Measuring Sustainability from Space
By: Alex Diamond
Tags: Sustainability, Environment, Geospatial, Data Science, Climate Change

Technology and risk-based modeling may soon put the world on a path to eliminate the concept of “negative externalities” as data begins to transform physical industries in the same way it powered the engines of the internet economy. Negative externalities are the unaccounted environmental and societal side effects of commercial and industrial activities. They are often opaque to the general public and manifest themselves in long-term costs missing from business decisions during the moment of investment. A well-known example is the cost of producing plastic. Production costs don’t account for proper recycling or disposal, so plastic waste often ends up in rivers that empty into the ocean, and the world suffers from the negative externality of microplastic contamination. This cost eventually needs to be absorbed by the global population at large (e.g., taxpayers).

As environmental disasters encroach on global communities and ecosystems on a near-daily basis, the hidden costs from industrial processes and consumer behavior are increasingly visible as large swaths of people escape poverty and adopt a carbon-intensive Western lifestyle. Whether it’s the implicit costs from catastrophes like California’s Camp Fire that nearly brought down PG&E or the explicit rules and regulations of the cap and trade policies of the EU Emissions Trading System, it’s clear that the unaccounted side effects of commodity supply chains can no longer remain externalized. Instead, companies need to model these costs in long-term strategic planning in the form of internal carbon prices as governments, shareholders, and communities reward good stewards and punish careless actors.

Vegetation encroachment on PG&E power lines caused California’s Camp Fire. Descartes Labs generated this image using LiDAR data and our proprietary tree detector to assess tree locations relative to power infrastructure.

ESG Investing — Rewarding Companies that Limit Risk Exposure

Major corporations are finding that it’s in their best interest to adapt to the implicit and explicit costs of carbon or pollutant-intensive supply chains. A direct result of this trend is the emergence of Environmental, Safety, and Governance investing (ESG), which aims to generate long-term investment returns by channeling financing to companies that carefully limit their exposure to dangerous and costly environmental accidents. Examples include wildfires, oil spills, illegal deforestation, dam breaches, or societal impacts like workplace health & safety, labor disputes, privacy & security, and more.

The table below lists 37 key ESG issues as outlined by MSCI, a leading index and analytics provider for institutional investors.

Major ESG issues as defined by MSCI’s ratings methodology. (source)

ESG is among the most critical “alternative” factors driving investment decisions today. According to the Global Sustainable Investment Alliance (GSIA), $30.7 trillion of the nearly $90 trillion in total global assets under management (AUM) in 2018 were defined as “sustainable investing assets.” This statistic illustrates the financial weight behind ESG, which has increased in parallel with sustainability reporting by the world’s largest public companies. In a report released by The Governance and Accountability Institute, Fortune 500 corporations publishing sustainability reports have increased from 20% in 2011 to 85% in 2017. Almost every leading capital allocator now believes ESG and sustainability are economically prudent and not merely social issues.

For the purpose of this document, Climate-Related Sustainability can be defined as follows:

Comprehensive actions by large organizations to reduce large scale environmental and social impacts resulting from business and trade. Environmental and social impacts are summarized by the UN’s Sustainable Development Goals.

Sustainability reporting increasing over time. (source)

Fiduciary Duty to Sustainability — Measurement in Practice

The link between integrated sustainability practices and share price outperformance is a theme echoed by industry experts:

“Robert Eccles, a visiting professor of management practice at Saïd Business School at the University of Oxford, says that the global investment community’s interest in environmental, social, and governance (ESG) issues has finally reached a tipping point. Large asset management firms and pensions funds are now pressuring corporate leaders to improve sustainability practices in material ways that both benefit their firms’ bottom line and create broader impact. They’re also advocating for more uniform metrics and industry standards.” — Harvard Business Review, March 2019

Many of these experts see a parallel to the way GAAP accounting standards were developed and adopted in the early 1970s. Definition, self-regulation, and standardization were delegated by the government to a private entity, and public companies have had a common set of standards to measure and report against ever since. Public company investors now make decisions about the quality and future earnings potential of businesses based mainly on this information. The necessary conditions are clear rules, clear metrics, clear means of measurement, and a consistent and predictable playing field for companies to operate within.

While there is still work to do in terms of establishing generally accepted ESG standards, more companies are taking a closer look at their commodity supply chains and identifying ways to model and address impacts, including setting internal carbon prices. Many see managing carbon risk in a similar light as managing other financial risks, such as interest rates, foreign exchange, and debt servicing. As a result, companies are working to determine the geographic locations and volumes of their CO2 emissions, as well as those from suppliers and customers that fall upstream and downstream of their core operations and production.