatures would mean for the
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Indian monsoon. It found that global mean warming
approaching 4°C would result in a 10% increase in
annual mean monsoon intensity and a 15% increase
in year-to-year variability of Indian summer
monsoon rainfall compared with normal levels
during the first half of the 20th century. This would
clearly impact agricultural activity.
Surprise events bring macro
volatility
Chart 14: Thai quarterly GDP progression (flood H2 2011)
20%
Chart 13: Australian quarterly GDP progression
6%
5%
4%
Flood
Dec 2010 ->
3%
2%
GDP growth YoY (%)
Source: Thomson Reuters Datastream
Flooding in Thailand
In the monsoon season in H2 2011, Thailand
witnessed floods that inundated 66 of the
country’s 75 provinces. In the immediate
Q1-13
Q1-12
Q1-11
Q1-10
Q1-09
Q1-08
Q1-07
Q1-06
Q1-05
Q1-04
1%
Q1-03
5%
0%
Q1-13
Q1-12
Q1-11
Q1-08
Q1-07
Q1-06
Q1-05
Q1-04
Q1-03
-10%
Q1-10
Flood
H2 2011 ->
Q1-02
In December 2010, Queensland in Australia
received 2.5x the normal volume of rainfall
resulting in disruption to the coal mining industry.
Queensland usually produces 40% of global coking
coal exports, but in Q1 2011 export volumes were
down 27% year on year. GDP fell -0.5% q/q from
Q4 2010 to Q1 over the period (see ‘Australian
GDP washed out’, 1 June 2011). In addition, the
coal price, though not reaching pre-crisis levels, hit
a high of USD138.5/t in January 2011.
Q1-02
10%
-5%
Flooding in Australia
14
15%
Q1-09
Recent events in the Philippines provide a stark
reminder of the destruction of which nature is
capable. Previously, Australia and Thailand have
been subject to extreme floods.
0%
aftermath of the disaster, HSBC revised 2011
GDP forecasts down from 4.9% to 3.9% (Floods
in Thailand, 10 October 2011) and the Thai
finance ministry cut its 2011 growth forecast from
4.0% to 3.7%. In addition, the Bank of Thailand
cut policy rates by 25bp to 3.25% “to support the
economy’s recovery from devastating floods”.
GDP growth YoY (%)
Source: IMF, Thomson Reuters Datastream
The World Bank estimated the damage cost
USD45.7bn, while economic growth fell 11% q/q
in Q4 2011, resulting an 8.8% fall from Q4 2010.
According to the Office of Insurance Commission
(OIC), insured losses by the end of the year were
only USD10.8bn, implying that the majority of
the damage was uninsured.
The biggest damage was in the manufacturing
sector with a total loss of USD32bn (around 9%
of GDP) (see Asian Economics Q2 2012: When
you least expect it, 29 March 2012, Frederic
Neumann). Flooding seriously affected industrial
manufacturing and transport infrastructure
resulting in far-reaching impacts on the global
supply chain of automotive and electronic
components. Thailand is a major exporter of
auto/electronic components – electronic
components constituted over 16% of its total
export in 2010; auto parts accounted for 35% of
total exports in 2011.
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 In terms of biodiversity, the rate of species
extinction in recent decades is estimated to be
between 100 and 1,000 times faster than the
‘natural’ rate. Two thirds of the ecosystem
services examined in the Millennium
Assessment have been degraded or used
unsustainably over the past 50 years, including
freshwater, fisheries, air and water purification.
 The TEEB (The Economics of Ecosystems
and Biodiversity) initiative is a global effort to
draw attention to the economic benefits of
biodiversity, including the growing cost of
biodiversity loss and ecosystem degradation.
The idea behind TEEB is to acknowledge the
plurality of values (including monetary, nonmonetary, ethical and aesthetic), which people
hold for nature. TEEB’s aim is to mainstream
ecosystem services into policy making.
100%
80%
60%
40%
Natural capital
Produced capital
UK
Japan
US
France
Brazil
Germany
India
China
0%
S.Africa
20%
Canada
 The Millennium Ecosystem Assessment
offered a preliminary account of the extent of
natural capital degradation and loss,
particularly regarding biodiversity,
ecosystems and the services they provide.
Chart 15: Composition of the capital base in selected G20
countries (2008)
Australia
Increasing incidences of unsustainable practices
has led to recognition among policymakers that
maintaining natural capital has economic value. In
2011, in the ‘Towards a Green Economy’ report,
economist Partha Dasgupta noted “ecosystems are
capital assets. Like reproducible capital
assets…ecosystems depreciate if they are
misused.” Both the Millennium Ecosystem
Assessment (MEA 2005) and UNEP’s Green
Economy Report (UNEP, 2011) show that the
economic growth of recent decades, while being
underpinned by the contribution of nature, did not
allow natural capital to regenerate and brought
about substantial negative environmental impacts.
S.Arabia
Independent assessments
 The Inclusive Wealth Report, produced by
UNEP and the UN University’s International
Human Dimensions programme on global
environmental change, highlighted the
varying balance of natural, produced and
human capital in the country-level asset mix,
as shown in Chart 15. The report showed that
in many countries natural capital has been
declining in the past two decades. In some
cases, such as for the UK and Saudi Arabia,
this is due to the depletion of fossil fuels.
Russia
Natural capital losses are
significant
Human capital
Source: UNEP and UNU-IHDP: Inclusive Wealth Report 2012
More work on metrics
In tandem, work is underway to create the metrics
to monitor changing levels of natural capital by
country. In addition, a variety of organisations
have also launched composite indices and
accounting. These give an overview of country-tocountry environmental differences and provide a
high level starting point for understanding the
most critical issues across geographies.
Here it is worth reiterating that data gathering and
methodologies are still in their infancy, and a
number of issues can affect the outcome of the
indices, including weighting, aggregation and data
availability between different resources across
countries. It is therefore necessary to be aware of
the limitations of each index so as not to
misinterpret or over-rely on their results.
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Nevertheless, we think the composite indices are a
good starting point for assessing the relative
strengths of country natural capital positioning.
One of the most influential indices has been Yale
University’s Environmental Performance Index,
which is composed of 22 performance indicators
representing ecosystem vitality and environmental
health, and covers 132 countries. The breakdown
of components is given in Appendix 1. In our
view, the value of composite indices will become
much greater over time as trends in natural capital
factors will emerge.
We believe that country climate vulnerability and,
in particular, water and carbon risks are the most
important factors to look at when determining
natural capital risks.
Increased demand for analysis
UK Natural Capital Committee
Some governments are increasing commitments to
identifying how to account for and value natural
capital. For instance, the UK Government set up
the Natural Capital Committee in 2012 as an
independent body to advise on the effects of
natural environment on the performance of the
economy and individual well-being. The NCC
work programme includes:
1
Producing an annual report on the State of
Natural Capital;
2
Developing experimental natural capital
national accounts and exploring the links with
corporate natural capital accounting;
3
Working with land owners, businesses and
accounting bodies to encourage the take-up of
corporate natural capital accounting; and
4
Working with academics and research
councils to identify research priorities.
The aim is for natural capital metrics to be
included in economic accounting by 2020.
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Europe is aiming to enhance natural capital
The European Commission recently published a
paper on ‘Green Infrastructure – Enhancing
Europe’s natural capital’, building on its
commitment to resource efficiency. The paper
provides guidance on how to integrate green
infrastructure into the implementation of key policy
areas (eg, transport and energy, climate change
mitigation and adaptation among others). The plan
is to set up a financing facility to support green
infrastructure projects by 2014, complete a study
on the ways to implement green infrastructure
across an EU-wide network by the end of 2015 and
publish further recommendations by 2017.
Natural capital declaration
Investors are also recognising the importance of
natural capital, which was one of the key themes at
the Rio +20 summit last year. Then, governments
agreed on the need ‘for broader measures of
progress to complement GDP’, and alongside this
over 50 countries and nearly 90 companies agreed
on specific initiatives to factor in the value of
natural assets into decision-making.
During the summit, financial institutions
including banks, investors and insurance firms
committed to the Natural Capital Declaration, an
initiative for signatories to change their business
models to reflect the materiality of natural capital
for the financial sector. More than 40 CEOs of
banks, investors and insurers worldwide signed
the declaration. The four commitments in the
Natural Capital Declaration are:
 Understanding impacts and dependencies on
natural capital;
 Embed natural capital considerations in loans,
equities, bonds and insurance products;
 Embed natural capital in financial accounts; and
 Disclose and report on natural capital.
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Investors know that natural capital risks are
increasing
Investors are increasingly recognising that in a
bear-case scenario regulation targeting
greenhouse gases and/or the physical effects of
climate change may result in ‘asset stranding’, ie,
that the expected value of an asset may not be
realised. When an element of natural capital
breaches a critical threshold and can no longer be
utilised, the underlying asset is stranded. This
discussion has mostly focused on the fossil fuel
industry in relation to CO2-reduction goals, but a
driver to stranding could also be an absolute
resource shortage (such as water).
Regulatory drivers to manage natural capital (such
as limiting greenhouse gases) are likely to change
the demand for a particular good so that the
‘stranding’ effect is likely to impact an industry
more broadly. Realised asset value would fall to
zero with complete asset stranding.
and Germany. However, all countries are
impacted by natural capital factors.
So far, the analysis of weather-related natural
capital disruption has naturally been retrospective
because the ability to predict the scale and timing
of extreme weather events is challenging.
Climate scientists and meteorological
organisations are focusing on assessing the
probability of an increased likelihood of extremes
however, and up-to-date analysis on adapting to
climate change will be published in the ‘Impacts,
Adaptation and Vulnerability’ report from the
Intergovernmental Panel on Climate Change
(IPCC) to be released in April 2014.
This is most relevant for economies and
companies exposed to fossil fuels, such as oil and
mining. We have looked at the concept of
stranded assets in relation to regulating
greenhouse gas emissions to mitigate global
warming in ‘Coal and carbon’, 21 June 2012, and
‘Oil & carbon revisited: Value at risk from
‘unburnable’ reserves’ 25 January 2013.
Conclusions
Clearly, identifying the timing of an extreme
disruptive weather event that will impact natural
capital is difficult. However, we identified which
countries are the most vulnerable to climate
change factors in ‘Scoring climate change risk’,
24 September 2013. This is a good framework to
prioritise country analysis. Our analysis shows
that India, China, Indonesia, South Africa and
Brazil are most vulnerable to extreme events
relating to climate. The least vulnerable G20
countries are Canada, South Korea, USA, Japan
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How does it fit into the
macro-economy?
 Economic growth relies on labour, capital and natural capital
 Economic activity uses up natural capital stocks; to maintain
quality and quantity of stocks spend is necessary
 No easy plug in methodology, but macroeconomic tools to
manage natural capital include taxes, subsidies and regulation
Natural capital contribution
At the heart of the natural capital concept lies the
stock of resources used to create goods and
services, and the flow of environmental services
these resources provide. While a number of the
resources, such as coal, oil and timber, are well
quantified in markets, there are many others that
are not, which can lead to stocks and flows being
significantly undervalued or ignored altogether.
However, it is often not straightforward to apply
common economic valuation techniques to these.
It is important to relate the natural capital
variables to demographic and economic factors in
order to incorporate them into any analysis, which
is more difficult. Natural capital flows affect
people and the economy, which in turn affects the
natural capital stock. Increasing human population
sizes and urban concentrations will affect many of
the characteristics of air, water, land and habitats.
Substantial development of analytical models and
techniques has taken place to try to give greater
weight to, and generate more reliable insights
into, natural capital issues in economic analyses.
But substantial further development of these
18
models and techniques is required before the
economic issues relating to natural capital can be
fully taken into account.
Theoretical approach: natural capital in the
production function
The theory of capital as a factor of production and
driver of economic growth is long established in
economics literature.
In the traditional production function, output is a
function of manufactured capital, which includes
all the machinery and tools used in production as
well as the value of the buildings in which formal
economic activity is carried out, and labour,
which represents the total number of workers.
Labour is needed to execute work, either directly
or through the use of capital, and contributes to
the creation of value. Natural capital and
environmental services are missing in this simple
but quite standard representation of the factors
driving economic growth.
Total Factor Productivity (TFP) captures
efficiency
Over time, output is simply a function of how
much capital and labour an economy employs,
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and importantly, the efficiency with which it
combines these for full effect. The latter is total
factor productivity. Since TFP cannot be directly
observed, it is calculated as a residual: after we
account for the amount of capital and labour that
was added to an economy in a given year, the part
of growth not directly explained by the addition of
these inputs must have been achieved through
gains in productivity.
Testing the hypothesis that natural capital
TFP is routinely used to track technological
progress and efficiency improvement. Indeed, in
‘An Inconvenient Truth’, 1 August 2013, Co-Head
of Asian economics Fred Neumann shows that the
slowdown in economic growth in Asia is in part
down to a decline in TFP growth. In reality,
elements of natural capital change are probably
included by the TFP residual, but data availability
and understanding of the relationship between
natural capital and economic growth has hindered
isolation of the natural capital variable. We think
this is changing because of increased
measurement of resource stocks.
It is therefore difficult to demonstrate the true
relationship between a change in an element of
the natural capital stock (eg, less clean air) with
its impact on people (worse health) and the
resulting implications for contribution to growth
(lower labour productivity).
At this point, however, it is worth remembering
that analysis of the contribution of natural capital
to the macro-economy is so far in its infancy,
partly because a common assumption in economics
has been that substitution between manufactured
and natural capital is unconstrained, an assumption
that now seems increasingly questionable. The
balance between capital stocks has shifted
dramatically, such that in many contexts it is
natural capital that is now the scarce factor.
Why is it so difficult to include natural
capital in GDP growth forecasting?
In a more realistic production function, natural
capital would combine with manufactured and
human capital as an input to production. This is
much easier said than done for several reasons.
contributes to growth is difficult because
isolating the relationships is complex
Natural processes are complex, even before
assessing how they relate to growth. Many of the
most fundamental environmental functions, such
as climate regulation, operate globally and involve
many natural systems in sometimes little
understood ways.
But isn’t the labour relationship with growth
also complicated?
Measuring the contribution of labour to growth is
relatively straight forward by comparison. At any
moment in time, there is a fixed stock of workers
who are of working age (which clearly changes
over time because of demographics and net
migration). Of these, some will gain higher
education, and there are techniques to quantify
and aggregate these gains, such that the
contribution to growth from an increase in the
number of workers that achieve a given level of
education can be modelled.
So why can’t we measure natural capital
productivity?
For natural capital, it is difficult to determine how
productive the fixed stock is. Often the stock
component is quantifiable (litres of water, barrels
of oil, hectares of land), as is the flow (X litres of
water to produce Y KWh of hydro-electricity, A
barrels of oil to drive B km), but the overall
contribution of the resource to economic activity
is dependent on other variables.
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Example: water and coal for electricity
Electricity can be produced using clean or
polluting sources. In the production of electricity
with the ‘clean’ source, hydro, the value of the
end electricity output is known by the price that is
paid for it, but the value of water in producing it is
effectively a residual: the price of electricity (in
part set by another source of power generation)
less the cost of all the labour and capital inputs to
generate the power.
If the quantity of water declines, so will the power
output from the dam, and the value of that can be
calculated and accounted for as the value of the
water reduction, but the effect on the macroeconomy will depend on the availability of other
power supplies (such as coal) to supplement the
reduction in hydro-electric power, and the cost of
these substitute resources.
The macroeconomic contribution of the water
crucially depends not only on itself but on the
availability of other variables as well.
Furthermore, the electricity end user can produce
the same number of goods because of the
substitutability between the ‘good’ and the ‘bad’.
It gets more complicated
Economic activity, for instance agriculture, can
also be dependent on two interdependent natural
capital components.
Example: land, its sub components and
contribution to agricultural productivity
In the case of assessing the contribution of soil to
agricultural productivity the main stock of the
resource – land – has sub categories such as soil
and interdependencies with other natural capital
factors such as water and air (productivity
depends on the right air temperatures during the
growing season).
Soil allows food to be grown with varying
productivity depending on other inputs, but it also
acts as a sink for storing carbon, permits the
20
seepage of water to recharge groundwater and
supports biodiversity. Of these examples, only
food has a clearly marketable output to give a
direct sense of the value of the contribution of soil
to the economy.
The contribution of the other inputs to food
production (machinery, fertiliser, labour) is
relatively easy to identify because they are mostly
purchased. However, the separation of the
contribution of soil to food production from that
of water (especially rain) is effectively
impossible. Either too much or too little water can
damage agricultural productivity, but by how
much will also depend on the type of soil, the crop
and timing of the water deficit or surplus.
Separating out these different economic
contributions even at a farm level is very hard
indeed. At the level of the macro-economy, it is
only possible with the most sweeping general
assumptions that abstract almost completely from
the detail of the actual processes involved.
These interdependencies provide insight into why
assessing, and by extension forecasting, the
contribution to economic growth from the natural
capital factor is so difficult.
Cost of depletion
Mainly quantifying individual cases
On a more positive note, it is much easier to assess
the impact of economic activity on natural capital,
e.g., the polluting effect of industrial activity and
the resulting costs of the health impact.
In many instances, the costs arising from the
depreciation of natural capital, including ecosystems,
are externalised onto society. This is due in part to
market signals that account imperfectly for the
economic value of natural capital goods and
services, and for the costs of related degradation
and loss, but also due to the lack of appropriate
measurement and valuation methodologies.
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Costs are usually calculated as environmental
degradation and expressed in terms of GDP. It is
easier to quantify negative externalities than
positive ones because there is a ‘forced’ cost to
‘fix’ the problem when activity depletes resources
to critical levels, such as purifying drinking water,
increasing health treatment for pollution, or
infrastructure rebuild after natural capital disasters.
Example: The many costs of forest depletion
The presence of forests is crucial for timber
production, such that depletion will impact the
profitability of firms. In addition, excessive
deforestation can also lead to higher river
sedimentation, reducing the use of waterways for
the transport of goods and people.
The creation of roads is then seen as a solution to
the problem, but it is in fact a cost required to
replace a (free) function previously offered by
nature, as is the cost of dredging, an action
implemented to restore an environmental
function, and a cost that could have been avoided
by maintaining the forest.
Interestingly, the cost of replacement of these
functions very often will show up in GDP as an
increase in economic output, when in fact such
costs are only replacing goods and services that
were previously provided for free. GDP in such
cases systematically overstates the actual net gain
from such economic replacement activities.
Vicious cycle of increasing costs as stocks are
diminished below sustainable thresholds
Initially, small costs can escalate into significant
ones as more is required to achieve the same
productivity. For example, if fish stocks are
depleted, more capital investment (eg, in
expanding the fleet and more nets, and more
employment to operate them) will be required to
maintain the catch, the cost and price of which
will increase. Further economic growth will add
to the demand for fish and raise the price further.
Technology can provide initial solutions, but
also comes at a cost
Initially, if a natural capital element becomes
scarcer because of increased use, solutions can be
found through technology, but this too is likely to
result in higher costs – the need for desalination
technology in the mining industry is a good
example. In some cases this may lead to a
situation where the state subsidises unsustainable
practices, such as water for agricultural irrigation,
leading to even greater inefficiency and depleting
the natural capital factor further. In other cases,
corporates may face the cost increase.
The costs of degradation vary widely
(depending on the assumptions used)
In India, the country we consider most vulnerable
to water and climate risk, the World Bank
calculates that natural capital degradation costs
between USD36bn and USD124bn annually,
equivalent to 2.6-8.8% of 2009 GDP. Chart 16
shows the midpoint estimate of the damage costs
for each category assessed.
Chart 16: Annual cost of environmental damage in India
USD bn
50
40
30
20
10
0
Env ironmental demage
Share of total cost
Annual cost of
environmental
degradation: USD80bn
60%
50%
40%
30%
20%
10%
0%
Air pollution Crop lands Water Pastures
Forest
degradation
degradation degradation
Note: Air pollution is summation of both outdoor and indoor air pollution and Water
comprises supply, sanitation and hygiene. Source: World Bank, 2013
The report considers the damage costs of urban air
pollution, including particulate matter and lead,
inadequate water supply, poor sanitation and
hygiene and agricultural damage – from soil
salinity, water logging and soil erosion, rangeland
degradation and deforestation.
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The calculation does not include damage from
natural disasters, but separately the World Bank
notes that India incurred damages equivalent to
INR150bn (USD2.3bn) per year from 1953 to
2009 from natural disasters.
In a separate report on China, the World Bank
estimates that the costs of environmental
degradation and resource depletion would
approach 10% of GDP by 2030. Of this, air
pollution would account for 6.5%, water pollution
2.1% and soil degradation 1.1%. Based on 2008
data, more than half of China’s water is polluted,
over 300m people use contaminated water
supplies and about a fifth of China’s farmland has
been contaminated with heavy metals. In 2007,
the World Bank estimated that the annual
environmental damage costs the country
USD76bn from air pollution, water pollution and
scarcity, crop loss, fishery loss and material
damages (Chart 17).
Chart 17: China’s environmental burden
USD bn
Env ironmental damage
Share of total cost
50
40
Annual environmental
30
burden : USD76 bilion
20
10
0
Air
pollution
Water Crop loss Fishery
loss
70%
60%
50%
40%
30%
20%
10%
0%
Material
damage
Source: Note: Water costs are for water pollution mortality, and scarcity. Crop loss is
from waste water irrigation and acid rain. Source: World Bank, 2007
not included in the analysis would suggest to us
that the forecasts are conservative.
Table 3: Annual environmental costs for the global economy
Greenhouse gas
(GHG) emissions
Water abstraction
Pollution*
General waste*
2008
USD bn
2008
% of GDP
2050
2050
USD bn % of GDP
4,530
7.5
20,809
12.9
1,226
546
197
2.0
0.9
0.3
4,702
1,926
635
2.9
1.2
0.4
54
42
6,596
0.1
0.1
11%
287
256
28,615
0.2
0.2
17.8
Natural resources
Fish
Timber
Total
Source: Trucost Note pollution includes Sox, Nox, PM, VOCs, mercury
With increasing regulatory constraints, mounting
civil society pressure and growing risks of
disruption to supply chains, the materiality to
investors of natural capital loss and degradation is
becoming more obvious, as is the need for this
materiality to be better integrated into assessment
and decision-making processes.
Investment to maintain the
capital stock
Managing the capital stock can be achieved
through direct regulation (such as implementing
water use caps or emission standards), or by
investing in the stocks and flows that are critical
for nature’s functions. There is increasing
recognition by investors and policymakers of the
risks of not managing natural capital resources
and ecosystems; however, currently it is at the
bottom of the priority list.
Government investment is low
In 2011, Trucost estimated the annual
environmental costs caused by human activity at
USD6.6trn for 2008 (11% of global GDP). It
projected an increase to USD28.6trn by 2050
under a ‘business as usual’ scenario. Clearly, there
are uncertainties with long-term forecasts, not
least discussion around the underlying
assumptions. However, the fact that several
natural resources and other ecosystem services are
22
Government expenditure on natural capital and
environmental protection is considerably smaller
than for other types of capital. For instance, there
is usually considerable spend on human capital for
education or health, as shown in Table 4.
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Table 4: Public spend as a % of GDP for selected countries
% of GDP
Defence
Education
Health
Environment
EU-15 Germany
1.5%
5.3%
7.5%
0.9%
1.1%
4.2%
7.0%
0.7%
Norway
US
China
1.6%
5.6%
7.3%
0.7%
4.1%
0.5%
5.1%
0.3%
1.2%
4.1%
1.4%
0.6%
Source: OECD, BEA, US Treasury, China National Bureau of Statistics
Country environmental spend varies but is mostly
less than 1% of government expenditure. In the
UNEP Green Economy report, UNEP showed that
an investment of 2% of global GDP into natural
capital helps to decouple growth from resource
use. We think that spend as a percentage of GDP
for environmental purposes will increase as the
accounting linkages between growth and natural
capital are developed.
In 2011, in the ‘Towards a Green Economy’ report,
economist Partha Dasgupata noted “ecosystems are
capital assets. Like reproducible capital assets…
ecosystems depreciate if they are misused.” But
natural capital is profoundly different from capital
stocks as traditionally understood by economists
and investors. Firstly, its depreciation can be
irreversible; secondly, it is difficult, if not
impossible, to replace a depleted natural asset with
another; and finally, ecosystems can collapse
abruptly as we demonstrated previously.
Future proofing the natural capital stock by
investing will be cheaper than reacting to natural
capital disruption, but governments still need a
framework to account for natural capital to assess
the spend required.
The SEEA (System of Environmental-Economic
accounting) attempts to harmonise accounting
principles and data. So far, 14 countries are
implementing the SEEA framework, as shown in
the Table 5.
Table 5: Countries implementing the System of Environmental
Economic accounting framework
Australia
Brazil
Egypt
India
Indonesia
Jamaica
Mexico
Morocco
Philippines
Russia
Samoa
Tanzania
Uganda
Vietnam
Source: UN Statistical Database, UN Department of Economic and Social Affairs
In addition, the World Bank’s Wealth Accounting
and the Valuation of Ecosystems Services
(WAVES) initiative is aimed at consistency of
natural capital accounting for economic
planning purposes.
A stock of natural capital may provide many
different functions at the same time and over time
as part of the replenishment and evolution process,
to arrive at a full valuation of the natural capital in
this context it is necessary to capture the benefits of
social (eg, human health and nutrition benefits) and
ecological (eg, climate regulation) factors and
compute a value in terms of their net present value.
For the most part, these are externalities and
difficult to ascribe monetary values to.
In ‘The cost of policy inaction’, in 2008 Braat &
ten Brink calculated the environmental damage
resulting from the absence of additional policy or
policy revision, using, among other reports, the
conceptual framework set out in the Millennium
Ecosystem Assessment. It estimated the welfare
losses from the loss of ecosystem services at
EUR545bn in 2010 (just under 1% of world GDP).
In our view, it is appropriate for investors to devote
time to identifying the contribution of natural
capital to economic activity and the impact on
expected growth and asset values arising from
natural capital degradation and the policy changes
adopted in response.
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Increasing policy drivers will
become the norm
It is difficult to value and account for natural
capital functions and their contribution to
economic productivity. Nonetheless, depreciating
natural capital stocks can create a drag on
economic activity, and sudden natural capital
shocks create output volatility. However, policy
tools can increase resilience to such shocks.
Policy drivers can be kneejerk responses to surprise
events or longer-term attempts to create behavioural
change. For instance, the kneejerk response to the
Thai floods was a monetary one, with the Thai
Central Bank reducing interest rates from 3.50% to
3.25% immediately to stimulate activity in relation
to the anticipated activity slowdown.
An alternative approach to change behaviour
towards a natural capital factor over the long term
could be fiscal, by way of a pollution tax. Either
way, standard economic tools can be utilised in
response to managing natural capital issues.
The choice of response boils down to scale and
speed of disruption compared with economic
activity management, ie, an interest rate response
is usually quicker to implement than a fiscal one.
These economic management responses to the
natural capital issue are standard policy tools and
can be analysed in relation to growth and inflation
expectations in the usual way.
Environmental taxes
Policymakers are facing up to the risks around the
depreciation of natural capital. Some are being
kicked into shape by a desire to reduce pollution
(China), while others are using the notion to
change behaviour (energy consumption in Korea).
In both cases, carbon taxes have been mooted as a
solution. Taxes encourage gains in overall
efficiency by spurring the adoption of more
advanced technology, which would likely boost
productivity in countries – but taxes can also be a
welcome revenue boost.
For China, we think a carbon tax would be among
the most consequential reforms officials could
adopt. The Ministry of Finance has already
proposed its introduction, but it now needs the
explicit backing of the leadership. A tax would
Chart 18: Summary of how natural capital factors permeate into the macro economy
Quantity and quality of natural capital is a driver of economic activity
Economic productivity can be enhanced or
disrupted because of natural capital factors
Managing natural capital can lead to
regulatory, fiscal or monetary responses
Growth boost / drag
Source: HSBC
24
Price pressures
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include a fixed charge per ton of carbon emitted
by industrial polluters (for China this would be an
initiative in addition to cap and trade). In China’s
case, we think a carbon tax would be a positive
measure (see ‘For China, benefits of carbon tax
far outweigh the costs’ 12 November 2013)
On the negative side, carbon taxes may have an
inflationary impact. Ronald Man, HSBC’s
economist for Korea, estimates that the
implementation of a carbon tax in Korea may
trigger and upward bias to inflation – he estimates
that a 1% increase in energy prices raises headline
CPI by around 0.2% (please see ‘A taxing
prevention to blackouts’ 16 July 2013).
On balance, we think taxes can and should be
used advantageously to drive behaviour towards
low carbon growth.
Cap-and-trade schemes
While the European emissions trading scheme
(ETS) is long established, new carbon cap-andtrade schemes have sprung up, notably in China
and the USA (the carbon giants). The EU scheme
has only had limited success in terms of
generating a high enough carbon price to trigger
long-term investment flows into low-carbon
technologies, but it has achieved some success in
helping to reduce emissions.
Several studies have attempted to quantify the
effect the EU ETS has had on emission reduction
in Europe. In general, the literature estimates the
savings attributable to the scheme at 40-80
MtCO2/year (around 2-4% of the phase 2 cap), but
New Carbon Finance found that 40% of the 3%
fall in 2008 emissions was due to the ETS.
Product standards and legislation
Regulatory drivers can be successful at changing
behaviour. Most performance standards have been
aimed at improving the environmental efficiency
of products or industrial facilities, such as by
mandating pollution control standards or
guidelines around resource efficiency
Conclusions
Metrics and methodology to analyse natural
capital factors have developed significantly in
recent years, driven by government and investor
appetite to understand further and manage natural
capital risks. On the whole, however, analysis is
still in its infancy, but we do not think this should
be used as an excuse to ignore natural capital.
Countries are increasingly building frameworks to
account for the depletion of natural capital as a result
of economic activity. For now, there is a disconnect
between the proportion of government spend on the
environment compared with government spend on
other issues, such as health and education, but we
expect this gap to narrow in the future as recognition
of the benefits of pre-emptive investment over
retroactive cost become clearer.
The current status of economic thinking suggests
that for the time being natural-capital-related
analysis will mainly be reactionary rather than preemptive. However, we think this means there is
greater justification for investors to identify which
countries are more susceptible to natural capital
risk factors, which we have done in ‘Scoring
climate change risk’, 24 September 2013.
More importantly, in our view, survey results
reveal that the ETS has been effective in terms of
raising climate change awareness in company
boardrooms, helping to pave the way for future
policies aimed at promoting low-carbon
investment decisions.
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What should investors do?
 Identify the contribution of natural capital to country economic
activity. Water- and carbon-related factors are the most important
 Evaluate whether natural capital is well managed and above
sustainability thresholds
 Assess the future risks and potential economic consequences
Incorporating natural capital
Natural capital, the environmental functions it
performs and the ecosystem goods and services it
provides, has always played a fundamental role in
sustaining human economies, health and welfare.
Over time, we think that developments in metrics
and methodology will overcome the current
uncertainty on how the various natural capital
components interact to underpin economic
growth. For now, we think water and carbon risk
(in relation to climate change) are the most
important issues to assess.
Currently, there is no ‘one stop shop’ approach for
investors to translate natural capital analytical
techniques across countries, simply because
countries have different natural capital resources
and are at different stages of development.
However, there is a consistent assessment
framework (contribution, management, risk,
impact) that is relevant across economies and can
be applied on a case-by-case basis.
Table 6 provides a starting point for investors to
compare water and carbon risks between
countries. The key points to note are:
 National water risk: Saudi Arabia and South
Africa are already water scarce
26
(<1,000m3/capita), and Saudi is deteriorating
fast; India, South Korea and Germany are
water stressed (<1,700m3/capita) and India is
deteriorating fast.
 Sub-national water risk: National averages,
however, can hide significant regional water
risk, and we highlight China and India as
particularly exposed (see ‘Scoring climate
change risk’, 24 September 2013).
 National carbon risk: China and the USA
are the highest emitters of CO2 in absolute
terms, but Australia, Canada, Saudi Arabia,
South Korea and the USA have the highest
per-capita emissions. Russia, Germany and
the USA show the best improvement in
carbon intensity (CO2/GDP). We identify the
USA as the economy within the G-8 with
greatest distance to target in terms of carbon
improvement, and China as the country with
the greatest alignment of factors – air
pollution, water, technology and carbon –
pushing on carbon risk.
In the following framework, we take Australia as an
example. This is because, on paper, Australia has
plenty of water, as shown below, but at a regional
level the country has suffered long term drought.
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Table 1: Water and carbon factors are the most important issues to assess from a natural capital perspective
G20
Countries
Argentina*
Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Italy
Japan
Mexico
Russia
Saudi Arabia
South Africa
South Korea
Turkey
UK
US
World
2020 target
emissions
Water 2012 CO2 2012 CO2 % change 2012 CO2 % change
Water availability†
% of world
2011 water
real GDP
resource, resource % emissions per capita CO2 / cap intensity of
CO2 (Optimum is very high
change
2012 m3/per capita
MtCO2
2003-2012
GDP intensity of availability and rising
2002-2011
fast)
GDP 20032012
0.8%
1.6%
2.1%
2.3%
8.4%
4.2%
5.7%
2.5%
0.8%
3.2%
8.8%
1.9%
1.8%
0.9%
0.6%
2.0%
1.2%
4.5%
25.2%
6,771
21,764
27,551
82,969
2,041
3,168
1,302
1,165
8,332
3,002
3,399
3,563
30,195
85
888
1,340
3,083
2,314
9,001
-7.6%
-13.3%
-8.8%
-8.9%
-4.5%
-5.3%
0.3%
-12.3%
-9.6%
-5.4%
-0.4%
-10.6%
1.9%
-23.6%
-8.8%
-4.1%
-11.1%
-4.9%
-7.9%
190
392
500
620
9,208
383
815
1,823
495
406
1,409
496
1,704
615
446
764
318
530
5,786
4.6
17.3
2.5
17.8
6.8
5.8
10.0
1.5
2.0
6.7
11.0
4.1
11.9
21.7
8.7
15.3
4.3
8.4
18.4
33%
-5%
31%
-11%
102%
-16%
-10%
55%
27%
-21%
2%
11%
7%
32%
1%
26%
29%
-16%
-16%
0.45
0.46
0.44
0.49
2.04
0.17
0.27
1.33
1.16
0.24
0.30
0.50
1.74
1.24
1.45
0.71
0.51
0.22
0.43
-48%
-17%
2%
-16%
-14%
-19%
-21%
-9%
-14%
-16%
-5%
-2%
-27%
-8%
-18%
-5%
-6%
-19%
-21%
34,466
31,693
4.9
4.1*
14%
0.64
0%
High, falling
Very high, falling fast
Very high, falling
Very high, falling
Medium, falling
Medium, falling
Low, rising
Low, falling fast
High, falling
Medium, falling
Medium, falling
Medium, falling fast
Very high, rising
Very low, falling fast
Very low, falling fast
Low, falling
Medium, falling fast
Medium, falling
High, falling
Carbon per capita‡
(Optimum is low per
capita and falling fast)
Low, rising fast
Very high, falling
Low, rising fast
Very high, falling fast
Medium, rising very fast
Medium, falling fast
High, falling
Very low, rising very fast
Low, rising fast
Medium, falling fast
High, rising
Low, rising fast
High, rising
Very high, rising fast
Medium, rising
High, rising fast
Low, rising fast
Medium, falling fast
High, falling fast
Source: HSBC, BP Statistical Review. Note: Argentine latest GDP is for 2010. *2020 targets based on IEA World Energy Outlook 2013 reference scenario CO2 from energy, calculated using UN population forecasts
Water Risk† Resource availability: Very low = <1,000m3/cap (water scarce), low = 1,000-1,700m3/cap (water stress), medium = 1,700-5,000m3/cap, high = 5,000-10,000m3/cap, very high = 10,000+m3/cap.
Water availability per capita change: Falling fast = -10%-50%, falling = -10% -0%, rising = 0-10%, rising fast = 10%-50%, rising very fast = 50%+
Carbon per capita‡ Per capita levels: low = under 5 tCO2/ cap; medium = 5-10 tCO2/ cap; high = 10-15 tCO2/ cap; very high = 15+ tCO2/ cap.
Per capita change: Falling fast = -10%-50%, falling = -10% -0%, rising = 0-10%, rising fast = 10%-50%, rising very fast = 50%+
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1) Identify the natural capital
contribution
Identifying the contribution of natural capital to
economic activity enables an assessment of
whether a country would be able to meet growth
expectations against a natural capital disruption or
constraint. For instance, if an economy is reliant on
water-intensive activities, shortages in supply could
mean that output would suffer. This could come
from two factors – interrupted power supply
because of lack of water for electricity, and/or lack
of water for operational processes. A first assessment
in relation to water, therefore, should be of the
contribution of water-intensive sectors – agriculture,
utilities, mining and energy – to the economy.
Australia: Relatively water dependent
1
economy
Australian mining contributes around 10% to gross
value added (GVA) and is also relatively water
intensive. Mining activities are split 50:50 between
fossil fuels, and iron ore and copper. Other industries
contribute 77% to economic output but only
consume 11% of water. However, these industries
would be at risk of disruption if the electricity
supply is disrupted because of water issues.
Electricity generation is a relatively waterintensive sector, consuming 16% of the total, with
85% of Australia’s electricity generated from coal
(also presenting a carbon risk) and the remainder
mostly hydropower, both water-intensive sources.
Agriculture, though contributing only around 3%
of total gross value added (GVA), consumes the
most water.
1
The information on Australia is drawn from a longer case
study by Dr Matthew Winning, UCL Institute for Sustainable
Resources
28
Chart 19: Gross value added per industry and water
productivity (2010-11)
Agriculture
Manufacturing
Other industries
Mining
Electricity , w atse & w ater
100%
80%
77%
60%
40%
20%
0%
3%
8%
10%
6%
5%
11%
16%
63%
2%
Gross v alue added (%)
Water consumption (%)
Source: Australia Bureau of Economics, Note: Agriculture includes forestry and fishing;
mining includes oil & gas extraction; manufacturing includes food & beverages, textile,
petroleum, wood & paper, metallic and non-metallic products, machineries
In 2012, exports accounted for over 21% of GDP,
some USD313bn, with the top three the relatively
water-intense iron ore, coal and gold. We think
there is a risk to Australian industry from
disruption to electricity supply that could come
from water constraints.
2) Evaluate natural capital
management
A high dependency on a natural capital
component does not always present a risk if it is
managed appropriately. For many regions, natural
capital management is crucial to at least
maintaining, if not increasing, output.
Australia has long experience of drought
management
Australia, despite having the highest per-capita
surface water storage capacity in the world, is also
the driest inhabited continent on the planet, with
variable rainfall and aridity. As of July 2013,
water storage in Australia was at 69.5% capacity,
but by year and territory the volume levels can
vary significantly.
The most recent drought in Australia lasted 10
years from 2002 to 2012. Severely low levels of
rainfall meant that a number of rivers, dams and
lakes operated substantially below capacity,
impacting agricultural production. Major
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reservoirs in the Murray Darling Basin (MDB)
fell from c75% capacity in 2001 to 17% capacity
in 2007. During the drought periods, the
Australian authorities used water pricing and use
restrictions and subsidies as policy tools.
Water pricing
Water prices vary between territories, but between
2008 and 2011 prices increased from AUD/L 0.74 to
AUD/L 1.03 on average. Varying tariff structures
were introduced and mandated water use restrictions
were implemented, backed up by fines.
Farmer compensation
Price rises had a significant effect on farmers. In
2007, the cost of a million litres of water had risen
from AUD50 to AUD950, making it impossible
for many to afford to continue farming.
The Australian Government paid compensation
and provided interest rate subsidies to farmers
whose product yields were affected by drought. In
2010, around AUD4.4bn was paid out from
exceptional circumstance funds, with
approximately 70% of agricultural land in
Australia receiving support during this period.
3) Assess future risks and
economic consequences
Identifying the future risks for natural capital
means analysing potential changes to the
availability of the resource, in this case water, and
the disruption potential because of other factors.
For water, this includes assessing future changes
to the water cycle driven by temperature rises.
More droughts a risk
For Australia, droughts remain a concern, in our
view. The Commonwealth Scientific and
Industrial Research Organisation (CSIRO) and the
Bureau of Meteorology (BOM) estimate that 50%
of the rainfall decrease in south-western Australia
since the late 1960s is due to climate change, as is
the rainfall decline in south-eastern Australia
since the late 1950s.
Chart 20: Temperature anomalies in Australia
1.5
1
0.5
0
-0.5
-1
Regional subsidies
In order to attempt to save the MDB both federal
and state governments have committed AUD1bn
since 1998 into programmes seeking to restore the
flow of water. In addition, AUD1.4bn has been
spent on the National Action Plan for Salinity and
Water Quality comprising 1,700 projects in 21
priority areas in Australia over a seven-year
period from 2000.
Public policy response
Australia has used a public policy response to
change behaviour in relation to monitoring water
and in respect of pricing and subsidy payments. In
our view, the management of water is well
understood and managed but is and will continue
to be a drain on public finances.
-1.5
1910 1921 1932 1943 1954 1965 1976 1987 1998 2009
Australia annual mean temperature anomaly (°C)
Source: Australian Bureau of Meteorology
CSIRO provide climate forecasts. It estimates that
by 2030 temperatures will increase by another 1oC
on average in Australia. These forecasts are based
on the current stock of emissions already in
the atmosphere2.
Water use and sustainability thresholds
Water use and sustainability thresholds must be
examined on a case-by-case basis. For instance,
increasing water use and declining water
2
Projections are given relative to the period 1980-1999
29
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availability in Canada may not matter much
(provided it is significantly above sustainability
thresholds) for the country’s ability to deliver
growth, but is likely to be critical for India.
The Water Exploitation Index (WEI) is a good
indicator of breaching sustainability thresholds. It
is calculated as the mean of the annual abstraction
of freshwater divided by the mean annual
freshwater resources. A warning threshold would
be around 20% with medium water stress up to
40% and severe water stress above this level.
In Australia for 2011, we calculate the WEI as
14.6%, an increase from 4.5% in 2000 as measured
by Aquastat, demonstrating a significant increase in
water stress over the last decade with a decline in
resources and an increase in water-intensive
industries. It is currently not possible to calculate
the WEI at a territorial level because extraction and
consumption data rates are inconsistent.
In a bear case, Australia’s water will become
extremely scarce. Some water storage facilities were
operating at a fifth of their capacity during the
droughts of the 2000s. Temperatures of several
degrees higher and rainfall reductions of 20% would
reduce resources to levels never before witnessed.
Previously, the economic effect of drought played
out through consumer price inflation. Charts 21
and 22 show headline inflation and inflation rates
for selected food groups.
Chart 21: Headline CPI
8.0%
6.0%
4.0%
From a natural capital perspective, we think
Australia is managing its most vulnerable natural
capital component – water, well. Over the longer
term, it will likely have to continue allocating
public funding to providing continuity of supply,
and subsidies to farmers may be higher if
significant drought prevails. In the short term, we
think there is limited risk of significant variation
to growth forecasts directly attributable to water.
Carbon risk
For carbon risk, a starting point is to identify
country emission levels, the country policy on
emission reduction, the energy intensity of
growth, the carbon intensity of energy and the
carbon intensity of GDP. Australia has the third
highest CO2 level per capita in the G20 at 17.8
tonnes (behind Saudi Arabia and the USA), but
the new government recently retracted most of its
carbon commitments (see ‘Australia’s uncertain
climate future’, 9 September 2013). We expect the
carbon risk in Australia to manifest through global
carbon pressures, namely the reduction in demand
for CO2-intensive fossil fuels, which will change
the demand profile for one of Australia’s most
important exports – coal. HSBC mining analysts
looked at potential risk factors from the long-term
curbing of coal demand in ‘Coal and carbon’, 21
June 2012.
Chart 22: Inflation for selected food groups – shading
represents drought periods
60%
30%
40%
20%
20%
10%
0%
0%
Source: Australian Bureau of Statistics, Thomson Reuters Datastream
30
Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q1 2012
Q1 2013
Q1 2013
Q1 2012
Q1 2011
Headline CPI YoY
Q1 2010
Q1 2009
Q1 2008
Q1 2007
Q1 2006
Q1 2005
-20%
Q1 2004
-40%
Q1 2003
0.0%
Q1 2002
-10%
Q1 2001
-20%
Q1 2000
2.0%
CPI Fruit & Veg YoY
CPI Lamb YoY
Source: Australian Bureau of Statistics, Thomson Reuters Datastream
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Forecasting the future impact of a natural capital
issue (such as continued risk of drought in
Australia) means, at this stage, an assessment of
whether country growth expectation is more or
less likely to be achieved, or whether a policy
may be implemented to tackle the natural capital
issue, which will result in another economic issue,
such as inflationary pressures.
Conclusions
There is no silver bullet template for capturing
and analysing natural capital factors, which can be
rolled out across countries and industries.
However, there is a consistent methodology to
assess and analyse the issues that can be applied
across countries, namely – identify the
contribution, assess how well the natural capital
factor is managed, identify future risk and assess
the potential economic impact. This could come
from changes to trend growth, inflationary
pressures or policy responses.
Our previous analysis on climate change issues
leads us to believe that water and carbon risks are
the most critical natural capital issues for
investors to take into account at present.
Ultimately, analysis will evolve to include new
data, metrics and methodology to incorporate air,
land, water and habitats, along all elements of the
value chain of assessing natural capital. This is an
evolving issue that is not straightforward but
complexity is not a reason to ignore natural capital.
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Appendix 1: Data, indices,
accounting, modelling
 Quantity, quality and frequency of observations are improving,
while indices provide country snapshots using aggregated data
 Standardised accounting methodologies are under development
 Economic models are in use for central planning purposes
Data monitoring has improved
There is now a substantial quantity of
internationally comparable data on environmental
and resource issues, which is available from a
range of global economic and scientific
institutions. In our view, the most robust data is
from the organisations summarised in Table A1.
Table A1: Organisations providing time series on data
Category
Organisation
Water
Land
Air
Air, Land, Water
Aquastat
Food and Agricultural Organisation
NASA Earth Data
NASA Socio-Economic Data
Analysis Centre
OECD statistics
UN Environment Programme's
Environmental Data Explorer
UN Statistics Division
World Bank
World Meteorological Organisation
Air, land, water
Air, land water
Air, land, water
Air, land, water
Temperature,
rainfall
Water
World Resources Institute
Source: HSBC, Y/ZenGroup
32
Acronym
AS
FAO
NASA
SEDAC
OECD
UNEP EDE
UNSD
WB
WMO
WRI
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Indices – further development
The data series noted above have been used in the
construction of a number of composite indices for
cross-country comparison. In our view, these are a
necessary starting point for identifying analytical
and investment priorities for policymakers.
The indices provide different functions. Some are
a tool to assist in capital allocation for
policymakers, whereas others are designed to
monitor the utilisation of natural capital resources
across countries.
Chart A1 shows the components. The time series
is useful for monitoring how much progress
countries are making in certain categories. The
indices provide a snapshot of country-level
vulnerabilities and strengths, and compare them
with other countries. We think these indices are a
useful starting point for further analysis. To
identify the true impact of natural capital changes
on the economy, investors must make a
judgement on the contribution of natural capitalintensive sectors to the economy.
In our view, the most comprehensive index is the
Yale Environmental Performance Index, which
provides a breakdown of 22 performance
indicators across 10 policy categories.
Table A2: Comparison of composite indices
Index
Source
Countries
Period
Frequency
WB
246
1980 to 2012
Annual
SEDAC
132
2000 to 2010
Environmental
Sustainability Index
SEDAC
146
2000, 2001,
2002, 2005
Environmental
Vulnerability Index
SEDAC
235
2004
Natural Resource
Management Index
SEDAC
174
2004 to 2011
Benefits Index for
Climate Change
GEF
160
Jul-08
Benefits Index for
Biodiversity
GEF
160
July 2008
Adjusted Net
National Income
Environmental
Performance Index
(Yale performance
index from 2012)
Comment Methodology
Time series data Net National Income adjusted for depletion of natural
resources
All static data except 22 performance indicators in 10 policy categories for the 2012 2012 environmental burden of disease, water (effects on human
publication contains health), air pollution (effects on human health), air pollution
revisions to (ecosystem effects), water resources (ecosystem effects),
methodologies biodiversity and habitat, forestry, fisheries, agriculture and
climate change.
Four publications
2006 (1994-2006
data), 2008 (19942007 data), 2010
(1994-2009 data),
2012 (2000-2010
data).
Static data.
Total four
Methodological
publications. 2000
changes between
(1979-1999 data),
publications
2001 (1980-2000
data), 2002 (19802000 data) 2005
(1980-2000 data)
Static data
Single publication
released in 2004,
using data from
1973-2003
Total two Time series data. Some
methodological
publications. 2010
(2004-2011 data) changes between the
two publications
and 2011 (20062011 data)
Single publication
Static data
released in 2008
Single publication
released in 2008
The index provides a composite profile of national
environmental stewardship based on a compilation of 21
indicators derived from 76 underlying data sets.
This index contains 111 variables and is designed to be
used with economic and social vulnerability indices to
provide insights into the processes that can negatively
influence the sustainable development of countries.
Composite index derived from the average of four
proximity-to-target indicators for eco-region protection
(weighted average percentage of biomes under protected
status), access to improved sanitation, access to improved
water and child mortality
Seeks to measure the potential global benefits that can be
realized from climate change mitigation activities in a
country. The approach reflects the objectives of the GEF
climate change operational programs to address long-term
priorities to mitigate climate change.
Static data Seeks to measure the potential global benefits that can be
realized from biodiversity related activities in a country. It
reflects the complex, highly uneven distribution of species
and threats to them across the ecosystems of the world,
both within and across countries.
Source: HSBC, World Bank, Y/Zen Group, UCL
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Chart A1: Components of Yale environment composite indicator
EPI
Objectives
Policy Categories
Environmental Health 15%
Environmental
Health
(30%)
Air
(Effects on Human Health) 7.5%
Air
(Effects on Human Health) 7.5%
Air (Ecosystem Effects) 8.75%
2012
Environmental
Performance
Index
Water Resources
(Ecosystem Effects) 8.75%
Biodiversity & Habitat 17.5%
Ecosystem
Vitality
(70%)
Agriculture 5.83%
Forests 5.83%
Fisheries 5.83%
Climate Change & Energy 17.5%
Indicators
Environmental Health 15%
Particulate Matter 3.75%
Indoor Air Pollution 3.75%
Access to Sanitation 3.75%
Access to Drinking Water 3.75%
SO2 per Capita 4.38%
SO2 per $ GDP 4.38%
Change in Water Quantity 8.75%
Critical Habitat Protection 4.38%
Biome protection 8.75%
Marine Protected Area 4.38%
Agricultural subsidies 3.89%
Pesticide Regulations 1.94%
Forest Growing Stock 1.94%
Change in Forest Cover 1.94%
Forest Loss 1.94%
Coastal Shelf Fishing Pressure 2.92%
Fish Stocks Overexploited 2.92%
CO2 per Capita 6.13%
CO2 per $ GDP 6.13%
CO2 per KWH 2.63%
Renewable Electricity 2.63%
Source: Yale
Adjusted net income indices
aid natural capital accounting
Sub-systems of the SEEA accounts are split
between individual resources on energy, water
and land, and ecosystem services. Linked to the
UN SEEA procedure is the World Bank’ WAVES
project (Wealth Accounting and Valuation of
Ecosystem Services). This project aims to help
individual countries implement and use the SEEA
data on environmental accounting. It includes the
UN Environment Programme, UN Development
Programme and UN Statistical Commission, as
well as a number of countries and private
sector organisations.
Adjusted net savings
In practice, perhaps the most ambitious attempt to
date to implement environmental and resource
valuation in a systematic way at a global scale,
and particularly to estimate the annual change in
the value of natural capital as affected by
depletion and natural regeneration, has been
carried out through the ‘genuine savings’
methodology and indicators of the World Bank.
34
The adjusted net savings (ANS) estimates how
much gross national savings would change if
natural capital considerations were taken into
account, expressed as a percentage of gross
national income. The methodology is as follows.
 Start with net national savings,
 Add investments in human capital (education
expenditure),
 Deduct depletions of natural resources
(energy, mineral and net forest depletion), and
 Deduct pollution damages (CO2 and PM10).
The values of energy, mineral and net forest
depletion are calculated as the present value of
resource rents to exhaustion time of the resource.
A carbon price of USD20 per tonne is used for the
CO2 damage cost, and PM damages are calculated
on a willingness to pay basis, in the context of
willingness to pay for avoided mortality and
morbidity attributable to particulate emissions.
This varies for different countries.
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Table A3 compares adjusted net savings
methodology for 2008 and 2012 for the UK, USA,
China and India. The ANS result is dependent on
investments in education being adequate substitutes
for the depletion of natural capital that has taken
place. In environmental terms, these four countries
(like many others) are depleting their natural capital,
but all the countries are sustainable in the sense that
they all have positive adjusted net savings levels.
The same is true for all OECD countries. However,
it is unlikely that this situation can continue globally
on an indefinite basis, no matter how much countries
are investing in education.
The estimation of genuine savings is important in
that it permits the comparison of the economic
value created through production with the change
(perhaps a reduction) in the value of the natural
resources used as inputs for that production.
However, a shortcoming with this methodology is
that there is no explicit consideration of water and
soil. There is a consideration of the source and
some of the human welfare functions of natural
capital, but not the sink or the majority of the lifesupport functions. Also, there is an assumption
that manufactured and human capital can
substitute for natural resources, which is not
always the case.
Table A3: Comparison of adjusted net savings (values expressed as a percentage of gross national income)
% of gross national income
___ United Kingdom ___
2008
2010
Gross national saving
Consumption of fixed capital
Net national saving
Education expenditure
Energy depletion
Mineral depletion
Net forest depletion
CO2 damage
PM10 damage (2002 and 2004 WHO data)
Adjusted net saving (including PM10 damage)
Adjusted net saving (excluding PM10 damage)
15.6
-10.3
5.3
5.1
-2.1
0.0
0.0
-0.1
0.0
8.1
3.91
12.3
-11.1
1.2
5.1
-1.3
0.0
0.0
-0.2
0.0
4.8
4.8
____ United States _____
2008
2010
12.7
-12.3
-0.8
4.8
-1.8
-0.1
0.0
-0.3
-0.1
2.8
2.9
11.5
-12.3
-0.8
4.8
-0.8
-0.1
0.0
-0.3
-0.1
2.8
2.8
_______ China _________ ________ India _________
2008
2010
2008
2010
52.9
-10.8
42.0
1.8
-6.0
-1.7
0.0
-1.1
1.2
33.6
35.0
52.6
-10.8
41.8
1.8
-3.7
-1.8
0.0
-1.1
-1.3
35.7
37.0
34.1
-10.1
23.9
3.1
-4.5
-1.5
-0.8
-1.0
-0.6
18.6
19.3
35.0
-9.8
25.2
3.1
-2.6
-1.2
-0.6
-0.9
-0.6
22.5
23.0
Source: World Bank, Note: 2010 is the most recent year of data for all countries
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Economic modelling
Incorporating natural capital into the
production function
In their analysis of the drivers of economic
growth, economic models have tended to ignore
the role of natural capital. So far, natural capital
and environmental services are missing in the
simple but quite standard representation that
manufactured capital and labour are the main
factors driving economic activity.
It is becoming increasingly apparent that natural
capital plays a very important role in supporting
economic activity, as well as contributing directly
to health and welfare. However, the dominance in
the modern economy of the industrial and service
sectors (for example, natural capital-intensive
agriculture only contributes 3.14% to global GDP)
obscures the reliance of sectors on natural capital,
and fails to indicate the importance of the quantity
and quality of either the natural capital stocks or
the functions that it performs.
One of the reasons for this is that natural capital has
been perceived to be effectively infinite as far as
the scale of the human economy was concerned.
In addition, at the time the models were
developed, there was insufficient understanding
of, and data about, the complexities and functions
of natural capital and the contribution
However, while it is relatively simple to
incorporate natural capital into an illustrative
diagram of the economy (see Chart A2) adding a
Chart A2: The contribution of natural capital and its environmental functions to national economic production
3
Environmental
functions
Human welfare
(Income, Societal benefits)
2
Stocks of capital
Natural capital
Intermediate
production
1
Investment
Labour
Manufactured
capital
Production
process/National
economy
Capital feedback effects
Source: Ekins, P
36
Goods
Bads
Consumption
Waste pollution
Depreciation,
depletion
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natural capital parameter to the production function
in economic models is not straightforward.
A more realistic production function would need
to capture the facts that:
1
Natural capital combines with manufactured
and human capital as inputs to production.
From the natural capital perspective,
resources – such as fossil fuels to provide
energy for industrial processes – or raw
materials – such as wood and minerals – are
the inputs. These may be transformed into
finished products.
2
Some environmental functions and services
are sustained by the natural capital stock (the
functions ‘of’ the environment, eg, sources or
sinks), and the replenishment and evolution
part of the cycle.
3
Some environmental functions contribute
directly to human welfare (environmental
functions ‘for’ humans’, eg, clean
drinking water).
4
Natural (and other) capital stocks may
experience depreciation through depletion and
pollution.
There have been a number of recent modelling
exercises to seek to represent these relationships,
as shown in Table A4. These efforts are still in
their infancy, and substantial research and
development is still required to produce models
that can adequately represent environmenteconomy relationships.
Table A4: Economic modelling for planning purposes
Model
Example
Methodology
Used by
Spatially disaggregated
model
Tallis et al.(2012), Integrated
Valuation of Ecosystem Services
and Trade-offs
Lenzen et al.(2012), MRIO model
Considers land-use mapping with GIS to draw economic
projections on the availability of natural capital and
environmental services
Uses extended I-O model to track the passage of resources,
and associated environmental impacts, through economic
sectors
Van Paddenburg et al. (2012), to study the
natural capital in Borneo forest along the border
of Indonesia, Malaysia and Brunei
Wiedmann et al. (2010), to calculate greenhouse
gas emissions associated with a country's
consumption rather than production
Chateau et al. (2011),
Environmental linkage model
Considers economic drivers to study the impact of natural
capital depletion on economy
Chateau et al. (2011), to study impact of natural
capital depletion in OECD economies
Bassi et al. (2010), T21- World
model
Considers natural capital as a factor of production and fully
couples biophysical variables with economic ones, across
social, economic and environmental sectors, also accounting
for feedbacks, delays and nonlinearity.
Econometrics
Bassi et al. (2010), to study natural capital for
UNEP's Green Economy Report
Econometrics
Barker et al. (2008) to analyse the economic
implications of large scale carbon reduction
Multi Regional InputOutput (MRIO)
Macro-economic model
Computable General
Equilibrium models
(CGEs)
System dynamics model
Macro-econometric model GINFORS
E3ME, E3MG
Lutz et al. (2010), to analyse environmental
economy at both the European and global levels.
Source: Ekins, P
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After the flood: Thailand’s central bank to cut rates, Frederic Neumann, November 2011
Aussie Economic Comment: A Levy to Break the Floods, Paul Bloxham, January 2011
Australian exports fall: Queensland floods to blame, Paul Bloxham, May 2011
Australian GDP preview: GDP to fall 1.3% q-o-q in Q1 due to Queensland floods, Paul Bloxham,
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Australian GDP washed out: Floods hit coal exports but domestic demand strong, Paul Bloxham,
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Climate Investment Update: Extreme climate; expect more droughts and floods, Zoe Knight,
November 2011
European Chemicals Weekly: Drought is good news for agrochemicals in 2013,Dr Geoff Haire,
September 2012
Floods in Thailand: A first look at the economic implications, Frederic Neumann, October 2011
Floods to boost inflation: Still expect next rate hike in Q2 2011, Paul Bloxham, January 2011
Sri Lanka: Flood factor; Bad weather push up February CPI inflation, Leif Eskesen, March 2011
Sri Lanka: Tempered by floods: Q1 GDP growth eased slightly, Leif Eskesen, July 2011
The Fertile Crescent: US drought dominates, Yonah Weisz, September 2012
The Philippines: Supply shocks from floods to keep rates steady, Trinh Nguyen, August 2012
This one's old news: Thai exports to drop after floods, Frederic Neumann, October 2011
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Notes
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Notes
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Zoe Knight, Nick Robins and Wai-shin Chan
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Zoe Knight*
Director, Climate Change Strategy
HSBC Bank plc
+44 20 7991 6715
[email protected]
Zoe Knight joined HSBC in 2010 as a senior analyst. She has been an investment analyst at global financial institutions since 1997, initially
focusing on Pan European small-cap strategy and subsequently moving into socially responsible investing, covering climate change issues.
Throughout her career she has been ranked in Extel and II. She holds a BSc (Hons) Economics from the University of Bath.
Wai-Shin Chan*, CFA
Director, Climate Change Strategy – Asia-Pacific
The Hongkong and Shanghai Banking Corporation Limited
+852 2822 4870
[email protected]
Wai-Shin joined HSBC in 2011 as the Director for Climate Change Strategy in Asia Pacific. Previously, he worked as a fund manager
and was centrally involved in the integration of Environmental Social Governance (ESG). Wai-Shin is a former Executive Director of
ASrIA (Association for Sustainable and Responsible Investment in Asia) and was previously an ESG equity analyst for Asia. He holds
a degree in Mathematics and Physics from Durham University (first class honours) and is a CFA charterholder.
Nick Robins*
Head of HSBC Climate Change Centre
HSBC Bank plc
+44 20 7991 6778
[email protected]
Nick Robins, head of the HSBC Climate Change Centre, joined the bank in 2007. He has extensive experience in the policy, business
and investment dimensions of climate change and sustainable development.
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.