Portfolio carbon: focus on the value chain, not the business premises

Tackling human induced climate change is a massive challenge for business and society. In Paris 2015, a global climate deal was reached to shift economies away from greenhouse gas releasing activities, and to limit the increase in average global temperatures to between 1.5 and 2 degrees Celsius. 

All investment has an impact beyond the portfolio, and investors are ultimately dependent on the health of the natural environment and society to generate sustainable returns. A growing number are seeking to address these external impacts in their analysis and decision-making process, and to get appropriate disclosure from the entities in which they invest. 

Investor initiatives related to climate change include the UNEP-FI and CDP Portfolio Decarbonisation Coalition, and the PRI Montreal Carbon Pledge, where signatories agree to measure and publish their carbon footprint annually. The Task Force on Climate-related Financial Disclosures (TFCD), chaired by Michael Bloomberg, is developing voluntary, consistent climate-related financial risk disclosures for use by companies, and France is the first country requiring asset owners and managers to measure their carbon footprint.

The carbon footprint of an investment portfolio, is a measure of its ‘climate friendliness’, and can be estimated based on the annual greenhouse gas emissions of all companies in that portfolio. 

Greenhouse gases (Carbon) are released into the atmosphere from processes including burning coal, oil, and gas for energy. As well as causing local air pollution, these emissions are contributing to global warming and climate change. The release of carbon into the atmosphere is not sufficiently priced, if priced at all, to reflect its impacts on clean air and climate. 

Greenhouse gas emissions can be directly measured at processes, or indirectly estimated from activity data, such as kWh of electricity used or business distance travelled. 

Carbon footprint measurement is relatively straightforward for emissions disclosed from (mainly metered) premises energy use and company-owned vehicles (part of the Greenhouse Gas Protocol scope 1 and 2 emissions categories), but is more challenging when it comes to the value chains that provide products and services (part of scope 3 emissions), and when comparing emissions over project and product life-cycles. In many business sectors, including household goods, automotive, banking and finance, these indirect scope 3 emissions are likely to have the most significant impact.

For this reason the carbon footprint of a portfolio is a realistic assessment of average carbon responsibility only if it goes beyond scope 1 and 2, and addresses key scope 3 emissions, of relevance to the company sector, product and services it provides. The assessment also needs to address potential emissions avoided from investing in alternative cleaner technologies and business models. This requires market context, environmental expertise, and sound judgements, and is not something that can be reduced to a simple model. 

Apart from climate responsibility, the portfolio carbon footprint only provides a limited insight of carbon risk.  Risks, from rising carbon taxes and prices, for example, may be passed along the supply chain depending on the pricing power of participants. Market context is required for individual sectors and investments, to understand what is driving emissions and how R&D, capital expenditure, asset life, etc. can impact on future emissions. 

Making decisions based solely on carbon intensity can exclude companies who are making a greater contribution to climate and energy transition. ‘Green-brown’ metrics, such as renewable energy versus coal, oil, and gas investment, can inform on the dispersion of potential risks and opportunities across investments. 

While many portfolio carbon models help to provide a first-cut proxy assessment, additional company, product, and sector-specific analysis is really needed to better predict future environmental impacts and business value.

From experience of context specific corporate, supply chain and product assessments, we know where the material risk and emission hotspots are likely to be in different companies, products and sectors. Investors need to ensure that portfolio carbon models align with this type of experience, and make sense when drilling down to individual companies.

 

Further reading:

Kepler Cheuvreux (2015) Carbon Compass: Investor guide to carbon footprinting

WRI, UNEP-FI and 2° Investing Initiative Portfolio Carbon Initiative (2015) Climate Strategies and Metrics: Exploring options for institutional investors