The global heat is on: preparing for a carbon-constrained world

Paul Boughton
No longer are we asking whether there should be limitations on emissions, but when and how. Measuring carbon emissions along the value chain is now vital as Dr Peter J Nieuwenhuizen reports.

Climate change has become a business reality, to which companies must react. As a consequence, business executives are asking themselves questions such as: How should my company prepare for a carbon-constrained world? Do I know how much CO2, or greenhouse gases (GHG) in general, my company emits to make the products it depends upon? Do I know how much CO2 is emitted to produce the raw materials I buy? What is my total financial exposure once CO2 is fully priced in? And how does my company stack up against others, fulfilling customer demands and requirements?

Also, what does a product carbon footprint look like, what is driving its emergence, and how can companies prepare to do business in a carbon-constrained world?

Without action, global emissions are forecast to double by 2030. The Intergovernmental Panel on Climate Change, the advisory body to world leaders, concluded in 2007 that global carbon dioxide emissions would need to fall by 50-85 per cent by 2050 to prevent average global temperatures from rising more than 2°C. In the short and medium term, much of the emphasis to act will be on the developed economies, Europe, North America, Japan and Oceania, home to just a fifth of the world's population, but responsible for nearly half of the world's annual CO2 emissions. Developing economies, even though their emissions are growing rapidly, expect OECD countries to reduce emissions sharply; to 'make room' for their fair share of emissions as they develop their economies, the OECD countries should mathematically reduce by as much as 80-90 per cent. Indeed, the developed world is taking up the challenge and implementing a variety of initiatives, like a cap-and-trade programme, that will impose a price on carbon emissions. Estimates about the future price of carbon vary from as low as EUR25 ($38) up to EUR150 ($200). Wherever the price settles, the impact will be substantial.

To understand their exposure, companies first need to know how much carbon is emitted to produce their products or services. Today, companies typically measure and report carbon emissions on an absolute basis, eg by production location, totaled by region and eventually by company. This is then reported, for example in company annual reports, or through dedicated initiatives, of which the not-for-profit Carbon Disclosure Project is the largest.

Carbon productivity ratio

To provide additional insight, total company emissions may be divided by total production or sales, to obtain a CO2 productivity ratio. This type of reporting is becoming more prevalent as companies set CO2 reduction targets using total production to normalize the ratios.

In their reporting of emissions companies generally follow the GreenHouse Gas Protocol, pulled together by the World Resources Institute (set-up by the World Business Council for Sustainable Development), or the ISO14064 standard, compiled by the International Organization for Standardization. The standards are basically equivalent. Both have been set up to create a global, harmonized standard to account for CO2 emissions. They divide company emissions in three 'scopes'. Scopes 1 and 2 broadly correspond to emissions from energy use controlled by the firm. Scope 1 concerns direct emissions, eg a furnace that a company is operating. Scope 2 relates to indirect emissions, predominantly those from the electricity that is purchased and that has been generated by the combustion of primary fuels like coal, oil or gas.

Until very recently, Scopes 1 and 2 were regarded the most relevant, and all other emissions were lumped together as Scope 3. While it is certainly good to report and minimise Scope 1 and 2 emissions, there are two important disadvantages. Firstly, it does not take into account the emissions related to raw materials that a company procures, and secondly, total company emissions do not convey how emissions relate to the different products or services a company provides.

As a result, the current system of emission reporting makes it near impossible to correctly benchmark companies about their ability to manage emissions. For example, if we compare four global, diversified chemical companies, all leaders in the DJSI, we would find a significant spread in both total emissions and carbon efficiency. Is Dow Chemical worse than the others because it emits so much carbon, or is it simply a much larger firm? Is AkzoNobel better than the others because its carbon efficiencies are comparatively low? We couldn't tell because the product portfolio of these companies is so different. Indeed, we need to consider Scope 3 emissions and get to a greater level of granularity, comparing emissions for products, not companies.

To help reduce carbon emissions, Scope 1 and 2 emission reporting can only be seen as a first step towards a more sophisticated system of carbon reporting. Indeed, more and more companies focus on product carbon footprint (PCF), instead. PCF is the cumulative CO2 that is emitted along the value chain to make a particular product and deliver it to the customer. It is obtained by calculating all the emissions related to the raw materials and ingredients that a company's product is composed of. To this is added the energy the company needs to manufacture the product, and get it to the customer.

PCF is being evaluated by a number of leading firms, often in collaboration with NGO's. Each of these companies realised that as the world gets more serious and more sophisticated about managing carbon emissions, the only useful measure to compare companies on is the total carbon footprint of the products they supply.

A host of leading companies are presently experimenting with product carbon footprint, believing this to be the appropriate measure to compare suppliers and manufacturing methods, and stimulating emission reductions for their products. As these companies ask their raw material suppliers to give them the necessary data, they drive the demand for a reliable product carbon footprint up the value chain, and stimulate competition between their suppliers.

- Tesco: Tesco CEO Terry Leahy has stated that as a company "... we must help to stimulate the development of low-carbon technology, and work with our suppliers and others to deliver significant CO2 reductions throughout our supply chain end to end ...". The firm is leading by example by providing carbon footprints for a number of its products.

- Wal-Mart: In September 2007, Wal-Mart announced that it will begin asking its suppliers to measure their carbon footprint and find ways to reduce it, part of an effort by the world's largest retailer to transform itself into a more environmentally friendly company.

- PepsiCo: PepsiCo's Walkers brand is the first major food brand in the world to display a carbon footprint/reduction logo on its packs. Walkers has reduced energy use per pack by a third and water use by almost half.

We are a long way from an ideal world in which each company can expect to receive from its suppliers an accurate carbon content for the products it buys. For the time being, those companies leading the way need to do some serious data evaluation to reliably inform their customers how much carbon they are buying. Not only do they have to determine how their own carbon emission relates to the products they sell, they also need to do so for most of their suppliers, and suppliers' suppliers, who have not reached the same level of sophistication.

We are moving towards a world where carbon is constrained, and which will put a price on its emissions. This is set to be implemented first in the developed economies, as developing nations argue they are morally allowed to increase their emissions to enable their current growth path. Already, many companies are measuring and/or reporting their carbon emissions.

Along the supply chain, companies will add up the carbon emissions specifically related to their products and services, thus providing a Product Carbon Footprint, or PCF, which totals all upstream carbon emissions. This shift is being driven by some of the most well-known brands, is supported by NGO's, and will ultimately allow us to compare the carbon efficiency of competing technologies, companies, and whole value chains.

How should forward-thinking executives prepare their companies? We suggest three key actions:

- Determine the product carbon footprint for you products and services.

- Take the first-mover advantage, if still possible.

- Start reducing carbon in your company and value chain.

Dr. Peter J Nieuwenhuizen is a Principal in Arthur D Little's Benelux office in Rotterdam.