Relevant, Not Yet Calculated?!

Relevant, Not Yet Calculated?!

It’s getting easier for ESG analysts to estimate the greenhouse gas emissions of public companies. But not everyone is forthcoming yet with complete information on how their business affects the environment. Environmental activists, investors, and and analysts need to keep pressing for full disclosure.

Most public companies respond to the annual Climate Change questionnaire received from CDP, formerly the Carbon Disclosure Project. CDP, The largest data repository of its kind, collects estimates of greenhouse gas (GHG) emissions from thousands of companies globally. CDP’s annual Climate Change questionnaire asks companies to report the emissions of six GHGs covered by the Kyoto Protocol related to the company’s products and services sold during the prior year.

Almost all of the largest companies offer estimates of emissions from owned or controlled sources as well as from purchased energy (e.g., electricity generation) — scope 1 and 2 emissions in the parlance of the Greenhouse Gas Protocol. This is fantastic for compiling regional, national and global estimates of GHG emissions. Not so much for estimating the true carbon footprint of a company’s products and services. Hyper specialization has led to extensive corporate value chains that may involve thousands of suppliers. Limiting the emissions analysis to a company’s owned or controlled assets misses more than 90% of the GHG impact in some cases.

To understand the full emissions picture, companies must extend their analysis upstream to the extraction of all the natural resources touched by their businesses and downstream to the end of each product’s life (up to the point that emissions cease). The group of emissions not included in scope 1 and 2 are scope 3 emissions. Scope 3 emissions are divided into 15 categories representing different segments of the value chain.

Scope 3 emissions disclosures are still lacking. If you take a sample of reporting companies in a given category, no more than about half of them will report at estimate. The lone exception is business travel emissions.

The most glaring holes in the CDP Climate Change questionnaire responses are emissions estimates for purchased goods and services, capital goods, transportation and distribution costs, and use of sold products. In most instances where estimates are missing, companies respond with “Relevant, Not Yet Calculated”.

The “Relevant, Not Yet Calculated” response would be understandable if the Scope 3 standard was new — not formally released in 2011. The only good excuse for not providing an estimate for all categories at this point is a lack of will. Activists, investors, and analysts need to continue to demand full GHG accounting from corporate managements.

Below is detail on each of the fifteen scope 3 categories, the activities included, their importance to ESG analysts, and the number of S&P 100 companies providing non-zero emissions estimates in 2018.

1. Purchased Goods and Services

Which activities are covered?

Extraction, production, and transportation of goods and services used by the company.

Should ESG analysts care?

Yes. This is arguably the most important of all scope 3 categories. The biggest expense line item on most corporate income statements is “cost of goods sold” or “cost of sales”, categories which includes purchased goods and services directly related to the creation of the company’s own products and services. An explicit price on GHG emissions would certainly raise the cost of manufacturing or providing service.

How many are reporting on this?

In 2018, 51 of the S&P 100 companies included a non-zero estimate in their CDP disclosure. A similar proportion of the companies that derive most of their business from selling goods reported in this category (31 of 64 companies).

2. Capital Goods

Which activities are covered?

Extraction, production, and transportation of capital goods acquired during the year.

Should ESG analysts care?

Yes. This category is especially important for capital intensive industries such as facilities-based communications services, natural resource extraction and processing, real estate development, semiconductor manufacturing, transportation, and utilities.

How many are reporting on this?

In 2018, 39 of the S&P 100 companies included a non-zero estimate in their CDP disclosure. And of the 33 companies I classified as capital intensive, just 8 estimated emissions from acquired capital goods.

3. Fuel- and Energy-Related Activities

Which activities are covered?

Upstream emissions of purchased fuels prior to combustion by the company or the company’s utility providers. Also, includes emissions from transportation and distribution (T&D) losses that occur outside of the electric generation facility. For electric utility companies, this category includes emissions related to wholesale electricity purchased for resale to the company’s customers.

Should ESG analysts care?

Probably not. Most companies are reporting estimates of emissions from transmission and distribution losses related to purchased electricity. This is directly related to purchased electricity reported in scope 2 emissions. From an analyst’s perspective, it may be more prudent to uniformly scale up scope 2 emissions for most companies that report this figure. Methodology choices reduce the comparability of emissions data; eliminating this category for most companies may help to mitigate this problem.

How many are reporting on this?

In 2018, 48 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

4. Upstream Transportation and Distribution

Which activities are covered?

Movement of goods to or between company sites using vehicles and facilities not owned or controlled by the company, i.e., third-party logistics.

Should ESG analysts care?

Yes. The secular trend toward asset-light business models has led companies to outsource as much of their transportation needs as possible. Transport accounts for one of the largest sources of a product’s GHG emissions. Companies have the option to include life-cycle emissions from manufacturing of vehicles, facilities, and infrastructure (e.g., airports). But jet fuel, diesel, gasoline, electricity use, and emissions related to heating and cooling are what we’re after here.

How many are reporting on this?

In 2018, 45 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

5. Waste Generated in Operations

Which activities are covered?

Third-party disposal and treatment of waste. Includes emissions from the degradation or decomposition of waste.

Should ESG analysts care?

Yes. This category is a bit muddled. Most companies report the GHG emissions related to the breakdown of disposed waste. But the GHG protocol makes it optional to include only the emissions related to the transportation of waste to its final resting place. This may prove to be a loophole for companies that generate tremendous amounts of garbage.

How many are reporting on this?

In 2018, 48 of the S&P 100 companies include a non-zero estimate in their CDP disclosure.

6. Business Travel

Which activities are covered?

All forms of business travel in vehicles not owned or operated by the company.

Should ESG analysts care?

Yes. One of the most important categories for service companies after purchased electricity. Companies have the option to include life-cycle emissions from manufacturing of vehicles and infrastructure.

How many are reporting on this?

In 2018, 78 of the S&P 100 companies included a non-zero estimate in their CDP disclosure. However, some companies report only one mode of travel (e.g., air), potentially affecting peer comparisons.

7. Employee Commuting

Which activities are covered?

All forms of employee travel between home and work in vehicles not owned or operated by the company.

Should ESG analysts care?

No, in most cases. Little of any increase in the cost of employee commuting due to carbon pricing is likely to show up in product and service prices. In the U.S., the IRS caps the deductibility of employee commuting benefits — increases in commuting costs will be borne by the employee. However, wages might be forced higher if employee retention suffers. Bizarrely, companies may choose to include emissions from telecommuting in this category. I can’t imagine this is a useful metric unless a company has numerous employees working remotely from personal yachts.

How many are reporting on this?

In 2018, 53 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

8. Upstream Leased Assets

Which activities are covered?

Emissions related to the operation of leased assets not already included in scope 1 and 2. In practice, this category includes assets subject to operating lease treatment for accounting purposes.

Should ESG analysts care?

Yes. This category is a catch all for emissions that might otherwise go unreported. Analysts should insist on some estimate for this category, even if it’s zero. Absence of any calculation without a sufficient explanation should be regarded with suspicion.

How many are reporting on this?

In 2018, only 11 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

9. Downstream Transportation and Distribution

Which activities are covered?

Transportation and distribution of products (including retail) from the point-of-sale to the end consumer. Note: this only includes activities for which the cost is not borne directly by the company.

Should ESG analysts care?

Yes. But only to the extent that downstream transportation and distribution costs are a significant proportion of the final cost to the end user. This category does not directly impact the company’s cost structure.

How many are reporting on this?

In 2018, 27 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

10. Processing of Sold Products

Which activities are covered?

Processing of the company’s intermediate products by other companies downstream.

Should ESG analysts care?

Yes. Will not directly affect the cost of a company’s product, but may hurt unit sales volume and pricing if the processing of the intermediate product is energy intensive.

How many are reporting on this?

In 2018, only 6 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

11. Use of Sold Products

Which activities are covered?

Products that consume fuel or electricity during use, and products that otherwise emit GHGs during use.

Should ESG analysts care?

Yes. Will not directly affect the cost of a company’s product, but may hurt unit sales volume and pricing. Durable goods may be vulnerable to demand shocks if fuel and electricity prices fully internalize carbon costs.

How many are reporting on this?

In 2018, 31 of the S&P 100 companies included a non-zero estimate in their CDP disclosure. A slightly higher proportion of the companies that derive most of their business from selling goods reported in this category (24 of 64 companies).

12. End-of-Life Treatment of Sold Products

Which activities are covered?

Waste disposal and treatment.

Should ESG analysts care?

No, unless the end user needs to pay incremental disposal costs related to the products in question. Otherwise, it will be difficult for end users to see a link between the products and higher waste disposal costs that may result from carbon pricing.

How many are reporting on this?

In 2018, 24 of the S&P 100 companies included a non-zero estimate in their CDP disclosure. A slightly higher proportion of the companies that derive most of their business from selling goods reported in this category (19 of 64 companies).

13. Downstream Leased Assets

Which activities are covered?

The operation of businesses that lease or sublease assets (e.g., floor space) from the company.

Should ESG analysts care?

No, in most cases. The most common circumstance is a company that subleases a portion of its office or other commercial space. These activities have zero impact on the products and services of the company.

How many are reporting on this?

In 2018, 14 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

14. Franchises

Which activities are covered?

Operations of company franchises.

Should ESG analysts care?

Yes. The franchise royalties received by the company are usually tied to the franchisee’s sales. If carbon pricing hurts franchisee sales, royalties will decline.

How many are reporting on this?

In 2018, only 6 of the S&P 100 companies included a non-zero estimate in their CDP disclosure. However, most companies don’t have franchise businesses. We believe most of the S&P 100 companies with significant franchise operations are reporting an estimate.

15. Investments

Which activities are covered?

Operations of investments not already accounted for in scope 1 and 2 emissions. This category is designed to incorporate financial services. It also encompasses emissions from the investments of corporations that use a control approach to defining operational boundaries for scope 1 and 2 calculations.

Should ESG analysts care?

Yes. Analysts should be aware that financial services companies may exclude emissions tied to debt investments if proceeds are used for general corporate purposes. Emissions associated with investments managed for clients may also be excluded.

How many are reporting on this?

In 2018, only 7 of the S&P 100 companies included a non-zero estimate in their CDP disclosure.

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