What’s Scope 3 Good For?

The now-commonplace “Scope” terminology used in emissions accounting was established by the Greenhouse Gas Protocol in 2001. At its inception, the Protocol was pitched primarily as a tool for corporate risk management and voluntary reporting to stakeholders; the focus was not on investors. With the EU emissions-trading scheme kicking off in 2005, and the U.S. nearly passing a cap-and-trade bill in 2009, the momentum to standardize accounting was largely driven by heavy-emitting industries anticipating participation in carbon markets. The primary concern was “Scope 1” emissions, the category covering sources the company directly owns and controls — like the fuel burned to make steel or power gas delivery-vehicles. Over time, however, the category of “Scope 3,” or “supply-chain” emissions has increased in use and importance, especially to investors in financial markets. The GHG Protocol breaks Scope 3 emissions into fifteen categories: eight “upstream,” including “1. Purchased goods and services” and “7. Employee commuting”; and seven “downstream,” including “11. Use of sold products” and “15. Investments.”

The GHG Protocol “Scope 3” system gained near-universality in voluntary corporate reporting in part because it was designed to be flexible. The Protocol leaves a significant amount of discretion to the disclosing company to set reporting boundaries, determine which subcategories of emissions are “relevant,” and make a variety of methodological choices requiring judgment calls. As Jimmy Jia, Nicola Ranger, and Abrar Chaudhury describe in detail, the effect of these choices can aggregate through a supply chain, resulting in substantial differences in totaled emissions at the Scope 3 level. The GHG Protocol itself makes clear that it is designed to track individual corporate progress over time and should not be used for comparison between companies. Nevertheless, inter-corporate comparison appears to be a primary use of Scope 3 data today.

Channels of transition risk—and reputational risk—are not eliminated by simply outsourcing a high-risk process to a third-party.

I must emphasize that my critique on the limits of the applications of Scope 3 data does not mean this data is not needed by investors. Indeed, limiting mandatory disclosures to Scope 1 and 2 emissions makes little sense, as the division between Scopes follow the arbitrariness of firm boundaries. Channels of transition risk—and reputational risk—are not eliminated by simply outsourcing a high-risk process to a third-party.

However, the utility of Scope 3 as a metric depends on the use-case, as well as its granularity and the availability of other contextual data. The proliferation of Scope 3 as a blunt metric for all measures of climate progress and transition risk overlooks not only its lack of standardization but also what Scope 3 on its own is capturing. In various legal and practical contexts determining “relevant” corporate emissions requires judgment calls about: 1. Timeframe; 2. Granularity and Aggregation; 3. “Double Counting” and Boundary Drawing; 4. Control; and 5. Tradeoffs. Users of emissions data may have different preferences and expectations around each of these judgment calls. I elaborate on these considerations in my forthcoming symposium article in the U.C. Davis Law Review, What’s Scope 3 Good For? To point out just one oddity in the application of Scope 3 accounting: a growing number of lawsuits seek to hold fossil companies responsible for the harms of their products. In this case, historic emissions are likely to be more relevant for assessing liability risk than forward-looking projections, yet this metric does not appear in many financial sector uses of emissions data.

A range of initiatives seek to make carbon accounting more transparent and granular, such as the proposed “Net-Zero Data Public Utility,” an open platform for verified data on emissions and other transition information. Others try to increase the granularity and reliability of emissions measurements along the supply chain, including industry coalitions using blockchain to pass information related to emissions without needing to share internal business information like costs and sourcing. Some of these initiatives work to improve reporting at the (Scope 3) corporate level, while others work to meet the growing demand for disclosure of emissions footprints at the product level. In the US, a growing number of “Buy Clean” purchasing standards are based on “embodied” emissions, calculated through a traditional life-cycle analysis (LCA) approach. And the EU is rolling out product-level carbon border adjustments that similarly rest on third-party certification of “embedded” emissions. One may expect that there might be an easy way to aggregate various product level disclosures to the corporate level and back again, but there are fundamental inter-comparison challenges. Scope 3 aims to be a snapshot of yearly emissions, including product use, while LCA aims to capture all of those attributable to a material product, even if the production process began two years ago in time. Linking product level to corporate level accounting becomes yet more complicated and abstract when Scope 3 data is used for asset level accounting that purports to capture forward-looking risks.   

Without (granular) Scope 3 data, investors might miss some of the easiest-to-decarbonize parts of a company’s supply chain, or some of its riskiest regulatory exposures.

To many, Scope 3 double-counting “is a feature, not a bug.” It is meant to shed insight on all the various exposures throughout the economy. Without (granular) Scope 3 data, investors might miss some of the easiest-to-decarbonize parts of a company’s supply chain, or some of its riskiest regulatory exposures. From a strategic angle of decarbonization, a focus on certain corporations may provide better leverage than other parts of the corporation’s financial ecosystem — there are certainly fewer insurers underwriting oil wells than there are potential customers for oil. But from a transition perspective, financial risks are channel, regulation, and asset specific. Meaning, “Scope”’ emissions, even in intensity form, can serve as only a poor proxy of asset-level transition risk without more contextual information incorporating sector, geography, and net-zero policy pathways. To illustrate: A recent engineering article highlighting the philosophical challenge of allocating downstream Scope emissions asks, rhetorically, “[H]ow much does an injection pump contribute to the emissions of a passenger car during its use phase?”. But if your carbon-aware investing strategy is to simply underweight the injection pump manufacturer in your portfolio, you should perhaps think more deeply about the future of the diesel engine.

While these metrics will develop and standardize over time—and must, I end by arguing that their limits surely need not result in paralysis. It’s not like we don’t know where the emissions are, we just need to stop consuming, selling, investing in, and insuring them. I say this as a moral matter, but I can also observe for the first time that the energy transition really is happening. Being part of it seems more like a governance problem than one for index tilting.

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By Madison Condon, Associate Professor, Boston University School of Law.

If you would like to read further articles in the 'Governance and Climate Change' series, click here

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