In the current environment when climate activities are at the forefront of investments, we believe companies that are contributing toward climate change mitigation and adaptation will stand out. While focusing on a company’s own scope 1, 2 and 3 emissions1 is important, it often misses the mark when thinking about investment impact. In many cases, companies have a much larger impact on the environment by providing the products, materials and services that are needed for the transition. One of the ways that we think this can be measured is known as avoided emissions.
What are avoided emissions?
When building a climate-change portfolio, there are numerous tools and metrics that can be used to measure efficacy and ensure that each holding is having a meaningful impact on climate change mitigation or adaptation. One such gauge is to calculate “avoided emissions,” which means estimating the CO2 reduction impact that the solutions of a given business contribute.
In other words, avoided emissions are emissions that would have been released if a particular action or intervention did not take place.3 Emissions can be avoided using a more efficient product or service. Since this still depends on consumer or market behavior, we refer to them as potential avoided emissions.
One means of achieving avoided emissions is through the generation of low-carbon energy as a substitute for high-carbon energy generation. Using local or global emissions factors per unit of generation as a baseline, companies can estimate avoided emissions from the difference in greenhouse gas (GHG)4 emissions between the baseline and scenario where the low-carbon energy is used.
Why this matters
Since avoided emissions represent a reduction in GHG emissions, by investing in companies offering products or services which contribute to avoided emissions, investors can align their portfolios with efforts to reduce GHG emissions—a vital facet of the collective enterprise of mitigating climate change.
From an investment point of view, we believe activities that help avoid emissions are an attractive opportunity. By actively seeking opportunities to reduce emissions, investors can align themselves with sustainability goals that contribute to a low-carbon economy.
As the transition to a low-carbon economy accelerates, identifying the activities that lead to avoided emissions can tap into emergent opportunities in a range of sectors engaged in reducing carbon emissions, including renewable energy, sustainable packaging and lower-carbon transportation.
We believe a company’s portfolio approach, which is sensitive to such developments, is well-placed to capitalize on the growth potential of emissions avoidant businesses.
How companies can use avoided emissions
While it’s true that the use of some products can help to avoid GHG emissions, accurately measuring a product’s impact—whether positive or negative—can be challenging. The estimated potential avoided emissions can significantly exceed the scope 1, 2 and 3 emissions of a company’s footprint.
Below is a recent assessment of our strategy’s carbon footprint vs avoided emissions, where we show potential avoided emissions compared to scope 1, 2 and 3 emissions for the strategy.
In calculating avoided emissions for each potential investee company, data is collected from company reports and via direct engagement. Where companies do not disclose sufficient information for us to calculate our own estimates, we typically assume no avoided emissions in our calculations. However, we may estimate avoided emissions using disclosed data, and compare it to similar businesses as a sense check. Where results may vary depending on assumptions, we would look to use lower estimates.
Measuring avoided emissions is not without its challenges, such as how to allocate the impact of different parts of the value chain. There are different standards that have been developed for specific products and industries, but there is no single common methodology.
There are also challenges which arise from both over- and under-estimation. Due to company linkages across the supply chain, double counting may add to the estimation error. For example, a company providing solar panels for a solar farm may report how this avoids emissions, but so might other operators in the supply chain, such as the company installing the panels, the utility operating the solar farm, or even the user of the energy.
Carbon accounting frameworks can also lack comparability, completeness and reliability across the full landscape of global emissions. Over time, however, this could be addressed if companies provide detailed underlying emissions data: an asset-by-asset list of each facility, its output, its combustion emissions, methane emissions, electricity purchases, estimated CO2 intensity per unity electricity and other relevant data. We believe that companies looking to promote climate progress should not only publish such data, but strive to reduce the emissions of these underlying processes, rather than focusing on headline data at the corporate level. We also prefer to see companies obtain third-party verification of their avoided emissions calculations. However, even when using verification services, we realize data will be imprecise.
While the “avoided emissions” concept is still to be standardized, we see significant value in calculating this for as many companies as we can—not just to better understand the impact of our investments, but also to make meaningful decisions about how the energy transition will unfold. There are many exciting investment opportunities that come with tackling carbon emissions, and the more data we have, the more likely we are to find the best opportunities.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss or principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
Equity securities are subject to price fluctuation and possible loss of principal. Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
The manager may consider environmental, social and governance (ESG) criteria in the research or investment process; however, ESG considerations may not be a determinative factor in security selection. In addition, the manager may not assess every investment for ESG criteria, and not every ESG factor may be identified or evaluated.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
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1. Greenhouse gas (GHC) emissions are classified into three scopes. Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy. Scope 3 emissions are all indirect emissions (not included in scope 2) that occur in the value chain of the reporting company, including both upstream and downstream emissions.
2. Carbon dioxide equivalent or CO2e means the number of metric tons of CO2 emissions with the same global warming potential as one metric ton of another greenhouse gas.
3. Source: CDP.
4. GHG are gases in the earth’s atmosphere that trap heat. During the day, the sun shines through the atmosphere, warming the earth’s surface. At night the earth’s surface cools, releasing heat back into the air. But some of the heat is trapped by the greenhouse gases in the atmosphere.