Welcome back. After an unusually warm winter, Washington’s cherry blossoms hit peak bloom about a month ago, the second-earliest flowering in more than a century, according to the National Park Service. Despite missing that attraction, our colleague Patrick Temple-West will be reporting from the US capital this week, where the IMF and World Bank are holding their spring meetings. Watch out for his updates.
In today’s newsletter, we look at critics seeking to de-throne carbon emissions as the ultimate measure of corporate readiness for the energy transition. Shareholder activists and climate economists have long sought to draw tighter links between a company’s emissions and its long-term financial health. Could there be better ways to measure how the green transition will become financially material?
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carbon emissions
A new way to measure energy transition risks
As proxy season kicks off, activists and some asset managers are calling on companies to disclose carbon emissions in ever greater detail, and to show progress on trimming them.
But year-on-year variations in headline emissions can be a poor measure of whether a company is making the right investments to clean up its operations in the long term. Emissions might shrink because a company is improving the energy efficiency of fossil fuel infrastructure while extending its lifespan.
For instance, a steelworks typically relines a blast furnace every 20 years — a major capital expenditure. Re-lining the furnaces that use coking coal to treat iron ore can bring down emissions, but can also lock in polluting infrastructure at a time when climate activists are urging steelmakers to switch to alternative processes that don’t use coal at all.
Moreover, how exposed a company is to the energy transition — including rising energy costs or uncertain supply — often has little to do with its emissions. Likewise, in banking, while a big footprint of financed emissions is sure to draw the ire of climate activists, it may be only a fuzzy measure of climate-linked risk.
The Center for Active Stewardship, a non-profit research organisation backed by Bobby Jain’s Jain Family Institute, is today launching a tool called Splice, which breaks out the causes of changing emission levels, with sometimes surprising results. And Unwritten, a start-up making software to show how climate-related risks could affect clients’ cash flow, today announced that it raised $3.5mn in seed funding. Both tools aim to look past headline carbon emissions to give a clearer picture of threats and opportunities posed by the energy transition.
Looking under the bonnet of carbon emissions
“Emissions are a vanity metric. They tell you little about what a company is actually doing to invest in decarbonisation,” Nolan Lindquist, director of the Center for Active Stewardship, told me.
Lindquist, who was previously a research analyst in equities at asset management giant Fidelity, argued that green-minded shareholders need tools to assign more value to durable investments, and strip out transient factors beyond their control.
For example, emissions can rise due to temporary changes in the grid’s energy mix. Recall the summer of 2022, when drought-stricken France saw a drop in hydropower generation and nuclear output, which led to greater reliance on gas- and coal-fired power.
Mark Campanale, founder of the Carbon Tracker Initiative, acknowledged that carbon tracking alone was “not helpful” to pension trustees, for example, evaluating green credentials of companies in their portfolio.
“What the investors really need to know is capital expenditure in new processes to remove those systems. Things like improved efficiency in the burning of a fuel may sound like good news, but often, all they do is delay,” Campanale told me.
CAS’s new tool, Splice, looks under the bonnet of major companies to identify how, exactly, they are achieving emissions reductions.
Take four big-box retailers in the US with similar business models. At a glance, CAS found, it appears that Walmart and Target have done more to cut emissions than competitors Costco and Kroger.
But, by breaking the emissions into its drivers, CAS shows that in 2022, Costco drove the largest energy efficiency gains, offsetting more sales growth than its competitors.
Conversely, the two companies that saw big headline emissions reductions, Target and Walmart, both relied heavily on trading activities — buying power purchase agreements and renewable energy credits — to do so. PPAs are long-term energy supply contracts, and RECs are certificates bought in lieu of direct renewable energy generation, typically representing savings of 1 tonne of C02-equivalent elsewhere. Lindquist said CAS treated both of these as “often but not always a lower-quality source of emissions reduction”.
PPAs and RECs can help companies reduce on-paper emissions. But RECs have come under criticism as failing to drive new clean energy supply. And, while some technology companies have used PPAs to secure cleaner energy for their operations — such as Amazon’s recent acquisition of an existing nuclear-powered data centre — adding new demand without adding new supply can increase the grid’s overall emissions.
A complex challenge
In 2022, the former heads of a climate data initiative at US tech company Palantir founded a start-up to evaluate companies’ exposure to the energy transition — both positive and negative.
With seed funding from London-based Connect Ventures and Berlin-based Planet A Ventures, Unwritten says it can help companies price climate risk and opportunity. It uses modelling based on the scenarios of the Network for Greening the Financial System, a group of central banks and financial supervisors, to translate long-term changes into company-level “cash flow” impacts.
In a case study, Unwritten analysed BHP, an Australian mining group with significant coal and copper holdings. Its exposure to materials critical for the energy transition, such as copper, could outweigh the risks of fossil fuel holdings, Unwritten suggested, making BHP “positively exposed to climate change in the coming decade”. As a result, Unwritten found, “An orderly and rapid transition could offer more than a 10% uplift in BHP’s EBITDA and free cash flows”.
Obstacles to such analysis abound. Predicting how climate change will feed through to companies’ balance sheets is enormously complex, and there are risks in suggesting false precision.
At Palantir, Unwritten co-founder Amos Wittenberg told me, “we were talking almost exclusively about carbon emissions.” While it remains an important metric, he said, there has been “an evolution in maturity, a sense that we’ve pushed this carbon emissions thing really pretty far, and how much more can we get out of it.”
Wittenberg argued that carbon emissions are a poor proxy for measuring the financial materiality of climate change. Whether or not Unwritten proves that it can render transition risks as company-level cash flows, we are likely to see more tools attempting to translate emissions data into decision-relevant information for executives.
Of course, the greenhouse gas emissions driving record-busting global temperatures will necessarily remain at the centre of this conversation. But as investors decide how to vote on shareholder proposals this spring, critics such as Lindquist argue that shifting the focus to the underlying drivers of emissions could help climate activists “keep emissions on the agenda, at a time when the climate-first framing is under a lot of pressure”.
“Headline emissions is really important, it’s great that companies are disclosing it, but it’s an output, not an input,” Lindquist said. “People talk about it as though management teams have a big emissions dial in their C-suite.”
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