Why carbon emissions reporting must be handled with care. . .

Featured Sponsor

Store	Link	Sample Product
UK Artful Impressions	Premiere Etsy Store

The writer is an assistant professor of finance at Dublin City University and a member of the GreenWatch team that analyzed the Europe Climate Leaders List 2023

In financial reporting, rigor is everything: Companies whose numbers don’t add up can expect a rocky ride from regulators and investors. But we’re a long way from that rigor when it comes to reporting greenhouse gas emissions, and the consequences for all of us, in the form of extreme weather due to global warming, are much harsher.

For the largest institutional investors, this is a manageable problem, as evidenced by the €116bn invested in Paris-aligned benchmark (PAB) indices. Introduced by the European Commission in 2019, BAP constituent companies must reduce their emissions enough to reach net zero by 2050: 7 percent every year.

But smaller investors, and especially civil society, should not assume that this means all is well with GHG reporting. By contrast, corporate issuance data cannot always be taken at face value. Too often, company reports give a misleading idea of ​​how much progress has been made towards the goal of net zero emissions.

Even data provided to established sources like CDP, a nonprofit organization that runs a platform for environmental disclosure, doesn’t always add up. Analysis carried out by my colleagues at University College Dublin, as well as Imperial College London and the University of Bamberg, found that for 39 percent of oil and gas companies, the sum of their emissions broken down by region or pipeline business did not equal its total reported emissions.

And that was for emissions that arise directly from the companies’ own operations, the so-called Scope 1 emissions, where the procedures for collecting and reporting data are more developed.

The situation is much worse with Scope 3 emissions, which come from all parts of the value chain outside company boundaries, while Scope 2 emissions, from purchased power, fall somewhere in between. .

So how could emissions reporting be strengthened? That is the question that drives a critical review which I am undertaking with four fellow academics: Matthew Brander at the University of Edinburgh; Andreas Hoepner and Tushar Saini from University College Dublin; and Joeri Rogelj at Imperial. Our initial findings suggest several enhancements that could provide the robust and scalable data investors and policymakers require.

One area that needs urgent attention relates to electricity use, as part of Scope 2 emissions. The Greenhouse Gas Protocol, the voluntary framework that establishes the “Scopes” system, allows for two ways of reporting this: using a so-called market-based or location-based approach.

With market-based reporting, companies report emissions from the electricity contracts they have chosen. In practice, this means buying renewable energy certificates (RECs), which electricity providers can sell as long as they supply 1 MwH, and which companies can compare to the energy they actually consume, however dirty.

Although these RECs rarely correspond to the actual physical electricity supplied to the companies that buy them, it is assumed that by purchasing them, companies will incentivize providers to produce more renewable energy. But that assumption is wrong: Research indicates REC purchases are unlikely to lead to additional renewable energy production.

With location-based reporting, on the other hand, regional grid averages are used to calculate emissions, without taking purchasing decisions into account. The point to note here is that average grid blend is different from residual grid mix: the generation (and emissions) remaining after RECs have been claimed and removed from the calculation. The result is that the location-based method includes the same separately sold renewable electricity that companies buy to claim zero emissions under the market-based method.

Therefore, the location-based approach can allow “free travelers” to pay less than others to green the network.

That, however, is a Scope 2 problem. And where emissions reporting has really stumbled so far is at the top tier: Scope 3.

In general, the greater the scope, the worse the availability and quality of the data. Scope 3 emissions have long been excluded from mandatory disclosure requirements as well as net-zero claims for being “out of the control” of the company, a dubious blame shift that smacks of green wash.

However, the magnitude of Scope 3 emissions demonstrates why taking action on them should be a key component of climate leadership.

In 2021, for example, ExxonMobil self-reported emissions of the use of the products sold (530 Mt CO₂ equivalent) would place it among the Top 20 GHG emitting countries. And that’s just one of the 15 Scope 3 subcategories that the GHG Protocol lists for companies to report on.

On average, across the 11 sectors in our research, Scope 3 accounts for 86 percent of total releases (see chart above). No company can legitimately boast its green credentials while tackling only about 15 percent of its total emissions. These emissions may be outside of company boundaries, but blaming suppliers and customers is an avoidance of responsibility. These are the purchases of the company, the product of the company.

If a business model is based on an emissions-intensive product, it is likely that consumers will eventually switch, due to preference, regulation or innovation, to a more sustainable alternative. Therefore, emissions from the use of sold products are a good indicator of transition risk and investors should take note.

When the data is not qualitatively comparable, or it is necessary to rely on estimates, it is essential that investors apply the precautionary principle.

Rather than omit companies that do not report or estimate their emissions based on industry averages, a prudent evaluator should assume the worst. If it becomes standard practice to estimate a value from the 95th percentile upwards, non-disclosers will be unable to hide behind an average. After all, they are unlikely to go unreported because their performance is above average.

Such an approach would encourage self-reporting, rather than giving greenhushers the benefit of the doubt. And it certainly is technically feasible: some data providers already use methodologies in this regard, which offer clients a threshold option when estimating missing information.

When the data is not as complete as they would like, investors still need to hold companies to account: the need to reduce emissions demands nothing less. And when in doubt, my colleague Andreas has a simple rule of thumb: err on the side of the planet, not the side of trade.