To prepare for the upcoming mandatory climate disclosures, many Australian businesses are investing significant capital and time into establishing their scope 3 inventories. However, even with a complete inventory, many remain dissatisfied with the quality of the available data, and unsure of their next steps.
But firstly, what are scope 3 (or value chain) emissions and why are companies prioritising them? Put simply, Scope 3 emissions result from you doing business. They arise upstream in your supply chain from the production of raw materials and the provision of goods and services; and they occur downstream of your operations through the distribution and use of your products and the delivery of your services.
Scope 3 emissions are indirect. You don't control them, but they matter for two reasons. First, they can represent a significant source of risk to your business. Second, you can influence them to great effect. With the introduction of mandatory climate reporting over the coming years, many Australian businesses are concerned about how they're going to measure and report on their Scope 3 emissions, and more importantly, what initiatives are needed to deliver value chain emissions reductions.
This article captures the discussion led by Dr Mary Stewart, Energetics' CEO, and Olivia Kember, Energetics Principal Consultant and climate risk expert.
Listen to our podcast.
The following is based on the transcript of the podcast episode.
(Mary) Given the new mandatory climate disclosure regime is about ensuring that investors have the information they require on the financial performance of a company, why does this include the disclosure of scope 3 emissions?
(Olivia) The focus on scope 3 emissions is a function of two areas of concern, but each one has different implications for how you measure them.
The first reason is exposure to the transition risks associated with those emissions. That could be the cost of complying with carbon policies passed through by your suppliers, or it could be changes in the competitiveness of products downstream if lower-emissions alternatives become available. You want to know where the hotspots are in your value chain.
The second reason is that you can help reduce your scope 3 emissions. Not all of them, but some of them. You should know which ones you can best influence. For identifying hotspots of risk, you can get by with pretty rough estimates. But if you’re trying to reduce your scope 3 emissions, it’s easy to get caught up in very precise measurements so that you can track progress. But measuring emissions is not as important as reducing emissions and that’s what we want to focus on today.
(Olivia) Let’s say you’ve got a big scope 3 inventory, which for most companies dwarfs their scope 1 and 2 emissions, and it’s pretty confronting. If you want to reduce your scope 3 footprint, where do you start?
(Mary) Typically companies look at their scope 3 emissions and rank them from the biggest to smallest category, and focus on those categories where the emissions are greatest. But if we look at both the Science-based Target Initiative (SBTi), and the Greenhouse Gas Protocol that have detailed criteria, companies can choose which scope 3 emissions to prioritise. Consideration should be given to the potential to influence the emission source, the significance of that emission source to stakeholders (not only to your shareholders), sources that represent a significant risk to you, and where you are outsourcing activities that other companies in your sector typically deliver in-house. Prioritising areas to drive emissions reductions is not just about those that are the biggest, it's about where you can apply influence and actually make a change.
Energetics recommends that, to start, you choose three emissions categories to focus on. You probably do need to include your largest emissions source, and then look at including those where you can best influence the reduction. It's the low hanging fruit approach. These are most often the sources for which there are commercially viable technologies for reducing emissions.
Energetics works across the breadth of the economy and have done so for 40 years. We know what the emissions reduction pathways are for all aspects of your supply chain, both upstream and downstream. We know how close to commercialisation technologies to deliver these reduction pathways are. It's better in the short term to focus on scope 3 emissions sources that have these commercially viable first steps to decarbonisation.
(Olivia) Let’s pick a category to work through. Greenhouse Gas Protocol Category 1, ‘Purchased goods and services’ is where most clients have substantial scope 3 emissions. But it’s also a very diverse category – purchased goods and services covers a lot! How should businesses tackle their Cat 1 emissions?
(Mary) They are two distinct activities. The provision of services is typically dominated by professional services companies, your lawyers, your accountants, consultants like us. The carbon footprint of these companies is mainly emissions from the electricity they use. Reduction should focus on grid decarbonisation. So you can almost look beyond how many service providers you have. If the grid decarbonises, the emissions associated with the provision of those services are going to reduce. There should be no barriers to any of your service providers reducing the emissions intensity of the electricity they buy. So, when you next sign a contract with your lawyers, or your auditors, ask them how they buy their electricity or perhaps even require them to buy Green PowerTM. That will decarbonise that part of your supply chain really quickly.
Purchased goods are more complex. Companies with significant spend in this area, so manufacturers and producers of physical products, need to understand the emissions intensity of their raw materials. You need to prioritise your raw materials in the context of this risk and work with your providers to decarbonise them. It's not an insignificant challenge as there are not always commercially feasible pathways to reduce these emissions. Actions to address them are usually by mutual agreements and can be industry wide. You could consider how you can support your suppliers with those activities, but it's difficult to prioritise actions to reduce emissions in this area. I'll note here that across the 15 scope 3 emissions categories, the primary source of emissions is consumption of electricity through your value chain. So taking a step back, if you support decarbonisation of the grid, you are supporting decarbonisation of your value chain to a great extent.
(Olivia) Going further on this point, financial institutions are very focused on category 15, financed emissions. A lot of those emissions will be from electricity use in the businesses that they're investing in, or category 13, downstream leased assets. If you own or finance property and infrastructure, one of the most clear cut ways you can decarbonise them is to ensure that they switch to lower carbon electricity. These are categories where, as you say, the decarbonisation technology is widespread, competitive (in a lot of cases) and the avenue for influence is very, very clear - there are contractual relationships you can leverage.
There's a quick win with renewable electricity.
(Olivia) Another emissions source of magnitude is liquid fuels. Across our 15 categories, liquid fuels contribute to up- and downstream transportation of materials, business travel and employee commuting. Business travel and employee commuting probably don’t make up big shares of your scope 3 total, but would you say they’re worth prioritising anyway?
(Mary) While they are typically not in the top 3 emission sources by magnitude, travel and commuting is an area where you're able to influence decisions and engage far more stakeholders. Companies looking to reduce emissions through employee commuting as part of a staff engagement program have done so with great success, not only from the point of view of changing how people use transport and therefore driving down emissions, but it's been great for staff empowerment. For companies that have outsourced passenger vehicle fleets for which decarbonisation pathways involve moving towards EVs and buying Green PowerTM, there is definitely a commercially viable pathway to reducing these emissions. Many people are pursuing these again with great feedback from their employees who want to feel part of the change.
Prioritising areas where you gain additional benefits for you as a company and not just the emissions reduction is important.
(Mary) Current approaches to estimating scope 3 emissions struggle to reflect any progress made. Measuring emissions isn't as important as reducing them, but if you're reducing your scope 3s you want that to show up in your data! Can you walk us through the challenges and options?
(Olivia) The easiest way to calculate upstream scope 3 emissions is to apply input/output factors to your spend. You need expertise to ensure that you're applying the right factors to the right line items, but this is the fastest and simplest way to produce a ballpark estimate. It’s what a lot of companies have done for a long time and it's pretty effective for finding the risk hotspots. Problem is, it’s not accurate and doesn't set you up to track progress because the input/output factors are industry averages. They're broad brush calculations, don't necessarily reflect your suppliers, and are usually updated on a five yearly cycle. That doesn't reflect the different decarbonisation trends in the economy and definitely is not keeping up with grid decarbonisation. Also, they go up and down with your expenditure at the other end of the scale.
You can get your suppliers to provide you their emissions data, but that’s very resource intensive for them and for you, especially the more suppliers you have. The tools that are emerging to simplify this task have to overcome a number of methodological issues. Ultimately you will get to more accurate scope 3 footprints, but it’s going to take several years to perfect.
(Olivia) How do you get beyond the spend based factors, before having to implement some extremely complicated data scheme that involves tracking the actual emissions of every single supplier that you deal with?
(Mary) We adopt the 80:20 rule where possible. Get the information for your big suppliers directly from them, but accept some estimation in your inventory and look at other approaches to increase accuracy in those data points. There are meta measurements, for example, information from SBTi or from the Net Zero Investment Framework. Electricity is a primary source of emissions across many of your scope 3 inventory items. If you can incorporate grid decarbonisation, then you can claim some of that emissions reduction through your Scope 3 inventory. Remember, for service providers like us, 60% of our footprint is associated with electricity emissions. So you can start looking at more rules of thumb across the broad base of your scope 3 categories and inferring what the reduction from grid decarbonisation might be.
AI has a significant role to play. In 10 years large companies are not going to go to each of their many thousands of suppliers. AI will build those data sets quickly and sufficiently accurately to allow you to track reductions. You will ask for data from your top 200 or so suppliers, but AI could model the rest of it.
However, quantification is not the end game. You want to reduce emissions. This will reduce risk – reducing costs and your exposure to transition challenges in the near term. Work out how you're going to reduce those emissions and then how to implement those changes as soon as possible.
(Mary) Olivia, do you have anything to add on how you've seen companies address these challenges?
(Olivia) We've seen some interesting experiments in terms of how companies are using Scope 3 reduction efforts to build relationships. You talked about employee commuting and the co-benefits of meeting other goals for your stakeholders and strengthening your relationship with them. That applies to many scope 3 categories. Working with your suppliers and, if you are a supplier to somebody else, being able to provide that emission reduction starter for them, perhaps proactively, is a good step. But you can do more together on emissions reduction efforts upstream. Progress can be something that you recognise and reward and that your stakeholders can recognise and reward.