Determining Materiality in Value Chain (Scope 3) Emissions

21 Sep 2021

Have you fully considered the impact your value chain has on greenhouse gas (GHG) emissions when setting net zero targets?

The latest United Nations (UN) Intergovernmental Panel on Climate Change (IPCC) Assessment Report (published on 09 August 2021) conveyed an alarming message that the world is dangerously close to approaching the 1.5°C temperature increase limit set out by the Paris Agreement. To stabilize the climate, the IPCC has stated that we must halve our emissions by 2030 and reach "net zero" emissions by 2050.

A company can achieve net zero emissions by balancing its greenhouse gas (GHG) emissions across the value chain through carbon neutralizing actions. Doing so requires companies to measure all of their material GHG emissions from upstream to downstream activities, including:

• Scope 1 – direct emissions from a company's owned or controlled operations;
• Scope 2 – indirect emissions from purchased electricity, steam, heating or cooling; and
• Scope 3 – other indirect emissions across the value chain.

Scope 1 and 2 emissions are relatively easy to understand as they relate to a company's owned and controlled operations. However, Scope 3 activities are often vast and ambiguous, making it hard for companies to measure their emissions and leaving room for interpretation. In addition, missing out on measuring material Scope 3 emissions may present significant GHG-related risks and/or opportunities, due to:

1. the far-reaching influence they have over the GHG impact of a company's decision and choices beyond its own operations; and
2. the emergence of more climate-related policies and/or market drivers will likely require companies to make low-carbon decisions and choices.

For example, if a company does not measure or understand its product's end-of-life emissions, there will be unabated emissions related to the product, which end up in a landfill.  As a result, the company will likely miss out on carbon reduction opportunities associated with a circular economy. With the push to meet net zero targets in the coming decades, the diversity across value chain emissions could cause misleading net zero claims. There is a growing need to be fully aware of the materiality and robustness of a company's GHG emissions across its value chain to reach net zero targets by mid-century.

The Greenhouse Gas Protocol establishes standardized frameworks that provide guidance on measuring and managing GHG emissions. Per the Greenhouse Gas Protocol, Scope 3 emissions are divided into 15 distinct categories across upstream and downstream value chain activities, including embedded GHG emissions of products/services; transportation of materials and people; waste; downstream consumption; and end-of-life treatment. Typically, companies will select value chain activities based on:

1. the expected magnitude of GHG emissions;
2. the availability of data, calculation methodologies, emission factors, and other resources; and/or
3. the minimum requirements of international or local standards.

Basing activities on the above criteria is not an "incorrect" approach, but the question remains whether these criteria are "enough" in a net zero world where climate-related risks associated with a company's decisions and actions will be perceived and regulated very different from those today.

Companies need to be confident that their net zero target strategy is forward-looking and able to stand the test of time. A good first step is to map the upstream and downstream activities of your company to better understand where goods and services are purchased and acquired, and how products are being used and disposed of at the end of their life. This will provide insight into the impact these activities have on your company's net zero targets and will help you prioritize the material emissions that need to be address first.

Additionally, a risk assessment of the value chain can not only take into consideration various geographies and transitional risks, but will also identify climate-related risks (i.e., financial, regulatory, supply chain, product, customer, litigation, or reputational) that your company may be exposed to.

Recognizing potential opportunities for GHG compensation and neutralization will help you understand the opportunities that exist within and beyond your company's value chain as you transition to net zero, which include a better understanding of the carbon credits and renewable energy certificates available to you.

It is equally important that your company engages with stakeholders regularly to stay informed of the values and concerns that drive their investment and purchasing decisions. Stakeholders may also expect your company to behave in a certain way or achieve certain goals to combat climate change, and this can shape their outlook on your company's long-term viability.

Now more than ever, the materiality of a company's GHG emissions across the value chain should be considered when setting your net zero target. If companies do not have a good understanding about GHG emissions within the value chain, how will they prove that their net zero target and claims are not misleading? It is important to plan ahead and prepare for any scrutiny that comes along with making net zero claims. After all, its crunch time, and whether we make‑or-break the Paris Agreement target will depend on how comprehensively companies measure their value chain emissions when setting net zero targets aligned with science-based pathways.

Stay tuned!  This blog is the first in a series of carbon-related topics to be released.