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How can we use Potential Avoided Emissions to Gain more Insight into Companies' Decarbonisation potential?

September 6, 2021

Gary Hart

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Introduction

As investors look to redirect capital towards impactful technologies and companies that contribute to the collective goal put forward in the Paris Agreement to “limit global warming to well below 2, preferably to 1.5 degrees Celsius compared to pre-industrial levels”, a question arises around how we quantify and compare the solutions to get us there. One metric that we believe to be useful in this case is the quantification of potential avoided emissions (PAE) of decarbonisation solutions. iClima have quantified potential avoided emissions for the companies in our Global Decarbonisation Enablers Index to provide a further understanding of relevant company, technology and sectorial impact on emissions reductions.

What are Potential Avoided Emissions (PAE)?

Potential avoided emissions are emission reductions that occur because of a solution, product, or service that provides the same or similar function as existing products in the marketplace, while its use emits significantly less Greenhouse Gas (GHG) emissions (Avoided Emissions Framework, 2020) or enables emission reductions of a third party.

In other words, it is the difference between GHG emissions from a business-as-usual (BAU) baseline scenario and GHG emissions from the use of a climate change solution. For example, the difference in emissions from electricity generated from wind power versus electricity generated from fossil fuels; or a plant-based burger vs a regular beef burger.

PAE is measured like other emissions, in tonnes of CO2 equivalent (tCO2e) which is the functional unit for quantifying the per unit impact of GHGs relative to one unit of carbon dioxide (CO2). If you would like to find out more about iClima’s approach to estimating PAE please check out this article on our CO2e avoidance methodology.

The Case for PAE: Identifying the Companies Leading & Innovating to Mitigate Climate Change

Many large companies already disclose estimates of their avoided emissions, often to demonstrate the environmental benefits of their products and services. We believe that the metric should be even more widely used, and we engage with companies to encourage further transparency of company estimates of avoided emissions. Much like how the reporting of company carbon footprint data allows us to see that they are reducing emissions over time so that we can ascertain which companies are “doing less harm”, to move our economies away from BAU based on solutions that cause high emissions and towards a net-zero economy, we need a metric like PAE to better identify companies producing the solutions that enable these reductions in emissions.

iClima’s use of PAE for portfolio analysis has been influenced by Vontobel’s recent series of Impact Reports where PAE is quantified and used as a metric to assess the positive impacts of emission reduction solutions and a company’s opportunities and risks in evolving climate change regulations and markets. In Vontobel’s words:

“Estimating PAE in addition to the traditional CO2 footprint assessment helps understanding a company’s relationship to climate change. Tightening regulatory measures to curb emissions and a potential price on CO2 emissions, be it a tax or through a trading platform, will shift demand towards energy efficient products, processes and related services. Companies offering high PAE could enjoy better financial performance in such a transition period”. Vontobel 2019.

We decided not to publish a PAE or Scope 1 & 2 emissions per dollar of investment metric. Although widely used, it has been argued that this metric can be misleading to investors as it can give the impression that a dollar amount invested will lead to avoidance of a certain quantity of emissions. An additional reservation is that this metric also attributes a company’s entire avoided emissions or carbon footprint to equity holders without considering the portion attributable to debt holders.

Index Level: Potential Avoided Emissions and Carbon Footprint 2019

Data Availability

As of May 2021, iClima’s Global Decarbonisation Enablers Index contained 157 companies of which 145 had absolute scope 1 & 2 data available from our data provider S&P Global Trucost, while 93 had both absolute scope 1 &2 available as well as PAE data disclosed by the company or estimated by iClima. For these 93 companies we estimated the total annual PAE to be 680.6 MMtCO2e (Million Metrics Tonnes of CO2 equivalent) and total absolute scope 1 & 2 emissions to be 114.9 MMtCO2e based on 2019 company data.

Source: iClima Research

The Green Energy Sector is the largest sector in our index and the sector with the highest PAE. It made up the majority of the index’s total PAE and contains four of the top five contributing companies. This was followed by the Sustainable Products, Enabling Solutions and Water & Waste Solutions sectors. The Green Transportation sector contributed the lowest PAE to the index’s total, in part this may be due to lack of relevant data disclosure from companies and perhaps the relative nascency of the sector meaning that currently smaller volumes of climate change solutions are being produced as companies are earlier in their business life cycle and still growing from a smaller base.

iClima’s Global Decarbonisation Enablers Index: Sector Distribution and Data Availability

Source: iClima Research

iClima’s Global Decarbonisation Enablers Index: Visualising Company PAE vs Absolute Scope 1 & 2 Emissions

Source: iClima Research. Graph axis on log scale for ease of visualisation

Plotting the PAE against absolute scope 1 & 2 carbon footprint data for each company allows us to easily identify sectorial trends, anomalies and potential climate superstars, companies that offer relatively high PAE and low absolute scope 1 & 2 carbon footprint. As well as using visual analysis to identify these companies, they can also be identified by calculating the ratio of PAE to absolute scope 1 & 2 emissions. It will be interesting to monitor companies’ direction of travel on this graph across years to see if companies such as Beyond Meat are able to achieve greater economies of scale and begin to offer higher volumes of more effective decarbonisation solutions while also reducing their absolute scope 1 and 2 carbon footprint, if they can, they will be expected to move towards the upper left quadrant of the graph. We will also monitor changes over time of key clusters of companies of interest such as Chinese solar companies whose manufacturing capabilities currently rely on arelatively high proportion of coal powering their electricity grid, although the solar equipment that they produce helps to avoid a great deal of emissions over their 25 year-plus lifespan when compared to electricity generated from fossil fuels.

What are Potential Avoided Emissions (PAE)? The Key Ratio: Annual PAE / Absolute Scope 1 & 2 Emissions

Vontobel’s 2020 Impact Report introduced a new PAE-based metric for each company: the ratio of PAE and absolute scope 1 and Scope 2 emissions. Companies were then ranked by this metric with a view to gaining insight into their resilience to an increase in carbon pricing – in other words, an indication of which of these companies are expected to benefit the most from increasing carbon pricing measures such as carbon taxes, subsidies, etc. A ratio of >50x indicates possibility of a high resilience to carbon pricing, whereas a ratio of >1x indicates potential of low resilience. We calculated this metric below for the 93 companies in our index where data was available.

iClima’s Global Decarbonisation Enablers Index: PAE / Absolute Scope 1 & 2 Emissions

Source: iClima Research

The category with a >50x ratio of PAE to absolute scope 1 & 2 emissions is dominated by companies classified by iClima as pure players in terms of green revenue that also belong to the Green Energy sector such as Vestas. These pure play companies may have a large opportunity to benefit from carbon pricing as they generate over 90% of their revenues from clean energy within an industry where business as usual largely comprised of companies generating energy from carbon-intensive fossil fuels. Other notable companies in this highest category include software companies with low carbon footprints that allow for large avoidance of emissions through digital products - such as DocuSign who provide customers with digital tools for agreements, contracts and signatures, allowing them to avoid the use of paper.  

Where do Companies Fall? Histogram of Annual PAE / Absolute Scope 1 & 2 Emissions Ratio

              Source: iClima Research

For the 93 companies where both PAE and absolute scope 1 & 2 carbon footprint data was available the average 2019 annual absolute scope 1 & 2 emissions were 1.24MMtCO2e and the average 2019 potential avoided emissions were 7.32MMtCO2e. This results in an average PAE/Scope 1+2 ratio of 5.93, indicating that on average companies in iClima’s Index may have a high potential to benefit from carbon pricing and provide solutions that avoid significantly more annual emissions than their own direct emissions and indirect emissions from the purchased electricity, steam, heating and cooling (Scope 1 & 2).

Average Scope 1 & 2 Emissions VS PAE for iClima’s Global Decarbonisation Enablers Index

                  Source: iClima Research

We will continue to monitor the potential avoided emissions and absolute scope 1 & 2 carbon footprint of the companies in our index each year with a view to analysing any changes over time. Ideally we hope to integrate company scope 3 emissions data when it becomes more reliable and widely available, as scope 3 emissions (a company’s indirect emissions that are not included in scope 2, that occur inthe value chain) can often contribute a large percentage of their overall carbon footprint and help to paint a more complete picture of a company’s overall emissions.

For now, we believe that PAE is a helpful additional metric that we use in conjunction with our green revenue and negative screening assessments to identify and monitor companies that are the key climate change innovators and doers, providing the climate change solutions that allow organisations to reduce their emissions. We believe that PAE may also be a useful metric to help connect top-down approaches that show global and sectorial emissions reduction targets such as UNEP’s Emissions Gap Report or Exponential Roadmap to a bottom-up approach that estimates the potential contribution to these emissions reductions targets that each company or solution can make. This will help us to provide greater insight and granularity to our understanding of our progress towards these emission reduction targets so that we can assess if we are on track or whether we may need to adjust our approach.

Reduction in Global Annual Emissions 2020-50 to Stay in line with Paris 1.5°C - By Sector

Source: Exponential Roadmap 1.5.1