Carbon Accounting: Methodologies for Climate Finance

Understanding Carbon Accounting

Carbon accounting is like keeping track of money. You balance your budget by counting income and expenses. Carbon accounting does this with emissions. It's all about figuring out how much carbon a business is releasing. This is known as their carbon inventory. They can lower this number if they make positive changes or use offsets.

There are three types of carbon emissions that people talk about in this field. They're called Scope 1, Scope 2, and Scope 3.

The formula to calculate total greenhouse gas (GHG) emissions is simple:

Total GHG Emissions = Scope 1 + Scope 2 + Scope 3

Frameworks and Standards

Greenhouse Gas Protocol (GHG Protocol)

The GHG Protocol is a gold standard framework for carbon accounting practices. The protocol is a widely recognised standard for measuring carbon emissions using scopes.

The World Resources Institute and the World Business Council for Sustainable Development created the GHG Protocol. This tool guides businesses in measuring their greenhouse gas emissions. It also aids them in understanding the regulatory environment and its climatic impact.

ISO 14064

ISO 14064 is another carbon accounting standard developed by the International Organization for Standardization. Complementary to the GHG Protocol, the ISO 14064 series ensures:

• Consistent reporting of carbon emissions and removals
• Assistance in tracking emission reductions
• Transparency and credibility in quantifying and verifying emissions data

Key terminology

Greenhouse Gas Emissions

Carbon accounting is sometimes known as greenhouse gas accounting when considering other GHGs. The three primary greenhouse gases are carbon dioxide, methane, and nitrous oxide. Accurate measurement and tracking are essential for understanding the impact on the environment. Carbon accounting helps to quantify the emissions of carbon dioxide.

Carbon Footprint

A carbon footprint represents the total emissions resulting from an organisation's activities. This includes direct emissions and indirect emissions from energy consumption and supply chains. Calculating their environmental impact allows organisations to identify areas for improvement.

Measurement and Calculation Methods

Scope 1, 2 and 3 Emissions

Emissions are categorised into three main scopes:

• Scope 1: These are direct GHG emissions produced by a firm's activities, like fuel combustion or gas leaks.
• Scope 2: Indirect emissions originating from purchased electricity, heat, or steam.
• Scope 3: All other indirect emissions from an organisation's supply chain. This includes transport, procurement, business travel and waste management. It can refer to upstream suppliers and downstream emissions from customers.

Each scope helps quantify an organisation's carbon dioxide, methane, and nitrous oxide emissions. This enables them to take targeted actions to reduce their carbon footprint.

Calculating Scope Emissions

To calculate the actual emissions for each scope, some steps include:

1. Define organisational and operational boundaries
2. Identify current emission sources and collect data
3. Apply emission factors to convert activity data into corporate GHG emissions
4. Calculate carbon dioxide equivalent (CO2e) emissions
5. Review and report results

Emission Factors and Estimates

Greenhouse gas accounting practices rely on emission factors. These are coefficients that estimate the emissions per unit for each activity.

An example might be the per-mile emissions from business flights or company vehicles. Various resources offer emission factors like governmental guidelines, scientific research, or secondary data.

Organisations can use these elements to calculate their total greenhouse gas emissions. They do this by multiplying the factor by the activity data. Sometimes, exact measurements aren't possible. In these cases, estimates are essential.

Total GHG Emissions = Activity * Emissions Factor

Methods for Measuring Emissions: Spend, Activity, and Hybrid Methods

When measuring carbon emissions, the choice of methodology matters. The right approach provides reliable data and insights. Let's explore the three main approaches to carbon accounting.

Spend-Based Method

This approach ties carbon emissions to the financial value of goods or services. Here's how it works:

• Emissions are calculated by taking the cost of a purchased item and multiplying it by an emission factor.
• These factors are based on industry averages derived from national or international data sets.
• The simplicity of the spend-based method makes it easy to estimate emissions per monetary unit. However, general industry averages might give an inaccurate picture for specific businesses.

Activity-Based Method

This approach focuses on the activities a business carries out.

• It measures emissions based on the actions taken by the organisation.
• It involves collecting raw data, which is then converted into emissions data.
• Its detailed information offers a more precise view of a business's emissions. This method is handy for tackling indirect emissions, which comprise around 90% of supply chain emissions.

Hybrid Method

This approach combines the strengths of the spend-based and activity-based methodologies. The Greenhouse Gas Protocol recommends it.

• The hybrid approach involves gathering as much activity-based data as possible.
• For areas where this data can't be collected, it uses spend-based estimates to fill in the gaps.
• This gives a balanced, comprehensive view of a business's carbon footprint. The aim is to maximise accuracy and minimise reporting gaps.

Understanding these methods is the first step. It helps your business find the right path towards carbon neutrality.

Reporting and Disclosure

Securities and Exchange Commission

The Securities and Exchange Commission (SEC) play a crucial role. As regulatory bodies impose stricter reporting requirements, organisations must disclose accurate Environmental, Social, and Governance (ESG) data. This makes their carbon footprint transparent to stakeholders.

Reporting Requirements

To meet SEC rules, firms must report on all their emissions. This involves disclosing all direct, indirect and supply chain emissions (scopes 1-3)

ESG Frameworks and Standards

Companies should follow established ESG frameworks and standards to maintain consistency and credibility. For example, the GHG Protocol sets widely-accepted principles for GHG accounting methods.

Management Strategies

Science Based Targets (SBTs)

Setting Science-Based Targets is a clever way to manage carbon. By using 'carbon budgets', businesses can plan to cut emissions in alignment with the Paris Agreement.

Some climate benefits of adopting SBTs include:

• Ensuring climate action aligns with scientific recommendations.
• Enhancing reputation by demonstrating a commitment to sustainability initiatives.
• Reducing regulatory risks and staying ahead of potential future legislation.

Carbon Offsets

Carbon offsets involve the purchase of carbon credits to compensate for enterprise emissions. These credits fund projects to balance the GHGs entering the atmosphere.

Some examples of carbon offset projects are:

• Reforestation or afforestation initiatives to increase carbon sequestration.
• Investing in energy-efficiency projects that reduce overall emissions.
• Supporting methane capture technologies at landfill sites.

Carbon Pricing

Carbon pricing is a method used to cut down on the release of greenhouse gases. It's a way to ensure that the businesses causing the pollution are paying for it. The goal is to motivate firms to lessen their carbon emissions. It operates in two key ways:

1. Carbon Taxes. The tax is set based on the tons of carbon dioxide (or equivalent) emitted. By making pollution expensive, businesses are incentivised to lower their emissions to avoid paying the tax.
2. Emissions Trading Systems (ETS). This method sets a 'cap' or a maximum limit on the total amount of certain greenhouse gases that can be emitted. If a business emits less than its allowance, it can sell its extra capacity to another company that needs it. It's a way of ensuring the total emissions stay under the cap.

Carbon pricing stimulates clean technology and market innovation. It also drives investment into clean, low-carbon technologies. Yet, it's essential that pricing is set at the right level. Too low, and it won't provide enough incentive to reduce emissions. Too high, and it may hinder economic growth.

Carbon Markets

Carbon markets build on carbon pricing. They offer a smart way to trade carbon allowances and credits. The system they use is called 'cap and trade'. This puts a limit on the carbon dioxide businesses can release.

Businesses that emit less than their quota can sell their excess allowances. This promotes a market mechanism to drive down emissions.

Carbon markets can be classified into two main types:

• Compliance Markets. Governments set emission caps in these markets, and companies must hold permits equal to their emissions. Companies that reduce their emissions below their cap can sell their excess permits.
• Voluntary Markets. Regulatory caps do not bind these markets. Instead, individuals, companies, or governments voluntarily purchase carbon offsets to reduce their footprint.

Carbon markets have been hailed as a cost-effective and flexible way to reduce emissions. However, they also face criticism regarding their efficacy, transparency, and fairness. Therefore, it is essential that these markets are well-regulated and that the environmental integrity of the carbon credits is maintained.

Role of Auditors in Carbon Markets

Auditors are like guardians in the world of carbon markets. Their work is critical due to the complexities and risks these markets pose. Here's how they contribute:

• Verifying Emission Data: Auditors confirm the truth of emission data that companies report. They make sure companies follow emission standards set by regulatory bodies.
• Role in the Voluntary Carbon Market. Auditors also check how effective carbon offset projects are. They verify if carbon offset schemes reduce emissions as promised. This task is critical because it affects the value and trustworthiness of carbon credits and market integrity.
• Assessing Carbon Credits Accounting. Carbon credits are increasingly critical financial assets. Auditors ensure they are valued and reported correctly in financial reports. This transparency helps investors, lenders, and other stakeholders make informed decisions.

However, the role of auditors in carbon markets is not without challenges:

• Need for Expertise. Verifying emission data and carbon offset projects requires specific knowledge and understanding of complex technical details.
• Standardisation Debates. There are ongoing discussions about making auditing procedures more uniform and the need for regulatory oversight.

Renewable Energy

Transitioning to renewable energy generation has many benefits. It reduces fossil fuel use, lowers energy costs, supports a low-carbon economy, and helps hit net-zero goals.

Implementing renewable energy sources can involve:

• Installing on-site renewable energy generation systems, such as solar panels or wind turbines.
• Purchasing clean energy directly from suppliers or through renewable energy certificates.
• Investing in off-site renewable projects, such as community solar or wind farms.
• Transitioning to electric vehicles for business travel.

Carbon Accounting Software

Various carbon accounting software and tools have emerged in recent years. Key features include data collection, carbon assessment, emissions tracking, and analytical insights.

Some sustainability software options include:

• Persefoni. A climate management software offering comprehensive data collection and analytics.
• NetO. Uses artificial intelligence to suggest future carbon dioxide emission reduction strategies and budgets.
• Watershed. A climate operating system. It helps companies measure, report, and cut their carbon footprint. It also supports new ways to invest in innovative carbon removal initiatives.

Key Features

These software solutions provide several significant features:

• Data Collection. They streamline carbon emission data collection, making it easier to track performance.
• Emissions Tracking. The tools allow companies to monitor and measure their supply chain emissions.
• Insights and Analytics. Advanced algorithms and analytics present insights for meeting sustainability goals.
• Carbon Management. Businesses can better manage their carbon emissions and work towards achieving net-zero targets.

Challenges and Criticisms

Greenwashing

One significant concern regarding GHG accounting methods is the issue of greenwashing. Greenwashing occurs when a company inaccurately portrays its environmental impact positively.

• Companies might overstate their efforts to reduce carbon emissions
• Misleading claims about their environmental responsibility can impact their ESG score
• This can create confusion and misinterpretation of a company's actual environmental performance

Measuring Scope 3

Scope 3 emissions are the tricky part of a company's carbon footprint. They're hard to track and manage. Let's break down why:

1. Lots of sources. Scope 3 emissions can span many geographies and sectors in a company's value chain. This makes them hard to track.
2. Data problems. It takes a lot of work to get good data. Many companies struggle to get reliable data from their suppliers and partners. This is even harder when those partners are smaller or in different countries.
3. No standard method to calculate Scope 3 emissions. The Greenhouse Gas Protocol gives some guidance, but there's still room for interpretation. Different companies report their emissions in different ways. This inconsistency and uncertainty make it difficult to compare across companies and sectors.
4. Accountability and responsibility. Scope 3 emissions are technically produced by entities outside the company's direct control. So, deciding who should be responsible for reducing these emissions is challenging.

Kaplan and Ramanna suggest addressing these challenges through an E-liability method. Here companies treat emissions like inventory and assign them a cost. This approach encourages an accurate representation across supply chains and vigorous decarbonisation efforts.

Accuracy and Verification

Accuracy is crucial because:

1. It enables companies to identify emissions hotspots and target specific areas for improvement.
2. Proper disclosures attract investment as it signifies responsible business practices and sustainability.
3. Transparent reporting aligns with the expectations of various stakeholders. These include customers, investors, and regulators.

However, several factors can cause difficulties in maintaining accurate data:

• Varying methodologies and assumptions can lead to differences in reported emissions
• Lack of clear guidelines can result in challenges when comparing data across industries
• Uncertain and inconsistent data sources can affect the credibility and comparability of emissions data

Proper verification of emissions data is vital, as it helps validate the accuracy of the reported emissions. However, some companies may face difficulties in the verification process, such as:

• Limited access to specialised expertise
• Ensuring comprehensive, high-quality data
• Addressing discrepancies in reported data

Organisational boundaries must be defined to avoid double-counting emissions. Robust verification processes should be implemented. Additionally, avoiding greenwashing and promoting transparency can better understand a company's environmental impact. This honesty aids in our global fight to lower greenhouse gas emissions.

The Role of Various Stakeholders

Value Chain

The value chain is crucial in understanding and refining the carbon accounting process. Firms must know their supply chain carbon impacts and look for improvements or offsets.

Key aspects that stakeholders, such as suppliers, manufacturers, and customers, must consider:

• Assessing carbon footprints of products and services
• Identifying opportunities for reducing emissions
• Implementing strategies to minimise adverse environmental impacts

Governments and Regulatory Bodies

Governments and regulatory bodies establish rules and guidelines for carbon accounting practices. They are responsible for the following:

• Defining and enforcing greenhouse gas (GHG) emissions regulations
• Monitoring and evaluating businesses' compliance with emission regulations
• Developing and implementing measures to encourage carbon reduction and innovation
• Supporting carbon reporting frameworks, such as those included in the Sustainable Development Goals (SDG)

The Interaction of Stakeholders

Both internal and external stakeholders are the backbone of carbon accounting practices. Internal stakeholders, such as management and employees, ensure adherence to protocols. External stakeholders offer insight into emerging trends and best practices.

• Value chains should work with governments and regulators to follow the rules and standards.
• Governments must ensure that policies encompass all aspects of the value chain. This includes the supply chain and downstream emissions from customers.
• Shareholders can also demand transparency in the reporting of greenhouse gas emissions. They can also push companies to cut emissions and support sustainable practices.

Wrapping Up: The Importance of Carbon Accounting

Carbon accounting processes are crucial for organisations to manage emissions and address sustainability issues. Regular monitoring and reporting of carbon emissions help to:

• Track performance against reduction targets
• Identify areas for improvement
• Communicate progress to stakeholders
• Comply with regulations and industry standards
• Mitigate the risk to reputation and competitive advantage

By embracing carbon accounting methods, organisations can make informed decisions. These choices can cut down carbon emissions and help create a greener future.