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Scope 4 emissions: Unlocking low-carbon innovation
We typically think of an individual company’s greenhouse gas (GHG) emissions being pigeonholed into one of three categories, or scopes as they are known. Scope 1 covers direct emissions from a company’s own operations. Scope 2 covers indirect emissions resulting from the generation of energy that a company buys. Finally, Scope 3 includes all the other indirect emissions that occur in a company's value chain.
While Scope 1 and 2 emissions are relatively straightforward to measure and report on, Scope 3 is much more challenging. In part this is due to the potential for double counting (i.e., one firms Scope 3 emissions may be another’s Scope 1 and 2 emissions), but also because of the sheer size and complexity. Scope 3 typically accounts for three-quarters of a company’s emissions (although this varies significantly by sector), and measuring it involves gauging the emissions both up and down the supply chain, often involving thousands of individual suppliers and products (see Owning up to Scope 3: How investors should think about the SEC's proposed disclosure requirements).
Just when you thought it couldn’t get any more complicated, Scope 4 emissions offer the potential for even more confusion. Scope 4 emissions are the “avoided emissions” resulting from the production and use of more carbon efficient products, or the employment of services such as energy efficiency that avoid carbon emissions (see Harnessing the invisible fuel).
The idea behind Scope 4 emissions was originally put forward by the World Resources Institute (WRI). The non-profit organisation originally defined the term in a 2013 article highlighting the need for a new avoided emissions category to complement the standard Scope 1, 2, and 3 emissions. In theory, Scope 4 emissions enable businesses to think beyond their own operations and supply chain, and instead consider the broader carbon benefit they may be having on the global economy.1
If all the incentives (monetary, reputational or otherwise) are focused on individual companies bearing down on their Scope 1, 2 and 3 emissions then we may be missing out on innovations that, while far from optimal at the individual firm or industry level, could have much larger net emissions benefits for the global economy. The manufacturing of electric batteries or a wind turbine may be energy and carbon intensive, but this may be vastly outweighed by their Scope 4 emissions.
For example, wind turbine manufacturer Vestas estimates that over the last four decades their turbines avoided emissions totalling 1.7 billion tonnes of CO2e, when compared to the average carbon footprint of electricity in the countries the turbines were installed. Vestas estimates that the turbines produced in 2021 will avoid 532 million tonnes of emissions over their expected operational lifetime. In comparison the wind turbine estimates its 2021 annual Scope 1, 2 and 3 emissions at 100,000 tonnes, 3,000 tonnes and 10.5 million tonnes respectively.2
Estimating the avoided emissions made by one firm is fraught with difficulty. Just ask the carbon credit market. One of the biggest risks there is over-crediting, i.e., more credits being issued than tonnes of CO2e avoided. The same challenges also apply to companies keen to take some credit for their Scope 4 emissions. The first question firms need to answer is what baseline level of emissions the new product is being compared against? Their previous product, the average emissions in the product category, or perhaps the previous technological solution (e.g. electric vehicles versus ICE)? Next, what assumption to make regarding the carbon intensity of the energy powering it? Charge that same efficient battery in South Africa or China and it will have much higher carbon emissions than if it is plugged into the grid in Canada or Norway. Another factor to consider is whether the new product or service will result in any rebound effects, perhaps offsetting any emissions saved as a result of the improvement. Unless businesses are employing a consistent approach across these and many other critical questions then it’s impossible to know (see The carbon tracking opportunity: Real time tracking of GHG emissions and carbon sinks is a huge growth market).3
Some companies might even consider using their Scope 4 emissions to obviate any obligation to address their Scope 1, 2 and 3 emissions. This is an absolute non-starter. Arguably, Scope 4 emissions should have already been accounted for under Scope 1, 2 and 3 emissions anyway, by some other firm, somewhere else in the economy. Nevertheless, the opportunity to realise and be rewarded for innovation with broad based net zero benefits has got many companies interested. Their own operations may be highly carbon intensive, but if they can point to the broader carbon benefits their products enable then they begin to look much more attractive, say for example, to sustainability orientated investors (see 'Green' lithium).4
Remember that the dominant sustainable investment strategy involves divesting from firms with a high emissions footprint, while re-directing capital towards companies with very low emissions, even if the scope for further reductions is negligible. Unfortunately this strategy of focusing on percentage emissions reductions, no matter the base level of emissions creates a misallocation of investment capital and results in unintended consequences.
Divesting from high emitting companies may increase their cost of capital, but in doing so it also reduces their incentive and ability to decarbonise. Instead of being shunned by investors for their adverse environmental impact, firms with an outsized Scope 4 emissions profile may be able to benefit from a lower cost of capital, helping them deliver products with carbon emission avoidance benefits to a much broader array of the global economy.
All too often critics point to the need for every single individual, company or government to pull their own weight, sharing in the burden of meeting net zero through cutting emissions. However, that isn’t necessarily the optimal way to achieve net zero. Carbon markets explicitly recognise that the most efficient way to achieve carbon abatement is by exploiting the lowest cost options first, with high cost emitters paying those more able to cut emissions.
Scope 4 emissions takes this one step further. It’s not only what you emit that counts, but what you enable others not to emit. Recognising the contribution played by Scope 4 emissions means putting a value on those avoided emissions.
The challenge involved in estimating Scope 4 emissions hasn’t stopped investment institutions trying to develop a consistent methodology for estimating them and so enabling Scope 4 to be integrated at a company level. In May, a group of eleven investment institutions launched a call for expressions of interest (closed 16th July) to develop a database on Scope 4 emissions https://www.mirova.com/sites/default/files/2023-05/Call-for-Expression-of-Interest-global-avoidance-factor-database.pdf
Note that the same principles might also apply to a country seeking to decarbonise. Take Indonesia. How should it balance the need to cut emissions by replacing its coal fleet with renewables versus the avoided emissions resulting from nickels use in electric vehicle batteries?