How Prevention Saves Money

In this context, the idea that environmental protection can actually save money is clearly a radical one. So it is worth outlining some of the reasons why this might be the case. It is also essential, of course, to try and identify the limitations of such an idea. Can it be true that environmental protection always saves money? Or that it saves everyone money? Or that the economic savings are immediately accessible and visible? The answer to all of these questions is: probably not. If it were otherwise, we should certainly expect to see far fewer environmental problems than we have seen. So we have to face the possibility that there are some limitations to the idea of economically favourable environmental protection. Before doing so, however, I shall outline some of the reasons why pollution prevention can be expected to pay.

In order to understand fully these economic deliberations it is necessary to know something about the practice of economic cost-benefit analysis. Basically, this is just a method for calculating the costs and benefits associated with a particular capital investment. The difficulty encountered is this: how do we balance out a one-off, upfront, capital cost against a stream of future running costs and benefits? For the benefit of the unfamiliar reader, three different economic balancing techniques are outlined briefly in Box 4. The first criterion—simple payback—is the easiest to understand, but not necessarily the most satisfactory. The other two involve the process of discounting capital costs. This complex procedure is related to the idea that interest is charged on the loan of money to borrowers: the discount rate in Box 4 is usually set according to the rate of interest a firm would encounter if they had to borrow the capital. Since I will return to the question of charging interest on borrowed money in a later chapter, it may be worth spending some time looking through the procedures outlined in Box 4. But a full understanding is not absolutely essential for what follows.

Let us look now examine the economics of preventive environmental management. We have seen that improving material and energy efficiencies represents one of the central elements of the preventive paradigm. Essentially, this strategy means that fewer material inputs are required to provide the same output. But raw material inputs represent costs for the company. So any strategy which enables the company to reduce these inputs while maintaining their output represents a source of cost savings.

Clearly, there may be some investment costs involved in making these material savings. But the experience of a large number of industrial enterprises indicates that many of these investment costs are very low. Improved housekeeping and stock-taking, better maintenance and repairs, and simple process modifications can all lead to less 'leakage' in the system, and to an overall reduction in the material needs of the company. Some good housekeeping measures and minor process modifications may actually have no initial investment cost at all. Box 5 gives several examples of low-cost measures which have led to raw material cost savings for the companies involved.

Efficiency improvements can also result in reduced running costs, reduced waste management costs, and sometimes lower capital costs. For example, innovative changes to the galvanisation process allowed a metal-processing company in France to reduce capital costs by two-thirds, compared with the traditional process.6

BOX 4 ECONOMIC TECHNIQUES FOR INVESTMENT ANALYSIS

A variety of different techniques is used to analyse the economic viability of capital investments. These include the simple payback period, the net present value (NPV), and the internal rate of return (IRR). These techniques are described in turn below. In each case we shall suppose that the investment costs or capital costs (C) are laid out in the first year of the project. In addition, we will assume that the annual running costs (c) and the annual benefits from the investment (b) are constant for each year of the project. Since we are really interested here in investments which might prove profitable we will suppose that b is greater than c.

SIMPLE PAYBACK PERIOD

This is the simplest of the three methods of determining the economic costeffectiveness of a particular investment. All that we do is calculate the net annual benefits from the investment by b-c. We then divide the capital cost C by these net annual benefits. This tells us the number of years it takes to 'pay back' the initial investment: The simple payback P is given by the formula:

A company may use a simple cut-off figure—e.g. a three-year payback—to decide on the financial acceptability of a project. Alternatively, the company may use payback periods to rank different prospective investments and then assign investment capital to those with the best paybacks.

NET PRESENT VALUE

The Net Present Value (NPV) reduces all present and future costs and benefits associated with an investment to a single figure. To do this it uses a procedure known as discounting. Briefly, future costs and benefits are taken to have a lower value than present costs and benefits. We can think of the discount rate (r) as the rate of return which is required on capital invested by the company.

The higher the discount rate, the lower the value of future costs against present costs. For example, a cost of $200,000 which occurs twenty years in the future has a net present value of $44,000 at 5 per cent and $10,400 at 10 per cent discount rate. The further into the future costs and benefits arise, the lower their value compared with present costs and benefits. For instance, if the $200,000 cost mentioned previously is delayed for a further twenty years (i.e. it occurs 40 years in the future) the net present value becomes $17,400 at 5 per cent and only $1,700 at 10 per cent discount rate. (From these numbers we can see why the costs of decommissioning a nuclear power station—which may occur up to 140 years after the commissioning of the plant—have had so little bearing on decisions to invest in nuclear power.)

The net present value of the overall investment is then calculated by adding up the net present values of each future cost and benefit from the investment for each of the n years over which the equipment remains operational, including the initial capital cost of the investment.

When the annual costs (c) and benefits (b) of the project are the same for each year after an initial capital investment C, the formula for calculating NPV is given by:

A project is supposed to be acceptable (at a given discount rate) if the NPV (at that discount rate) is greater than (or equal to) zero. It is unacceptable (at that rate) if the NPV is less than zero. Alternatively, projects may be prioritised by the investor so that those with higher NPVs are preferred over those with lower NPVs.

INTERNAL RATE OF RETURN AND REQUIRED RATE OF RETURN

The internal rate of return on a project is the discount rate r which makes the NPV exactly equal to zero. The required rate of return is the internal rate of return which a company demands from a project before that project is seen as an acceptable investment. If the actual internal rate of return is less than the required rate of return the investment will be unacceptable; but if the internal rate of return is greater than the required rate of return, then the investment will usually go ahead. Note, however, that a company may also use the internal rate of return to prioritise investments, and allocate investment only to those projects with the highest rates of return.

In other cases, substantial capital investments may be needed to replace one kind of technology with another. For example, the replacement of traditional mercury cell technology in the production of chlorine with membrane technology requires a substantial financial commitment by chemical companies. The robustness (in economic terms) of this kind of investment usually depends on whether the existing equipment is still operational, or whether it is reaching the end of its useful life. In many cases, natural recapitalisation—the investment in new technology to replace old or worn-out technology—will provide substantial opportunities to invest in new, cleaner production technologies (such as the membrane technology). These new technologies can sometimes be less expensive to install than the older technologies. Even when they are more expensive to install than the earlier technology, lower 'running costs' of the new technology can still justify replacement.

The strategy of substitution can also lead to economic savings. Some examples are provided in Box 6. These savings sometimes result from the fact that the substituted materials or processes have lower raw

BOX 5 EXAMPLES OF LOW-COST MODIFICATIONS TO

INDUSTRIAL PROCESSES

• A manufacturer of plumbing equipment in the US was producing hazardous waste from an electroplating operation. But a significant proportion of the waste generated came from plating parts which were later found to be defective. A simple procedural modification was made: inspect the parts for faults before plating rather than after plating. Considerable reductions in hazardous waste generation—and raw material inputs—were achieved.

• 30,000 gallons of cyanide-contaminated waste-waters were being generated each year by a US Defense Department metal-plating operation. Much of the contamination was the result of plating solution clinging to the plating parts after they were removed from the bath, and contaminating the rinse water. Drain boards were installed with a capital cost of $900, cutting cyanide wastes by 90 per cent and yielding monthly savings of $784: a payback of just over a month.

• Wastes from a car paint shop in the ECOPROFIT scheme in the city of Graz (see Box 3) arose because of the need to mix fixed quantities of paints for paint jobs of variable size. The development of a computerised mixing system could dispense 40,000 shades of colour in variable quantities and offer an estimated payback of three months.

• Simple design changes to the rinsing system at a Polish plating plant, and the addition of an ion exchange, have reduced the metal-contaminated waste streams by more than 80 per cent. The total capital investment was $36,000. But the annual savings are over $190,000, leading to a payback time of two months.

• An EXXON plant in the INFORM study (see text) achieved a 90 per cent reduction in evaporative losses from chemical storage tanks, simply by installing 'floating roofs' on 16 of the tanks containing the most volatile substances. The modification resulted in savings of $200,000 a year.

• Another plant in the same study made simple operational changes to its rinsing procedures, introducing a two-step process which allowed for recovery of concentrated chemicals at the first step, and reducing the water to dilute second rinse wastes. More than $100,000 were saved in raw material costs on top of the savings in pollution control costs.

Sources: Cleaner Production Worldwide, UNEP, 1993; Hirschhorn and Oldenburg, Prosperity without Pollution, 1991; INFORM, 1985, Cutting Chemical Wastes: what 29 organic chemical plants are doing to reduce their hazardous wastes, by D.Sarokin, W.Muir, C.Miller, S.Sperber, INFORM, New York.

BOX 6 EXAMPLES OF PROFITABLE SUBSTITUTION IN INDUSTRIAL

PROCESSES

• A Swedish lighting company, Thorn Jarnkonst, substituted the oils which they used to 'cut' aluminium sheets with biodegradable oils. This change allowed them to replace the trichloroethylene degreaser needed to remove the oils with an alkaline degreaser. The alkaline degreaser was cheaper than the trichloroethylene, and did not require the installation of expensive recovery equipment.

• The same company substituted electrostatic powder painting for a solvent-based lacquering process. The investment had a payback period of only 11 months.

• A US printing company, Cleo Wrap, spent six years developing water-based inks to substitute for organic solvent-based inks in one of its printing processes. The investment saved $35,000 a year in hazardous waste disposal costs. As a result of the measure, the company also managed to lower its fire insurance premiums and gain some good publicity.

• A Monsanto plant in Ohio modified a phenol-formaldehyde resin process to produce methylated melamine-formaldehyde resins instead. The substitution reduced hazardous waste generation by 89 per cent, saving the company $57,600 a year.

• An EXXON facility replaced oil as the phenol-absorbing medium in its process with another hydrocarbon. The new hydrocarbon/phenol mixture could be recycled back into the process, whereas the oil/phenol mixture had to be disposed of as hazardous waste. The substitution saved $83,000 a year and eliminated 480,000 pounds of waste.

Sources: Cleaner Production Worldwide, UNEP, 1993; Hirschhorn and Oldenburg, Prosperity without Pollution, 1991; INFORM, Cutting Chemical Wastes: what 29 organic chemical plants are doing to reduce their hazardous wastes, INFORM, New York, 1985.

material input costs. But substitution also generally replaces toxic materials with less toxic ones. This means they are likely to require less care in handling, have smaller environmental impacts and incur fewer environmental penalties. Operating costs will generally be reduced because of the lower safety requirements of the substituted materials.

In many cases, a major area of cost saving is in reduced waste management costs. For example, the disposal of solid wastes carries associated costs—such as landfill 'gate fees'; and waterborne effluents may be subject to sewerage charges. Occasionally, there may be other environmental taxes to pay. These taxes are one of the ways in which governments seek to influence corporate behaviour and improve the environmental performance of industry (see Chapter 8). For instance, an emissions charge levied on each tonne of sulphur emitted into the atmosphere acts as an economic incentive to industry to reduce sulphur emissions.

All these waste management and environmental costs are reduced when measures are taken to minimise the generation of wastes at the source. Sometimes, economic savings will go hand in hand with reduced raw material costs. Improved material efficiency means both fewer material inputs to the process and lower environmental outputs from the process.

Another economic area for potential savings is associated with the cost to industry of complying with environmental regulations. Regulation represents another important policy instrument through which governments can attempt to reduce the environmental impacts of industry. Through an appropriate legislative framework the state can impose specific environmental constraints on various aspects of corporate behaviour. For instance, it can legislate for a limit on allowable emissions of mercury into a local river, or sulphur dioxide into the atmosphere. It can lay down conditions on acceptable waste disposal practices. Or it might ban the use of certain hazardous substances. These environmental regulations are enforced through the legal system with financial or even custodial penalties for failure to comply.

The environmental constraints imposed by these regulations may carry significant compliance costs, especially if the regulations are met by the use of add-on or end-of-pipe technologies. As we have already noted, these technologies generally involve capital investment costs and sometimes higher operating costs as well. But preventive investments— whether aimed at improving material efficiency or substituting away from known hazards—may significantly reduce or even eliminate these compliance costs.

The following example illustrates some of these points. Dow Chemical were faced with environmental regulations to reduce suspended solids in the waste-water emissions from a latex process. An end-of-pipe coagulation unit to remove these solids from the waste-water stream would have resulted in landfilling costs of $70,000 a year. They managed to avoid these costs by implementing an intensive maintenance programme to improve seals and close off leaks, and investing $10,000 in a reservoir to hold and recycle the remaining latex leakages.7

The cost savings discussed so far all represent important tangible economic benefits from investing in preventive measures. There may also be some other, less tangible, economic advantages to be gained by reducing emissions into the environment from industrial processes. For instance, better environmental performance is very likely to improve the corporate image in the public eye. This, in its turn, may lead to increased shares in the market and improved profitability for the company concerned. Gaining commercial advantage from these strategies does depend, of course, on a relatively high public awareness about environmental issues. And there also has to be some kind of mechanism for relaying information about corporate environmental performance to the public. But the intuitive reasoning seems to be confirmed by a proliferation of corporate environmental reports, audits and position statements; and by the growing number of commercials which highlight a company's environmental credentials.

In summary, then, there are a number of reasons to suppose that prevention can be cheaper for a company than cure, where environmental management is concerned. End-of-pipe technologies generally add both capital costs and operating costs to a firm's balance sheet. Preventive investment may incur some upfront capital costs, but can generate savings in raw materials, labour costs, environmental charges, and compliance costs. It can also lead to improved corporate image and a greater market share. By way of example, Box 7 provides an illustrative investment appraisal using the cost-benefit methodology discussed in Box 4.

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