Making sense of greenhouse gas emissions types

Investors concerned about climate change have traditionally focused on companies’ direct emissions. But as investors act to align their portfolios with global climate goals, they’re sharpening their focus on carbon emissions from across portfolio companies’ value chains.

The Greenhouse Gas Protocol, a global standard, divides companies’ greenhouse-gas emissions into three scopes:

– Scope 1 (direct emissions from sources an organization controls)
– Scope 2 (emissions from purchased energy)
– Scope 3 (indirect emissions from an organization’s activities, such as use of its products by customers)

Scope 3 emissions come from sources not owned or controlled by an organization. A carmaker’s direct emissions, for instance, come from the buildings it occupies. Its Scope 2 emissions come from the electricity it uses. But its Scope 3 emissions come from such things as the making of the steel and batteries it purchases, or so-called upstream emissions, as well as all the gasoline used by its customers, or so-called downstream emissions.

Scope 3 emissions can dominate a company’s carbon footprint. The emissions scopes of companies in the oil, gas and consumable-fuels industry are more than six times the level of their Scope 1 and 2 emissions. Most emissions for an asset manager or hedge fund, for example, come from companies in its portfolio (Scope 3).

Because Scope 3 emissions occur indirectly, throughout the company’s value chain, they also can be the most difficult to measure. They’re also the least reported. Data from MSCI shows major gaps between emissions reported by the world’s largest companies by market value and what MSCI estimates their emissions to be, in part because many of those companies have yet to report most Scope 3 emissions.

Scope 3 emissions also can raise concerns about double counting. A carmaker’s Scope 3 emissions may be a steelmaker’s Scope 1 emissions. MSCI addresses that by calculating and then eliminating the redundant data to determine the actual carbon footprints of more than 12,000 companies.

Investors want to know where the climate risk lies in their portfolios. To determine whether companies are on a trajectory to keep their greenhouse-gas emissions within carbon budgets for their industries, investors need companies to disclose their complete carbon emissions, including the location of their largest facilities and the emissions of their largest suppliers. Investors further seek to have companies set emissions-reduction targets that cover all emissions scopes.

The Greenhouse Gas Protocol covers 15 categories of upstream and downstream emissions that fall within Scope 3. The Task Force on Climate-related Financial Disclosures (TCFD) encourages organizations to disclose categories of Scope 3 emissions — including financed emissions — that the organization considers to be relevant and material. This matters for issuers too.

The Global Greenhouse Gas Accounting and Reporting Standard. The Partnership for Carbon Accounting Financials (PCAF) has published a standard for investors and financial intermediaries that aims to measure and disclose the greenhouse-gas emissions associated with their investments. PCAF follows a phased-in approach that requires Scope 3 reporting for companies depending on the sector in which a company earns its revenues.

Scope 3 Carbon Emissions: Seeing the Full Picture. An explanation of what Scope 3 emissions are, why they are so important and what action investors can take to address them.

The MSCI Net-Zero Tracker. A quarterly report that shows the largest publicly listed companies by market value that have improved their emissions reporting, as well as gaps that remain.

The Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard. An introduction and guide to reporting emissions pursuant to the Greenhouse Gas Protocol.

The importance of Scope 3 emissions. While Scope 3 emissions are the hardest to measure, they can teach investors the most about a company’s carbon footprint and impact on climate change. This episode of MSCI’s ESG Now podcast explains why.