Three ways to tell if a company is a genuine climate leader
We explain why there is more to corporate climate targets than meets the eye.
As the world faces up to the need to cut harmful emissions, companies are keen to show they’re playing their part. But should their climate claims always be accepted at face value?
As specialists in climate change investing, we look to identify the companies who are genuine “climate leaders”. This means they have ambitious, credible plans to decarbonise their operations. Importantly, such plans must be consistent with limiting climate warming to 1.5 degrees above pre-industrial levels, as per the 2015 Paris Agreement.
There are many companies who do have these credible plans. And then there are plenty of others who have targets in place, but are not genuine leaders.
It can be very difficult to get the truth behind the headlines and the PR statements and really unpick what is going on at a company level. But we’ve identified three ways to tell the difference between a climate leader and the rest. These can be summarised as “how”, “what”, and “who”.
How is a company meeting its emissions reduction targets?
Example 1: Power
Let’s take, for example, a commitment to using 100% renewable energy. One company might build a whole set of renewable installations and equipment to generate their own renewable electricity that could power all of their operations. Alternatively, they could directly finance a third party to build and generate the renewable power for them. Both of these activities would be a real incremental investment that would decarbonise the business and get rid of their emissions.
But another company might claim the same shift to renewables by buying certificates. Every time someone in the world generates renewable energy a certificate is generated and those certificates can be bought, often very cheaply. And so, even if that certificate has been created in a completely different part of the world to where a company is operating, sometimes those certificates can be bought and used to claim that the company is using 100% renewable energy, despite it having no real influence on the actual electricity that the company is using in its operational markets.
Those two scenarios are obviously completely different. That said, there may be some valid reasons why a company has to rely on certificates. For example, small occupiers in a multi-tenanted building have little control over electricity procurement. There are also countries where direct purchase of renewables is very difficult. The Greenhouse Gas Protocol (a leading emissions accounting standard) allows companies to use either renewable procurement methodology to support the green claims they make publicly. Until regulation catches up with reality, investors will need to do their research to be sure the company is contributing to additional decarbonisation of energy, rather than decarbonisation ‘on paper’.
Example 2: Operational emissions
Emission reductions do not just happen on their own. They require hard work, and investments, to re-engineer manufacturing and distribution processes. The worst examples are where companies buy offsets and carry on as business as usual, crossing their fingers that no-one will care and that offset prices stay cheap.
To be a climate leader we need to see real business change. For example:
- An investment programme to electrify vehicle fleets, whether these are delivery vehicles or construction and mining equipment;
- An investment programme to replace fossil fuels in the manufacturing process with alternative energy and heat sources (e.g. hydrogen, electricity);
- An energy efficiency investment programme to reduce the use of energy in buildings and other operations;
- An internal price of carbon or other incentives to substitute emission intensive activities such as business-related air travel with video conferencing and other alternatives.
Offsets may have a place in compensating for emissions released during the period of transition to net zero but only if they are in addition to serious operational decarbonisation efforts, and they are not a long-term solution. It is only where there is real evidence of investment to transform the business that we can say a company is truly a climate leader.
What exactly has the company committed to reducing?
Here it’s important to understand whether a company is targeting a reduction in emissions intensity, or a reduction in absolute emissions.
Emissions intensity means the volume of emissions produced per unit of output (e.g. emissions per unit of profit, or emissions per product). Absolute emissions are, as the name suggests, an absolute measure of the emissions produced.
A company that is mature or in decline might find it much easier to meet an absolute reduction target than a company that is growing fast. Equally, an emission intensity reduction target may lead to still quite significant absolute emissions growth if the company is growing fast enough.
There's not necessarily a right or wrong answer here. Both need to be evaluated when we're considering the strength of an emission reduction target, particularly with regard to a company’s growth.
Let’s take a hypothetical example of a company that has found a way to make steel with 10% of the emission intensity of the incumbent steel makers. This company has a much lower emission intensity and we should all want it to expand its production as fast as possible, displacing the legacy emission-intensive incumbents. However, as it expands this new company will not find it easy to further reduce its absolute emissions as it has already removed 90% of them from the production process. And at the same time it is expanding capacity.
We therefore need to be realistic in how we appraise company targets, taking into account the growth status of the business when evaluating how stretching an absolute emission reduction target may be.
One other pitfall to be aware of is the effect of inflation. A target that is based on emission intensity as measured by emissions per unit of revenue will magically find that the more prices (and hence revenues) go up, the more their emission intensity falls. We’re absolutely sure that some companies realise this when setting emission intensity targets, as price inflation alone allows them to have a nice and steady decline in their emission intensity.
The most important thing is that the company has real and credible plans to remove the emissions from its manufacturing and supply chain operations. We believe it is best practice to have an absolute emission reduction target, not just an intensity-based one.
Who is cutting the emissions?
Our final point brings us to the difference between scope 1, 2 and 3 emissions. Scope 1 covers emissions from a business’s own operations. Scope 2 refers to the indirect emissions created in generating the electricity that a business uses. Scope 3 refers to emissions along the value chain. These are the emissions created by suppliers, or by users of the products. For many businesses, these will be much larger than the emissions that fall under scope 1 and 2.
If there's no target covering scope 3, it can be relatively easy for some companies to meet their own (scope 1 and 2) emissions reductions by outsourcing. If a business transfers an element of its production, or sells an asset to a supplier, that could lead to an immediate reduction of its own emissions. But that's a transfer of emissions to scope 3, rather than an actual emission reduction in itself.
It is actually very revealing to talk to a company about scope 3 emissions. You find out very quickly which companies don’t take emission reduction seriously, as these are the ones that say ‘the data from our suppliers is too patchy’ or ‘our supply chain is too complex’ to measure or reduce their scope 3 emissions. Of course some industry supply chains are more complex than others, but these statements can be excuses indicative of a company trying to look good without a real commitment to change.
These are all things that have got to be looked out for and evaluated carefully. A climate leader will have emissions reduction targets for scope 1, 2 and 3.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.