A framework for avoided emissions analysis

The race to net zero is on and it has turned decarbonisation into the dominant investment theme for the next decades. The transition will create winners and losers meaning that investors will need a robust framework to identify risks and opportunities.

Conventional carbon footprint analysis focuses on the greenhouse gases companies emit through their activities, which indeed need to be minimised to achieve net zero. But the leaders in the decarbonisation race are doing more than reducing their own emissions; they are developing products and services that drive meaningful reductions across the economy. These are not captured in the conventional analysis.

In this paper, we present a framework that considers companies’ contributions to emissions reductions. These are emissions saved indirectly by products and services through the substitution of high carbon activities with low carbon alternatives. As the emissions are saved outside the value chain of a company’s activity, they are not captured under conventional Scope 1 (direct), Scope 2 (indirect) and Scope 3 (value chain) emission measures.

For example, conventional analysis of wind turbine manufacturing would point to its high emissions and fail to recognise the reduction it causes in economy-wide emissions as wind turbines displace fossil fuel power generation; which is also the reason why they will gain from transition to net zero. In a way, avoided emissions represent a 4^th scope; one that helps provide a more complete picture of companies’ and portfolios’ contributions to decarbonisation.

Using a value chain approach, our framework estimates the contribution of a broad set of industries to avoided emissions while minimising the risk of double-counting. To do this we draw on academic and industry literature and focus on carbon-avoiding activities that are investable and scalable.

With this approach, we identified 19 carbon-avoiding activities and industries and estimated that if adoption of these activities were now at the levels we expect in 2030, almost a quarter of economy-wide emissions could be eliminated.

Moreover, based on our analysis, we find that companies with positive avoided emissions exposure saw revenues grow by an annualised rate of 7% over the past three years; 20% faster than the MSCI ACWI IMI stock universe as a whole.

We believe the framework will enhance understanding of the investment implications driven by the low carbon transition. Schroders’ proprietary tool SustainEx has incorporated this avoided emissions framework which, alongside Scope 1, 2 and 3 emissions, enables an integrated, measurable view of our investments and portfolios’ overall environmental impact.

We see two important benefits that this framework brings for investors.

First, it can help them identify and assess an extended set of winners from the green transition by considering how companies are contributing to solutions that mitigate emissions and not only whether they look “low carbon” now based on conventional methodologies.

Second, it can help them integrate analysis of climate risks and opportunities by capturing the potential avoided emissions and quantifying them in a metric directly comparable to conventional emissions measures, thereby enabling the analysis of risks and opportunities under a common unit of measurement.

We view this framework as an important first step in recognising the value of avoided emissions and integrating it in investment and portfolio analysis. We believe there is significant opportunity to further develop the framework and extend its functionality and would welcome feedback on this and the application of avoided emissions analysis.