Carbon emission calculation in investment opportunities

Climate change is in the driver’s seat of ESG risks at this moment – rightfully so as global initiatives, regulatory efforts and data has created a measurable infrastructure on progress and organizations’ have set targets. Climate change is measured with one KPI, emissions, sounds simple right? Let’s have a look.

Carbon emissions are divided into three different categories: Scope 1, Scope 2 and Scope 3. The global market has largely focused on Scope 1 & 2 emissions, while leaving out the Scope 3 in several instances. Scope 1 measures the direct emissions of the company, including company facilities and vehicles, while Scope 2 measures the purchase of heating, steam, electricity etc. for own use. Scope 3 takes into account all of the indirect measures such as transportation and distribution, processing of sold products, use of sold products, waste generation in operations and a lot more. The difficulty of measuring Scope 3 emissions is understandable, as we can identify in the160-pager Technical Guidance for Capturing Scope 3 Emissions by GHG Protocol written by GHG Protocol. Carbon Disclosure Project (CDP) estimated Scope 3 emissions account for an average of 75% of companies’ greenhouse gases which would leave out a significant part of total emissions if not estimated and reported correctly. This has led to additional efforts in mapping all relevant emissions – such as Science Based Targets Initiative (SBTi) requiring set Scope 3 emissions targets if a company’s total emissions are represented by over 40% in Scope 3 emissions.

If it was not complicated enough the discussions around Scope 4 emissions have picked up speed in 2022.  The definition is not yet set in stone as there is no consensus in how it should be interpreted. The most agreed upon term for the Scope 4 emissions is the avoided emissions outside of the companies’ value chain. In other words, there are two key categories of avoided emissions a) the product replaces an emission intensive product or b) that the product enables emissions reduction. Scope 4 emissions wants to capture how a company’s product, service and/or solution can contribute to solving climate change. The limiting factor is data availability as for Scope 1-3 emission which is why manual assessments and estimates are required.

However, what can be done is to consider the company’s complete life cycle while mapping potential investment opportunities. Questions we like to answer is can we identify a net-positive in total emissions from a company’s operations and business model? As a simplified example – imagine a wind turbine producer. The raw material and construction of the relevant parts of the turbine is intensive but the turbine can repay its carbon footprint from manufacturing in under one year. Furthermore, it most likely replaces a more traditional way of producing energy which allows for an even larger impact on the total carbon emissions. The result is obvious in this case as the investment would clear a margin of net positive emissions with the life expectancy of the wind turbine being around 20 years. Applying this approach gives better insight in a company’s actual impact on emissions and the same model can be applied to any sector. It also gives a better understanding in how the company is picking up the opportunities in climate change which in turn provides significantly better insights in the company’s operations compared to only looking at the fundamental ESG risks in the operations and a third-party ESG risk score. Embedding this line of thinking in the investment decision making process allows for a further layer of integration of ESG risks and opportunities and provides valuable insight in identifying the current and future best-in-class performers.

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