Beyond emissions: The life of a carbon molecule
Author: David Parham
Beyond emissions: The life of a carbon molecule
Mon, 10/12/2020 - 01:30
Carbon is everywhere. Carbon atoms flow through all living organisms, from the atmosphere to the earth to the oceans and back again.
But carbon is also moving constantly through the global economy, which historically has been powered by burning fossil fuels for energy. As a result, carbon dioxide (CO2) and other emissions have risen dramatically since the industrial revolution, presenting a daunting array of challenges for people, planet and prosperity.
As the most prevalent of the greenhouse gases (GHGs), CO2 plays an outsize role in global climate change — for example, it accounted for 81 percent of U.S. emissions in 2018. If human activity, including economic activity, is the primary driver of global warming, it only makes sense that an effective solution must start with changing that behavior. But how does one go about shifting the actions of thousands of businesses around the world?
The critical role of emissions data
First, let’s be clear: Measuring GHG emissions is incredibly important. GHG emissions are what directly contribute to global temperature rise and are therefore the ultimate target of any action to combat climate change.
As a result, this data informs policy decisions, shapes more effective regulation and helps scientists and other experts understand trends and evaluate potential solutions.
Metrics that focus on the direct levers available to a company — and measure how the company is using them — provide actionable data to management and decision-useful information to a firm’s investors.
GHG emission data also helps business monitor the effectiveness of mitigation strategies, and it helps investors understand broadly how the systemic risk across their portfolio is distributed among exposure to emitters (Scope 1 emissions), energy users (Scope 2) and companies with significant supply chain or use-phase impacts (Scope 3). The value of GHG emissions data to these users is incalculable.
However, at the end of the day, we don’t just want to observe the needle — we want to move it. And, especially when it comes to indirect emissions, that often requires a targeted approach — one that explores the important interconnections between the many points along the carbon value chain.
Identifying the levers of influence
So, how do we catalyze an evolution of carbon-related economic activity all over the world? As with most things in economics, the answer starts with incentives.
Companies understand that financial success and thriving markets go hand-in-hand, so they’re naturally inclined to care about how climate change affects their customers, employees, suppliers, communities and more. But caring about an issue and managing it effectively are very different things.
Effective risk management is often a function of the degree of control or influence a company has over the risk. With GHG emissions, that is a straightforward proposition for direct emitters. For everyone else, it can get significantly more complicated.
According to an analysis of CDP data, just seven industries account for 85 percent of direct Scope 1 emissions. That means a lot of companies — and, indeed, entire industries — need to identify levers of influence that align with their operations, business models and value creation strategies.
The questions companies must ask themselves are, "What business opportunities are inherent in this rapidly changing competitive landscape?" "What are the risks if we ignore climate change?" And, "What levers can we pull to help mitigate these risks, realize the opportunities and help society achieve its emission reduction goals?"
Accordingly, the indicators companies use to measure and manage performance must capture these risks and opportunities, which often vary from one industry to the next. The microeconomic decisions such metrics enable can exert strong influence on emissions while simultaneously contributing to enterprise value creation. For companies, investors and the planet, it’s win-win.
Figure 1. The Life of a Carbon Molecule through the Value Chain
Moving along the value chain
To illustrate, it may be helpful to trace the life of a carbon molecule through the value chain and explore the specific operational or product-design decisions that might be made at each stage. (See Figure 1, above.)
Let’s start with the "emitters," such as oil and gas companies and utilities. For these businesses, Scope 1 emissions data is actionable business intelligence. This is because they face potentially significant financial risks directly related to their emissions, including from existing or anticipated regulations to limit emissions, restrict or mandate specific energy sources, establish a price on carbon or other measures.
Although, in many cases, these companies may pass their increased operating costs or capital expenditures on to customers, this can dampen demand, especially as alternative energy sources and technologies become increasingly competitive.
But where direct emitters are in the driver’s seat in managing direct GHG emissions, companies further down the value chain have very different levers of influence.
Take energy consumers, for example, such as the industrial machinery and goods industry, which manufactures equipment for a variety of industries, including engines, earthmoving equipment, trucks, tractors, ships, industrial pumps, locomotives and turbines.
A company in this industry may benefit from measuring its emissions, but the financial risks it faces are more directly related to other issues: energy pricing and availability; fuel-economy standards; and materials sourcing. By measuring and managing its performance on these industry-specific issues, the company can reduce its own financial and operational risks and exert significant influence on emissions in a variety of ways, including the following:
Influence on Emissions
More energy-efficient manufacturing
Reduces upstream emissions from generation
Lowers manufacturing costs
More fuel-efficient vehicles
Reduces downstream emissions during use phase
Increases revenue by meeting consumer demand
Designing products that minimize the use of critical materials or that may be easily recycled
Reduces upstream emissions associated with extractive activities
Saves raw materials costs
Finally, as another example, automakers face a similar challenge in that the bulk of their emissions are associated with the use-phase of their products — which falls outside their direct control. Nevertheless, a car manufacturer has an important lever of influence in designing products that meet high standards for fuel economy or in diversifying its set of product offerings to increasingly feature zero-emission vehicles.
As consumer preferences shift, this approach enables automobile companies to capture market share while also addressing both downstream (use-phase) and upstream emissions (by decreasing the demand-side "pull").
The value of industry specificity
As these simple, hypothetical examples demonstrate, companies can face different emissions-influencing decisions depending on the activities in which they are involved or the products they produce. Of course, reality is always messier.
For example, when a company is involved in an array of activities or produces a wide range of products, aggregate emissions data can get especially unwieldy. Similarly, companies face different risks related to indirect emissions in their supply chain versus those that result from the use of their products.
For these firms and their investors, only industry-specific metrics can help them tease apart the relative contributions of business functions and inform an effective risk management strategy.
This dynamic is reflected in how we approach climate-related disclosure at the Sustainability Accounting Standards Board (SASB). Although our standards call for direct emitters to disclose their Scope 1 emissions in 22 industries, we also identify other industry-specific levers of influence.
Applying our evidence-based, market-informed standard-setting process to each of 77 industries, we’ve identified metrics associated with the key operational or product-design decisions most likely to influence indirect emissions — topics such as materials sourcing, energy usage, product energy-efficiency and end-of-life management.
Because the financial implications of each of these decisions are different, rolling them up into a single indirect emissions metric does not give investors insight into how a company is adapting its operations, business strategy and/or product mix to address climate-related risks and opportunities.
Although a single indirect emissions metric may not account for this complexity, measuring factors that affect indirect emissions that are under a company’s direct control helps align incentives and drive mutually beneficial outcomes.
For example, consider the financial impact of regulations designed to reduce tailpipe emissions at two points along the value chain (see bottom of Figure 1):
The auto manufacturer is likely to face financial risks and opportunities related to regulations targeting the fuel economy of its products. The company can manage this risk at least in part by changing its product mix toward increasingly fuel-efficient or zero-emission vehicles, lowering use-phase emissions.
At the other end of the value chain, the financial risk to the oil and gas company is several steps removed. Increasingly fuel-efficient vehicles likely would reduce the use of refined products, which would lower demand for hydrocarbons, which would decrease oil prices, which would impact the resiliency of the company’s reserves, which would impair the value of the assets on its balance sheet, which finally would put downward pressure on its stock price. The company could respond by investing in lower-cost, more resilient reserves or diversifying its business model toward alternative or renewable forms of energy — both metrics in the SASB Standard for this industry.
While the ultimate effect is to reduce tailpipe emissions, the levers of control available to companies at different points in the value chain differ. SASB focuses on measuring the industry-specific factor that is most relevant to the financial impact at each point. And because these decisions and impacts are connected through the value chain, in both cases effective management of the issue would support both financial risk-return objectives and emissions mitigation goals.
The life of a carbon molecule is complicated but important. The point at which a molecule of carbon leaves the value chain and enters the atmosphere as CO2 is driven by a complex and interrelated set of financial drivers.
At each point in the value chain, these incentives and the business decisions that result, have significant implications for both upstream and downstream emissions. Such complex systems-level problems require comprehensive solutions, and SASB standards offer an important set of industry-specific metrics that complement existing, widely used measures for indirect emissions.
As a leading contributor to climate change, GHG emissions pose obvious threats to human health, infrastructure, natural resources, energy security and even international order. They also create daunting challenges for business.
A landmark 2018 report by the Intergovernmental Panel on Climate Change (IPCC) suggested the price tag of unchecked climate change will run from $54 trillion to $69 trillion. Similarly, a 2019 study by the National Bureau of Economic Research found that under a "business as usual" scenario, global GDP would drop by 7.2 percent per capita by 2100.
Clearly, it’s critical for the world to have access to complete, reliable and timely GHG emissions data. But it’s not enough to simply know how much closer we’re getting to the iceberg; we also need to turn the ship’s wheel.
Metrics that focus on the direct levers available to a company — and measure how the company is using them — provide actionable data to management and decision-useful information to a firm’s investors. As a result, they help mobilize global capital markets toward a future in which business can optimize its impacts and offer solutions at scale.
To learn more about SASB’s approach to climate-related disclosure, watch the recording of the recent Climate Week webinar "Accelerating Change through ESG Disclosure."
This story was originally published by GreenBiz and can be accessed here.