Introducing three vital factors to measure and compare emissions
Business executives and MBA students are intimately familiar with the long-established ratios and other common standards used to compare one company to another (think GAAP, P/E ratios, current ratios, gross profit ratios, etc). We even see the same in processes (think throughput rate, utilisation rate, etc). However, in a recently posted working paper, my co-authors and I find comparability is lacking in greenhouse gas (GHG) emission standards. This presents a problem for the financial sector’s $130 trillion commitment to align with the goals of the Paris Agreement.
Some metrics can seem comparable on the surface, but upon closer scrutiny, fail to be comparable. If one asked, “Who was the best athlete at the Rio Olympics?” the default choice would be to compare who won the most gold medals. However, Michael Phelps competed in six events and won six medals while Alexander Lesun, a pentathlete, participated in five events (pistol, swimming, fencing, equestrian and cross country), yet was only awarded a single gold medal for his efforts.
The GHG Protocol
Existing GHG emission standards, such as the GHG Protocol, were developed to be consistent. The GHG Protocol is fit-for-purpose for within-organisation measurement (i.e. trend analysis; continuous improvement; and target setting). However, the GHG Protocol may not be suitable for either policy makers or the finance sector who require comparisons between organisations in order to make decisions, rate or rank performance, prioritise funding policies, and create inclusion/exclusion criteria for investments into both technology and corporations.
Why compare between organisations?
Comparability is defined as the ability to identify similarities and differences between two objects. This is a core principle of the financial reporting system and any high performing company’s internal metrics. Decision makers need to understand what the similarities and differences are between two choices, and whether they arise due to an operational parameter or an accounting choice. Although operational differences can indicate competitive advantage; a difference in accounting choices merely means that the values being compared were calculated differently (accrual accounting, for example, is notorious in this regard). Investors, policy makers, and regulators need to understand how items are similar and different in order to make the best choice.
Scope 1, 2 and 3 emissions
In our 2021 white paper Real estate and environmental performance — Bridging the gap with PropTech, we highlighted that GHG emissions are commonly reported based on the Scope 1, 2, and 3 accounting system. Scope 1 is defined as direct GHG emissions from assets owned by the reporting organisation. Scope 2 are indirect GHG emissions from purchased electricity and steam. Scope 3 is further split into 15 categories that represent indirect GHG emissions emitted as a consequence of the organisation’s upstream and downstream activities.
Consistent units of measurement
Our research points out three fundamental properties that are currently missing. We have just discussed the first, which is having the ability to differentiate between operational and accounting choices. The second is the necessity that the measurement describes the same phenomenon. Gold medals are not comparable because in swimming, it describes a single event while in the pentathlon, it describes five events. Our research finds that Scope 1, 2, and the 15 categories of Scope 3 represent a different phenomenon that is unique for each company. Even though they all use MTCO2e, none of the metrics can be added nor compared.
Classification systems: the third factor
Third, it is necessary to ensure that GHG emissions follow classification systems rather than a nomenclature. Classifications enable comparative assertions while nomenclatures are an agreed-upon naming scheme with no ability to compare. A detailed analysis of the standard for GHG inventory shows how it’s a nomenclature. Classification systems need to be mutually exclusive and collectively exhaustive (MECE). In essence, everything needs to be counted, and only counted once. There can be no over or under counting. For example, the events within a swim meet is MECE — the breast stroke, butterfly, and freestyle for 50m, 100m, and so on. Each event is clearly delineated, and one cannot swim freestyle in a butterfly race. A nomenclature, on the other hand, has ambiguous overlaps. Paella, pilaf, fried rice, biryani, are four forms of dishes that are meat with rice. Whether one calls the dish ‘meat with rice’ or another name is dependent on the customs of the individual.
Outlook
Our perspective for standard setters, policy makers, and regulators is it is necessary to add comparability of GHG accounting to the research agenda. We suggest several ideas for improvements that adhere to the necessary ingredients of comparability, including methods of how to ensure measurement of the same phenomenon, and how to modify GHG inventories into a classification system. Critical to this is introducing categories that differentiate embodied carbon that is passed through the supply chain from carbon that is emitted for operational purposes — which Scope 1, 2, and 3 do not currently differentiate. A simple first step is to separate out the accounting of past carbon (aking to historical cost accounting) with projected carbon of the future (financial pro formas).
Without comparability, the financial sector cannot make decisions. Let’s make it better.
Subscribe to our monthly newsletter to stay up to date on upcoming events ✉️
