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Second Environmental Economics Round Table Proceedings

Convened by Senator Robert Hill, Minister for the Environment and Heritage, Canberra, 5 July 2000
Environmental Economics Research Paper No. 7
Commonwealth of Australia, 2000
ISBN 0 642 19485 8


Paul D’Arcy


Mr D’ARCY–I am going to offer you a somewhat different perspective from other presenters today. My comments come from the viewpoint of the corporate sector and in particular from a multinational company that finds itself operating in industries which are right in the front and centre of many of the major environmental issues troubling the planet–air quality, climate change, protection of wilderness areas and so on. I am going to offer you a somewhat Shell-centric view of what is going on but I do not make any apology for that. I think some of the things we are doing are quite typical of what is going on in the corporate sector.

I guess it is fair to say that historically, in the oil industry, environmental management was about having robust systems and procedures. Provided you had a good enough rulebook and you followed it closely enough, things would turn out all right. You had an environmental manager who advised you on systems and procedures; you had ‘environmental performance’ on your meeting agenda; and every so often you went off to a meeting with government and agreed on new standards to apply. Environmental management was essentially an internal compliance issue. The central message of what I want to say to you is that, increasingly, environmental performance is a market issue. We are increasingly having a dialogue with our customers and with the communities in which we operate about environmental performance, over and above the ongoing dialogue we have with governments. Customers want to know more about our environmental performance. Communities in which we operate are increasingly asking questions. NGOs and government are becoming more adept at communicating performance that does not meet community expectations. Increasingly, environmental performance, as others have observed this morning, is a viable point of differentiation in the customer offer. I do not want to exaggerate that trend. In our markets–for example, here in Australia–there is some willingness to pay for products that are cleaner and greener, even in commodity areas like fuel. There is some willingness to pay for low-lead petrol, for example, but demand is still very elastic and that preference peters out fairly quickly if the price sits too high. It is part of a broader trend: as incomes rise and people are more educated, there is a growing willingness to make decisions based on values rather than needs. We see that right across the world. What does this mean for company approaches? What does it mean for government policy? That is really what I want to focus on here.

I will just take you through the traditional health safety environment model. This is a model that was formalised within our group worldwide in 1994. The history is that it came after some very high-profile disasters in the oil industry–the Piper Alpha disaster, the Exxon Valdez leak, and other incidents. It was clear that there was a need for a more formal system to deal with incidents and catastrophes. The main elements are similar to any quality management system. Leadership and commitment are required to ensure that there is compliance with accepted standards. Policy objectives are set, with a clear statement of the outcomes to be achieved, and organisational accountabilities are clear at each level of the organisation.

The hazards and effects management process involves four steps:

It is a very sound, sensible, obvious way of approaching environmental management, and we still use a lot of these processes today. But following this system has got us into serious trouble and I want to talk about why.

First of all, you would notice in that model there was nothing about consultation with external stakeholders. As I said, communities are increasingly informed. With the spread of electronic media, mistakes, incidents or under-performance in one market does not just cause a reaction in the marketplace in that market but it reverberates with electronic media across the world. We see that in lots of industries–for example, Nike, with its performance in terms of labour standards in developing countries. Communities are increasingly educated and able to assess information, and governments and NGOs are working harder to communicate performance and under-performance. We found out that failing to meet community expectations in terms of environmental performance can really damage you in the marketplace. Most famously, with the disposal of a piece of oil rig equipment called the Brent Spar in 1996, there was a long and arduous environmental approval process with the United Kingdom government. It was a dialogue that happened between our technical people and the UK regulatory authorities. We got approval to dispose of that piece of equipment at sea, in the North Sea. There was no consultation with external stakeholders or the community, and when Greenpeace communicated the decision to dispose of the piece of equipment at sea, the reaction was swift and fierce. Some of our service stations in Germany were raked with bullets. Two service stations were fire-bombed. The Lutheran Church prayed for our forgiveness. So failing to communicate with stakeholders can be a real issue. Increasingly, communities are willing to punish companies that do not match expectations.

The second problem with that model is that its emphasis on rigid processes means that it militates against innovation and it creates a kind of silo. I think Amory was talking about this in his organisational analysis. It creates a silo of the environmental manager, the environmental approval process internally and the commercial decision-making of the organisation. You have a separate issue on your management agenda which is ‘environment,’ and then you have the ‘real business’–commercial management. I think that is the problem with that traditional model.

We have now moved to formalise a sustainable development management framework across the group. You will see in that circle of arrows many things that still apply from the previous model. But it emphasises four new aspects. First, there is engagement with local communities in a much more structured way than was ever the case in our company in the past. Second, it emphasises integration of environmental decision-making into the commercial operations of our company, for example by building stakeholder consultation and environmental objectives into appraisal and reward systems. Thirdly, we have reporting and verification. There is a much stronger emphasis on demonstrating good practice through better reporting and greater use of external verification. The last aspect emphasises behaviour and skills. Clearly, the skills of an old-style Shell engineer–which is to determine a decision, announce it and then defend it after the event–are not well suited to the need for greater communication and consultation.

That is the internal framework. What are some of the instruments or tools that are being used to deliver better environmental outcomes? I want to focus on three. They all evolve around the idea that to win the trust of your customers and the communities in which you operate, you have to integrate sustainability into commercial decision-making. The key is integration. The first relates to using internal price signals, and I will say a little more about our internal emissions trading markets and other price signals in our decision-making process. The second, which Hartmut referred to, is the rise of finance market responses, like the Dow Jones sustainability index. Lastly, there is a much greater emphasis on using and utilising externally audited health safety environment data and external advisory roles within the company in terms of, for example, advisory panels to boards.

Let me give you a practical example of what Shell is doing in terms of climate change. Shell has been one of the leaders amongst multinational companies in taking action on climate change. We have not done that because we are moral crusaders; we have done it because our judgment is that our customers expect it and the communities in which we operate expect it. We have also done it because it is prudent risk management. For the kind of long-lived investments and assets that we are contemplating, it is prudent to plan for a world where carbon is no longer free. Thirdly, we are doing it because we see some opportunity in it. Increasingly we are moving into new and alternative fuels, and this can provide a catalyst for commercialising some of these activities.

We are taking three actions that utilise market instruments. First is shadow carbon pricing. For all major projects that come to our board for screening for decision-making, we screen them against various carbon price levels–$10, $20, $40. I cannot tell you that there has been a major project that would otherwise have got up but failed because it had an uncompetitive notional carbon price attached to it, but it is indicative of the changing attitude at the board level of incorporating environmental issues into commercial decision-making.

Secondly, we have launched an internal tradable emissions pilot scheme. This started at the beginning of this year. It involves about two-thirds of our developed country companies in Europe, America, Canada and Australia, and across the breadth of our operations in terms of upstream oil and gas, downstream refining of chemicals, and so on. The participating business units involved in this exercise were given an allocation of permits based on their 1998 level of emissions. That allocation was less than they would otherwise have achieved on a business as usual basis. So each participating business unit has a choice: it can either cut its own emissions by investing or it can buy permits from other businesses within the group that has cut their emissions. Why would a business unit take this seriously? We are not talking about the real transfer of cash across the group; because of tax reasons, that is simply not possible. But what we can do is make the business units pay in terms of their capital allocation. For example, if you are a net purchaser of permits in a year, the following year your capital allocation is commensurately reduced. If you are a net seller of permits, then your capital allocation in the following year is increased. You do not pay in cash; you pay in capital. That is why the business units take it seriously. Just to put this in context, we are not talking about a wild reordering of commercial priorities within the company. The reduction below business-as-usual that is required is fairly small but it is real and does force the company to start factoring in climate change into its commercial decision-making.

The third area is joining up with other companies in terms of voluntary training schemes. There is some discussion of that in Australia. There are actions being taken elsewhere, particularly in the United Kingdom.

To conclude, let me talk about implications for policy. In the spirit of being provocative, these are not particularly deeply thought out but hopefully will generate some discussion. First of all, I think there is tremendous opportunity to harness the power of the consumer to drive company environmental performance. The more customers are informed and the more they are willing to make judgments, the more businesses will follow. They will follow the consumer dollar. I think that says that there is opportunity for government in informing the community better on environmental performance. It is staggering to me to see that here in Australia air quality readings in our capital cities are not available freely and daily from each of the environmental protection authorities. In Victoria, I can log on and get the air quality reading for that day in Melbourne. I cannot get it in Sydney, I cannot get it in Brisbane and I cannot get it elsewhere.

I think there are untapped opportunities for market solutions in terms of air quality, tradable permits and waste oil recycling. But these things require our bureaucrats to have new skills. First, designing markets is not a game for environmentalists. It is probably not even a game for environmental economists; it is a game for people who understand market dynamics and trading markets and asset markets. That does take some different skill sets. It also requires, in terms of communication, perhaps some stronger media skills.

Lastly, there are potential new structures. I know at the federal level you have been through an exhaustive environmental legislation change process and probably the last thing you want to contemplate is new structures. But potentially there is scope for agencies that have a much stronger accreditation, verification and communication role in the environmental area. At the global level, it is not hard to imagine a world environment organisation sitting alongside the World Trade Organisation, with that kind of multilateral enforcement and dispute resolution mechanism.