The focus on net-zero targets has intensified scrutiny on measurement and disclosure of greenhouse gas emissions. But carbon accounting is a young art, explains Dr Matthew Brander, senior lecturer at the University of Edinburgh.
Stakeholders need to comfortable that recording is taking place in way that is rigorous and fair
The arrival of formal net-zero targets has revolutionised the way countries and companies are looking at and reporting their greenhouse gas emissions (GHGs). But for the targets to be meaningful, stakeholders need to comfortable that recording is taking place in way that is rigorous and fair.
In this Q&A, Dr Matthew Brander, senior lecturer in carbon accounting at the University of Edinburgh sets out the boundaries carbon accountants are working within, and highlights areas where commonly accepted practice might be falling short.
How comfortable are you with the accuracy of carbon data companies publish in their accounts?
It depends what the data is being used for, and that will determine an appropriate margin. For corporate accounting and mitigation planning, it is useful for companies to focus on their major sources of emissions, but you do not need absolute precision. If you carry out a corporate inventory and you have massive emissions from your fleet, you know you need to make changes.
However, your calculations could be out by as much as 20 per cent and it won’t alter the decisions you need to make. If you are concerned about understating your emissions, when the purpose is to buy the requisite number of offsets, you can always increase your purchases of offsets or even double offsets to address it.
The question about accuracy is less critical than understanding the value of your offset strategy
In my view, the question about accuracy is less critical than understanding the value of your offset strategy. Is it distracting you from undertaking abatement? Or is it leading you to a high emissions pathway because you can offset cheaply, potentially leaving you exposed to regulatory risk if carbon pricing is extended to your industry?
There is increasing interest in using corporate GHG data to assess climate-related risk and, for investors making impact investment decisions, to select low-carbon companies. There are lots of issues around comparability, and whether choosing a company with a low-carbon footprint will actually change emissions in the real economy. Maybe the company with a larger footprint needs the capital more, to decarbonise?
That brings us to another question: Where can you find quality in the offset market?
Yes – there is lots of debate in this area, most recently around corresponding adjustments. If you buy a carbon credit from a country, is the government also counting the value of the offset project within its own target, which undermines the additionality?
If you buy a carbon adjustment from a country, is the government also counting the value of the offset project?
To some extent the issue depends on what you want that carbon credit for. For users who want hard-and-fast “we have neutralised emissions” claims, you might want to buy an offset credit from methane capture and destruction project which is likely to be additional, and check the project has a corresponding adjustment reflected in the national GHG accounts.
Others buying credits have different motivations and might just want to do something good, with social and environmental co-benefits as well, such as avoiding deforestation and enhancing biodiversity.
Can a lay person read a company’s financial accounts and understand the carbon management strategy?
That would be hard, although companies do write narrative reports to explain what they have done and why, with a lay audience in mind. Perhaps we could draw a parallel with health messaging on food packaging? Most people do not understand what the numbers mean, and I think it is the same with carbon information. Learning to understand all this information is difficult.
So, is it fair to say that we are a long way off agreeing a transparent rulebook?
There is a lot of research on social and environmental reporting; many academics in that area have concluded there is plenty of greenwashing taking place. The reason companies disclose GHG information or any information may be to legitimise their current practices. We need to guard against that.
Financial carbon accounting is about how to report the financial value of carbon allowances and liabilities
There is a distinction between physical GHG accounting and financial carbon accounting. On the physical side, the unit of measurement is tonnes of CO2, and there is a reasonable amount of standardisation around the protocols.
Financial carbon accounting is different; it is mainly concerned with the accounting around tradeable carbon allowances. Participants in emissions trading schemes have allowances or obligations to surrender allowances, and financial carbon accounting is about how to report the financial value of carbon allowances and liabilities. But there is a lack of agreement on how to do this, so it is hard to compare across different companies’ accounts.
From an investor perspective, I find it useful to concentrate on two distinct audiences who want climate-related information. The largest group is those worried about climate risk, including physical and reputational risk. They want to know how exposed an investee company might be.
The other group is made up of impact investors, like the Church of England, who do not just wish to reduce their risk exposure but use it to reduce emissions. They need other kinds of information to deploy capital, particularly forward-looking scenario information. They need to be asking, “Is there a plan? Is there a strategy to decarbonise? Is it credible and is it costed?” If there is not, they should vote against the proposal at the AGM or engage with the board. The ultimate sanction will be to divest.
GHG accounting practises as they now stand do not tell you that much about climate risk
When it comes to disclosure, the framework suggested by the Task Force on Climate-related Financial Disclosures is a step in the right direction. It is not just about Scope 1, 2 and 3 emissions, it is about looking at a company’s strategy and exposure to different risks. It is still early days, and currently largely voluntary, but it would be great to have it mandated everywhere.
But GHG accounting practises as they now stand do not tell you that much about climate risk or the impact of investment decisions.
Are some companies gaming their carbon data?
It is hard to know how much gaming is going on. There is one practice I believe is misleading, relating to reporting electricity consumption under Scope 2. The market-based method allows companies to buy renewable energy certificates and then say their emissions are zero because their electricity is covered by the certificates. But there is a lot of evidence that buying the certificates does not increase renewable generation.
There should be penalties for those that withhold or distort information
Essentially, this approach makes it possible to shuffle who gets to claim they are using renewables. Many companies are using the same approach, saying emissions from electricity consumption are zero, although physically electricity is being supplied through the grid – from whoever is generating at the time.
A lot of companies engage in this, not because they are deliberately disingenuous or cynically gaming the system, but because the GHG Protocol allows it and others are using it as a cheap way of making it look as if they have low emissions.
As climate change risk becomes more material, there should be penalties for those that withhold or distort information that might be material as well.
Does the accounting treatment mean we have not achieved what we think we have?
That’s right. In the Science-Based Targets initiative, a proportion of the reductions reported are not ‘real’ reductions. They reflect the accounting treatment, which itself is essentially an accounting trick.
It is a good example of how corporate GHG accounting practise has a lot of maturing to do. We are at a point where the users of the GHG information do not see it as material. If they did, they would be shouting loudly about misleading information. But as climate change risk ramps up, certain practices that do not give meaningful representations of the carbon intensity of a company or its exposure to climate-related risk will be scrutinised much more carefully.
Is internal carbon pricing a useful tool or inherently flawed, and at what level should it be set?
There was a presentation from the Bank of England recently on net zero1 which mentioned the shadow carbon price being used in its scenario planning.
Will an asset be viable in 2030 if the carbon price is $150 per tonne?
Companies using internal carbon pricing are free to choose whatever price they want for planning, but it is worth looking at external sources for meaningful indicators. This is important if you take an asset like a gas-fired power station, which is likely to have a useful life of around 30 years. Will it be viable in 2030 if the carbon price is $150 per tonne or will you have a stranded asset?
Are there any carbon management practices currently perceived to be green that whole-of-life analysis shows are not as they first appear?
There have been a lot of academic papers on bioenergy and biofuels. The major issue is indirect land-use change.
If you have an energy company increasing demand for biomass, it may source product from a sustainably managed forest, but that may ultimately displace another user of the resource. The energy company may do its own whole-of-life analysis, but it will not include these market-mediated effects, where the company is driving change beyond its value chain. Those actions are likely to drive up the price of woody biomass, and then suppliers around the world respond to that price signal and deforest to meet displaced demand.
Modelling and estimating market-mediated effects is difficult. So, when a company converts to bioenergy, it cannot know with certainty whether its emissions are likely to be lower or not.
What place do you see for government in driving the low-carbon transition?
Ultimately it is government policy that will deliver the change. We cannot ask investors to voluntarily forego returns to reduce emissions, and we cannot ask companies to voluntarily hit net zero because they will incur costs from decarbonising. If they are up against a competitor that has not gone down this route, they are going to lose out.
We need clear policy around regulation and carbon pricing
What we need is clear policy around regulation and carbon pricing, to create market signals that ensure capital flows to where the best risk-adjusted returns can be achieved. If the government can create an environment where low-carbon options offer the lowest risk and highest return, and the high-carbon options have high risk and low return, the approach will be working. In that case, we will not have to rely on the vagaries of voluntary action and the complexities of carbon accounting.
In the UK, decarbonising the grid was achieved through renewables obligations and contracts for difference, simple policy interventions that that led to massive deployment of wind and solar. It did not require voluntary action; it just created an investment environment that made renewables attractive.