It’s generally well understood that the world’s best companies are embracing sustainability as a business imperative whilst aligning ESG issues with their missions and purposes. It’s an exciting time in the sustainability world. As this ESG momentum builds, more and more companies are reporting their carbon emissions in their sustainability reports. This is good news for ESG investors because if you can measure it, you can manage it. As such, carbon reporting creates an opportunity to accelerate the transition towards a low carbon world. We discuss the three scopes at the core of carbon reporting below.
Why are companies reporting their carbon emissions?
Firstly, the drive to report carbon emissions is supported by the Paris Agreement, which is the international contract aimed at addressing climate change. The 189 countries who signed the Paris Agreement have committed to take steps to reduce their carbon emissions in a global effort to limit global temperature rises to two degrees Celsius above pre-industrial levels by 2040. Moving away from high emission energy sources like coal towards renewable energy is a key goal for all of these countries if they are to deliver on their legally binding Paris commitments.
And secondly, investors are demanding carbon reporting. There’s a growing awareness in the investment world that companies who report and reduce their carbon emissions are often superior investments. There are many reasons for this including the importance of high quality disclosure of all business activities, the cost savings that result from lower carbon emissions, and the business opportunities associated with lower emissions. Also, more ESG investors are aware of the impacts of climate change, and are realigning their investments accordingly.
Introduction to carbon emission reporting
Carbon reporting generally follows the GHG Protocol which divides greenhouse gas emissions into three scopes as shown below. Whilst scope 1 and 2 emissions are compulsory to report, scope 3 emissions are voluntary and the most challenging to monitor.
Scope 1 emissions
Scope 1 greenhouse gas emissions are emissions which come directly from a company and its controlled entities. These are divided into four categories:
- Stationary combustion – covers all fuels and heating sources which produce greenhouse gas emissions.
- Mobile combustion –includes the greenhouse gas emissions from all vehicles owned or controlled by a company.
- Fugitive emissions – covers the greenhouse gas emission leaks from sources such as refrigeration and air conditioning units.
- Process emissions – includes the greenhouse gas emissions from industrial processes and onsite manufacturing.
Companies interested in reducing their Scope 1 emissions tend to be focused upon improving their energy efficiency, and transitioning their transportation fleet towards electric vehicles.
Scope 2 emissions
Scope 2 greenhouse gas emissions are emissions which come indirectly from the generation of purchased energy from a utility provider. For most companies, electricity consumption is their one and only source of Scope 2 emissions.
Companies focused upon reducing their Scope 2 emissions tend to purchase their energy from utility providers with clean energy options, as well as purchasing carbon offsets.
Scope 3 emissions
Scope 3 emissions are all indirect emissions – not included in scope 2 – that occur in the value chain of the reporting company, including both upstream and downstream emissions. In other words, emissions that are linked to the company’s operations. According to GHG protocol, scope 3 emissions are separated into 15 categories.
Companies focused upon reducing their Scope 3 emissions tend to be focused upon cutting back on business travel, encouraging employees to work from home, using climate-friendly transport across the business, and cutting back on waste generation.
Upstream activities fall under several categories: for many companies, business travel is one of the most significant to report (e.g. air travel, rail, underground and light rail, taxis, buses and business mileage using private vehicles). Also, employee commuting shall be reported, as it results from the emissions emitted through travel to and from work. It can be decreased through public transportation and home office.
Waste generated in operations relates to waste sent to landfills and wastewater treatments. Waste disposal emits methane (CH4) and nitrous oxide (N2O), which cause greater damage than CO2 emissions.
Purchased goods and services, includes all the upstream (‘cradle to gate’) emissions from the production of goods and services purchased by the company in the same year. It is useful to differentiate between purchases of production-related products (e.g, materials, components and parts) and non-production-related products (e.g, office furniture, office supplies and IT support).
Transportation and distribution occur in upstream (suppliers) and downstream (customers) elements of the value chain. It includes emissions from transportation by land, sea and air, as well as emissions relating to third-party warehousing.
Fuel and energy-related activities include emissions relating to the production of fuels and energy purchased and consumed by the reporting company, in the reporting year that is not included in scope 1 and 2.
Capital goods are final products that have an extended life and are used by the company to manufacture a product, provide a service or, store, sell and deliver merchandise. Examples of capital goods include buildings, vehicles, machinery. For purposes of accounting for scope 3 emissions, companies should not depreciate, discount, or amortize the emissions from the production of capital goods over time. Instead, companies should account for the total cradle-to-gate emissions of purchased capital goods in the year of acquisition (GHG protocol).
Investments are included largely for financial institutions, but other organisations can still integrate it into their reporting. According to GHG accounting, investments fall under 4 categories: equity investments, debt investments, project finance, managed investments and client services.
Franchises are businesses operating under a licence to sell or distribute another company’s goods or services within a certain location. Franchisees (e.g. companies that operate franchises and pay a fee to the franchisor) should include emissions, from operations under their control. “Franchisees may optionally report upstream scope 3 emissions associated with the franchisor’s operations (i.e., the scope 1 and scope 2 emissions of the franchisor) in category 1 (Purchased goods and services).”
Leased assets correspond to leased assets by the reporting organisation (upstream) and assets to other organisations (downstream). The calculation method is complex and shall be reported in scope 1 or 2, depending on the nature of the leased asset.
Used of sold products is included, concerning “in-use” products that are sold to the consumers. It measures the emissions resulting from product usage, even if it varies considerably. For example, the use of an iPhone will take many years to equal the emissions emitted during production.
At the same time, “end of life treatment” corresponds to products sold to consumers, and is reported similarly as “waste generated during operations”. Companies must assess how their products are disposed of, which can be difficult as it usually depends on the consumer. This encourages firms to design recyclable products that limit landfill disposal.
Let’s have a look at a carbon reporting example. The chart below shows Apple’s 2019 carbon emission data cross the three scopes mentioned above.
Apple is a useful example because it highlights the value of accessing all three carbon reporting scopes. Almost all of the company’s emissions are classified as Scope 3 emissions, with 76% coming from the company’s outsourced product manufacturing operations. This information is useful to ESG investors as it highlights where Apple faces a number of risks and opportunities. For example, there’s clearly a significant opportunity for Apple to use more recycled materials in its outsourced manufacturing operations, and to use less material in general. That’s both an environmental and financial opportunity.
Carbon reporting is here to stay, and ESG investors are benefiting from the availability of Scope 1,2 and 3 emission data on more and more companies. ESG Analytics has built a global database which provides clients with access to Scope 1, 2 and 3 carbon emission data for a global universe of companies.