Scope 3 Emissions: Systems Complexity
This post is one in a series to do with the SEC (United States Securities and Exchange Commission) proposed rule The Enhancement and Standardization of Climate-Related Disclosures for Investors. Other posts in this series include:
SEC Climate-Related Disclosures for Investors (Press Release),
The following quotation is from page 23 of the proposed rule,
. . . enhanced climate disclosure requirements could increase confidence in the capital markets and help promote efficient valuation of securities and capital formation by requiring more consistent, comparable, and reliable disclosure about climate-related risks . . .
Many climate-mitigation programs are organized around the idea of “Scopes”. Each Scope covers a different type of greenhouse gas emission. Scope 1 consists of those emissions for which the organization is directly responsible. Scope 2 covers purchased electricity and other utilities. Scope 3 emissions are “indirect”, i.e., the emissions from suppliers and customers. An organization has influence over Scope 3 emissions, but cannot control them directly.
The United States Environmental Protection Agency (EPA) defines Scope 3 emissions as follows,
Scope 3 emissions are the result of activities from assets not owned or controlled by the reporting organization, but that the organization indirectly impacts in its value chain.
The sketch illustrates the three types of Scope.
The Reporting Company’s direct Scope 1 emissions are shown by the green arrow. Its Scope 2 emissions are shown by the gray arrow. These are fairly easy to understand. The Scope 3 arrows, on the other hand, are complex and difficult to understand.
Continuing with the EPA quotation,
Scope 3 emissions include all sources not within an organization’s scope 1 and 2 boundary. The scope 3 emissions for one organization are the scope 1 and 2 emissions of another organization. Scope 3 emissions, also referred to as value chain emissions, often represent the majority of an organization’s total GHG emissions.
This paragraph raises many interpretation difficulties.
Scope 3 emissions are, by definition, not within an organization’s boundaries. In other words, the Reporting Company will be partially evaluated by the SEC and investors based on the performance of suppliers and customers over whom the company has no direct control.
The data from suppliers and customers may be inadequate, incorrect, difficult to understand, out of date, or simply missing.
Scope 3 emissions are someone else’s Scopes 1 and 2. Hence there appears to be a double-counting problem. Who gets the credit for what?
Supply chains are typically very long. How far back or forward does a company have to go to define the reporting boundaries? This is not a theoretical quibble. Moving backwards and forwards along supply chains can uncover surprises (both good and bad), but few companies have the time or resources for such an effort.
Upstream or downstream benefits may not what they are perceived to be. For example, a company may claim credit if its products are used by an automobile manufacturer that switches from diesel to electric vehicles (EVs). Yet, it is far from certain that EVs are indeed better for the environment if all the costs associated with their manufacture, operation, maintenance and final disposal are considered.
A related difficulty arises when comparing initiatives. For example, how much relative credit is to be given to companies that produced EVs powered by batteries and those powered by hydrogen?
Even if could be established with certainty that EVs are better for the climate than diesel vehicles, any attempt to quantify the difference would be a formidable challenge. Indeed, few companies have the time, resources and management skills needed to evaluate Scope 3 emissions up and down the supply chain. (The Greenhouse Gas Protocol organization has developed a Product Life Cycle and Reporting Standard. But even a detailed standard has its limits.)
The implementation of programs to reduce greenhouse gas emissions could lead to increased business. Customers may purchase that company’s products because they support its climate initiatives. Consequently that company’s emissions may actually increase. A better measure of progress would be emissions per dollar of sales.
It is difficult to evaluate the Scope 3 emissions if a company sells directly to the final customer who disposes of the product in a waste facility after he or she has used it.
The proposed rule does not consider the implications of Jevons’ Paradox — the idea that saving a resource in one place may be negated by increased use of that same resource somewhere else. He said,
It is wholly a confusion of ideas to suppose that the economical use of fuel is equivalent to a diminished consumption. The very contrary is the truth.
Maybe the biggest concern to do with Scope 3 reporting is also the most subtle. A company can point to the work it is doing with suppliers and customers to show how much progress it is making. At the same time that company may be failing to make equivalent progress with its own direct emissions. In other words, Scope 3 can lead to “greenwashing” (a word that the SEC itself uses.)
All of the above comments are reflections of the fact that climate change is just one component in many enormously complex systems. These systems include resource depletion, population levels, droughts and storms, refugee crises, and agricultural failures, and many other factors — each of which will impact every node in the multiple supply and product chains in which any company is included. These systems are constrained by physical, thermodynamic and ecological limits. But they are also affected by human behavior — something that is, to say the least, unpredictable.
We started this post pointing out that one of the most important goals of the proposed SEC rule is to ensure consistency of reporting. Yet trying to untangle the parameters of Scope 3 systems is a well-nigh impossible task for even the largest companies. Hence the goal of consistent reporting will remain elusive.
Past, Present and Future
Scope 1 and 2 emissions are a matter of record. A company can measure how much fuel it burned or how much electricity it purchased during the last few months. This is historical information that can be reported to the SEC.
Scope 3 emissions, on the other hand, tend to be more forward-looking. A company may be supplying materials to another company that is in the process of developing environmentally-friendly technology. To what extent should either company receive credit for actions that are mostly to take place in the future? It may turn out that the projections do not turn out to be realistic.
A related concern is to do with transition costs. Not only is it expensive for an automobile company to switch to EVs, the very act of making the change is likely to require an immense commitment of fossil fuel resources.
Some of the difficulties to do with Scope 3 described above apply also to Scope 2. Most companies purchase electricity from utility companies. They may also purchase energy in the form of steam or cooling water from other organizations.
The Reporting Company does have some direct control over the emissions associated with these sources. But there are complications. For example, if 25% of the electricity purchased comes from nuclear power plants, how much credit should the Reporting Company take?
None of this is easy.
All organizations, no matter what their size, are part of many immensely long, complex, confusing and hard-to-figure-out supply chains. One of the goals of the proposed SEC rule is to provide consistency in reporting. Including Scope 3 emissions in the standard is a worthy goal, but one that is difficult to achieve.
It is suggested that companies focus first on completing accurate and timely Scope 1 and 2 reports. Once that is done, they can develop Scope 3 analyses. The climate crisis is upon us and time is pressing. Any actions that are taken to reduce emissions are to be commended. However, it makes the most sense for companies to put their own houses in order before considering what other organizations are doing.
We conclude this post with the following sensible words from the U.S. Environmental Protection Agency.
The scope 3 emissions for one organization are the scope 1 and 2 emissions of another organization.