Measuring scope 3 emissions – a common solution required to solve two different sustainability issues

Introduction

Article 6 of the Paris Agreement outlines ways that countries can cooperate to reduce emissions and generate investment in climate change solutions.  Many experts believe that there is a need for effective rules on transparency and accounting to underlie Article 6 in order to achieve these aims and avoid the risk of double counting emissions reductions.  Further negotiation of the Article 6 rules is a key ambition of  COP26.

Whether these rules are actually finalised at COP26 or not, it is clear that improvements in accurately measuring and accounting for greenhouse gas emissions will be required as part of the solution.

Various pieces of legislation require organisations to measure and report on their emissions. These typically require reporting on “scope” 1 and 2 emissions.  Scope 3 emissions are not typically required to be reported on despite often representing the majority of an organisation’s total emissions.

In this article, we discuss the reasons why scope 3 emissions are not typically reported on and link the solution to another widespread sustainability issue – modern slavery.

What are the different levels of emissions?

Scope 1
Scope 1 emissions are the direct greenhouse gas emissions that result from the activities owned or controlled by an organisation.  For example, emissions that result from use of company facilities or vehicles during the normal course of business.

Scope 2
Scope 2 emissions are the indirect greenhouse gas emissions that result from purchase of electricity, steam, heat or cooling in the normal course of business.  Whilst these emissions occur at the facility where they were generated, they are accounted for by the end user organisation as part of the organisation’s energy use.

Scope 3
Scope 3 emissions are the indirect greenhouse gas emissions that result from the activities not owned or controlled by an organisation, however, are indirectly created in the organisation’s broader value chain.  Scope 3 emissions include all emissions not categorised as scope 1 or 2 emissions.  As shown in the diagram below, scope 3 emissions can occur upstream and downstream in the value chain.

Emissions across the value chain

Upstream scope 3 emissions are a result of inputs into an organisation’s day to day business operations such as employee commuting and leased office space.  Conversely, downstream scope 3 emissions are a result of an organisation’s business outputs such as transportation, distribution and use of sold products. For example, a car manufacturer’s scope 3 emissions would include the emissions created during the production of raw materials that are required to manufacture the cars and the emissions arising from those that purchased the cars. In the case of Toyota, only 1.9% of their 2021 emissions related to scope 1 and 2 emissions, with scope 3 representing the vast majority of total emissions. 91.6% of emissions related to downstream emissions arising from future use of Toyota’s products.

Scope 3 emissions often represent the majority of an organisation’s total emissions however, given their indirect nature, are typically the most difficult for an organisation to measure.

A common solution for two different sustainability issues

A separate sustainability issue that investors are currently grappling with is modern slavery.  Similar to scope 3 emissions, instances of modern slavery are difficult to identify given the often deep and complex nature of global value chains.

JANA believes that there is a common solution to these two issues – a better understanding of supply chains and the various sustainability risks inherent in these supply chains.

Given the prevalence of carbon emissions risk and modern slavery risk inherent in global supply chains, we know that the longer term aim of achieving sustainable supply chains is still some way off.

A better understanding of global supply chains should ultimately result in identification of sustainability risks and subsequent action to reduce or remove these risks altogether.  In order to gain a better understanding of supply chains, we need:

• Improvements in data and information up and down the supply chain, e.g. carbon emissions data and company labour practices, and
• Increased engagement from investors and companies within the supply chain in order to enact change if required.

Both of these actions can be encouraged by governments through consistent legislation being applied across various jurisdictions.  Regardless of whether it is legislated for or not, institutional investors have an opportunity to use their collective size and influence to lead the way.  Investors can use their influence to encourage investment managers and underlying investee companies to take actions to better understand their own supply chains and provide the required information to all relevant stakeholders.

JANA Perspective

Accurate emissions measurement is only part of the required solution and measurement of scope 3 emissions will be challenging.

Identifying instances of modern slavery is also challenging. Gaining a better understanding of supply chains will help identify and address ESG risks and take us a step closer to achieving sustainable global supply chains.