How can you measure a company's carbon footprint?
As climate change increasingly becomes an investment risk, understanding how a company's climate risks could impact its profitability is key for investors. We look at how you can measure a company's carbon value at risk (Carbon VaR).
The next 10 years will be a decade for delivery, as regulatory and transition risks from climate change increasingly become an investment risk. Evaluating a company’s total carbon footprint and how its climate risks may impact profitability in future is crucial to assessing the investment potential.
What is a carbon footprint?
A carbon footprint is in short, the measure of your climate impact – more specifically, it is the total amount of greenhouse gases generated by the activities of an organisation, country, community or individual. Climate change is caused by the release of greenhouse gases into the atmosphere – almost 75% of greenhouse gas emissions are from carbon dioxide, 17% are from methane and 6% are from nitrous oxide1. Carbon dioxide is emitted when we burn fossil fuels to make electricity, methane comes from raising livestock and nitrous oxide is released when we use fertiliser on soils. These three gases all have different strengths and lifetimes – for example, carbon dioxide is less potent than methane but it lasts longer in the atmosphere. For that reason, we convert all greenhouse gases into carbon dioxide equivalents (CO2e). When we talk about a person, an organisation or even a country’s carbon footprint – we are therefore talking about their CO2e footprint.
How do you measure a company's carbon footprint?
An individual’s carbon footprint mainly comes from how you travel, what you eat and the energy you use in your home. Businesses also have carbon footprints but as you might imagine, these are far larger and more complex – especially since their supply chains are now more global and interconnected. Think of a car manufacturer – the trucks it uses to transport the car parts from its suppliers to its factory, the electricity it uses within the factory to power the assembly line, and the customers driving the finished cars on the road all create emissions for the company. The extent to which a company can control these emissions varies – this is why we distinguish between three different scopes:
Scope 1: All the direct emissions under the company’s control, for example their delivery van fleets or company cars.
Scope 2: All the indirect emissions under the company’s control, such as the electricity they purchase and use to run their business.
Scope 3: All the other indirect emissions that a company does not control, but occur in its value chain. These can be either inputs (upstream) such as the materials a company purchases to create their endproduct, or outputs (downstream) like the investments asset managers make. Scope 3 emissions are usually the greatest share of a company’s carbon footprint.
Using carbon footprints in investment decisions
Carbon footprinting has become one of the most familiar ways for investors to gauge the impact of their investments on the environment – but the way it is used by most investors has its limitations. One such limitation is that most companies only currently disclose their scope 1 and 2 emissions. Let’s consider the curious case of Apple and Samsung. The two rivals sell fundamentally similar consumer electronics. Yet Samsung’s carbon footprint is significantly higher than Apple’s, because Apple outsources most of its manufacturing whereas Samsung manufactures more products itself. In climate terms, this is an irrelevance: the emissions created by producing and selling both sets of products are in reality much the same. However, if investors only take the disclosed scope 1 and 2 emissions of a company to represent its total carbon footprint, they are likely vastly underestimating the company’s emissions and therefore the climate risks it may face. Another limitation is that carbon footprinting undertaken by investors is often historical – a company disclosing their scope 1 and 2 emissions does so in their annual report for the previous year. This does little to help inform investors about the climate transition risks a company may face from changing regulation or consumer demand in future.
Such regulation may include setting a global carbon price. Most academics agree that we need a carbon price of at least $100/tonne of CO2e in order to force global industries to decarbonise their operations, in line with a 1.5 °C scenario. Our proprietary tool Carbon VaR aims to tackle these limitations by:
- Measuring scope 1, 2 and upstream scope 3 emissions – which provides a fuller picture of a company’s carbon footprint
- Calculating the impact of a $100/tonne carbon price on a company’s future profitability – taking into account changing climate regulation
Factoring in the consumer’s price sensitivity – in essence, how more or less likely are people to buy the company’s product if its price increases due to the added carbon price
- Therefore, Carbon VaR provides us with a more accurate measure of the climate risks and investment risks companies face today and in the future. Our Carbon VaR analysis shows that approximately 12-16% of global equity earnings on average are at risk, and almost half of listed global companies would face a rise or fall of more than 20% in earnings if carbon prices rose to $100 a tonne. Pleasingly, the Carbon VaR of the Charity Responsible Multi-Asset Fund is significantly lower than that of global equities2, reflecting our climate-aligned sustainable investment policy.
1 Climate Watch and World Resources Institute (2020).
2 MSCI All Countries World Index is used as a proxy for global equities.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.