Sustainability isn’t just a laudable goal, it’s often a necessity for compliance, investor confidence, and consumer loyalty.
Counting carbon accurately remains a struggle, one that internal audit can assist with.
The Big Idea: Counting carbon isn't as easy as
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Articles David Salierno Dec 11, 2023
But even with the best of intentions, companies are finding that progress toward their goal of net zero CO2 — or beyond — is stymied by a basic problem: counting carbon. With new regulations looming, the need to develop accurate measurements is more pressing now than ever before.
This is especially true as companies look beyond Scope 1 and 2 emissions, which encompass direct emissions from company facilities and vehicles, as well as those from electricity, steam, heating, and cooling for a company’s own use. Many are now setting their sights on Scope 3 — indirect emissions produced through logistics and value chains from sources not owned or operated by the company. These can include purchased capital goods, transportation, goods and services used in production, employee commuting, and leased assets — as well as downstream emissions from delivery of goods, consumer use of sold products, product end-of-life treatment, and even investments.
The intricacies of these issues occupy the thoughts of Carlos Cordon, professor of strategy and supply chain management at the International Institute for Management Development in Lausanne, Switzerland. “The challenge is that Scope 3 emissions are often 90% of the carbon footprint of a company,” he says. “If you are a food company, what are the emissions of farmers who supply you and for the transport of your raw materials?”
For example, Cordon estimates there are as many as 14 steps between the farmer who grows the beans and the cup of coffee a person has with breakfast — with each step emitting CO2. “If I need to go to hundreds or even thousands of suppliers, of farmers, and they don’t count their emissions, how do I estimate that?” he says.
The question is far from just academic. The answers can determine whether a company is in compliance with a growing body of regulations. It also can change the cost of its financing and affect profitability. In many ways, reducing Scope 3 emissions has become a business imperative.
Driving Forces
As public pressure for climate action increases, politicians have responded with new regulations. In 2021, the European Union (EU) passed the European Climate Law, which seeks climate neutrality across member states by 2050.
Beginning in January 2024, the EU will include maritime shipping — fundamental to most multinational operations — in its mandatory reporting requirements for greenhouse gas emissions. Shipping companies won’t just have to report emissions, they’ll have to buy carbon credits to offset them. Phased in over three years, the regulations require shippers to submit one European Union Allowance (EUA) for each ton of carbon emitted. These credits are purchased in the primary market through auction from the European Energy Exchange, at an estimated average cost of €90 (approximately $95) per EUA.
Cordon says these regulations, while important, aren’t the only reason organizations are counting — and counteracting — their Scope 3 emissions. “A second motivation is that investment funds are saying they will only invest in companies that are sustainable,” he says. “The CEO of a company told me he got a letter from an investor that said, ‘Given that you are not the most sustainable company in your industry, I am going to sell all my shares.’” Cordon also points out that some banks will charge businesses a lower interest rate if they are more sustainable.
The Risk of Inaction
Carlos Cordon notes there are significant risks of not moving aggressively on Scope 3 sustainability. In addition to complying with current regulation, there is a need to keep up with — and anticipate — regulatory changes.
For example, Cordon says he was recently in Madrid, where local regulations prohibit use of cars that emit a lot of carbon. “As a car manufacturer,” he explains, “you might suddenly find yourself making cars that a regulator has now forbidden in parts of Europe.” He adds that restrictions are likely to increase as extreme weather events raise more concern among country leaders, citizens, and regulators.
This is why many companies are examining the potential for these types of changes in their risk assessments, Cordon says. Prudent organizations will evaluate their sourcing strategies and materials used in the event there is a shift in regulation — so they aren’t left unprepared.
Cordon also highlights the possibility of competitor innovation and the risk of losing market share. “Suppose another company develops a superior technology that’s sustainable — if it’s cost-effective and practicable, that company could take business away from, or potentially wipe out, all of its competitors,” he says.
Then there are the concerns of consumers who want to make sustainable purchases. The demand for sustainable products has pushed companies to reconsider their processes and reevaluate suppliers.
The Complexity of CO2 Measurement
Counting carbon isn’t just useful or best practice — it could be critical to a company’s survival. Yet, producing accurate results is the crux of the issue. “A farmer may be able to measure what he is emitting from his own work,” Cordon says. “But what about the company that makes his fertilizer or the trucking company he relies on? They may not have the infrastructure to measure their emissions, so there’s a lot of potential for mistakes.”
Scope 3 also includes emissions from consumers’ use of a company’s products, but gauging post-purchase behavior is difficult. A detergent maker, for example, may create soap that works well at low temperatures, reducing the need to heat water to wash clothes. But are consumers actually using the product that way?
Part of the challenge for companies is while Scope 3 regulations are very precise, carbon measurement is largely based on estimates, Cordon explains. Despite significantly lowering its carbon emissions, a regulator may say a company fell short — even if it missed by a small amount.
“Sometimes there’s a preference to be precisely wrong rather than approximately right,” he says. For example, to demonstrate accuracy, a company may report that it emits 839,245 tons of carbon, when the imprecise nature of current measurements means it is really 840,000 tons, more or less.
Measurable Innovations
Cordon does see progress being made toward improving measurement accuracy, pointing to innovation in the farming industry. “Satellites, drones, and Internet of Things (IoT) technology are being used for measuring, sometimes with surprisingly good results,” he says. He cites a large Brazilian farming company that combines drones with IoT. “They have thousands of cows fitted with sensors to measure greenhouse gases — they’re also trying to understand how certain behaviors cause the cows to emit more or less gas and make adjustments.”
Cordon notes that to achieve net zero, many companies are looking outside the scope of their main business. For example, some food companies plant crops that aren’t directly connected to their product but instead are meant to capture CO2. Others have invested in preserving forests, which absorb and store large amounts of carbon from the atmosphere.
Using these techniques, certain companies are even striving to become carbon negative to address emissions from prior years, Cordon adds. These companies seek to retroactively erase their carbon footprint since they first started doing business.
“Being net negative is a great objective, but whether you can do it or not depends on the industry you’re in,” he says. “If you’re a car company or an airline, it’s virtually impossible.” Cordon adds that some companies are trying carbon capture techniques, putting carbon into the soil, but the available technologies are difficult to scale — particularly for large organizations.
Carbon Control
Overall, Cordon remains optimistic about both the ability of companies to increase sustainability and the development of new technologies that can be scaled to meet organizational demands. Counting carbon accurately, though, remains a struggle, one that internal audit can assist with.
“Auditors can play a fundamental role in helping with supply chain sustainability to find out where to put the effort, pinpointing where to improve,” he says. “They’re well-suited to assess the risks and advise companies about where to direct resources.” Cordon is optimistic about that too, predicting that, in the campaign to reduce carbon, “auditors are going to become a driving force.”