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April 21, 2021
The Paris Agreement entered into force in 2016 with the target of “Holding the increase in the global average temperature to well below 2 °C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5 °C”. Since then, assessments of climate change risks and impacts on business operations and GHG emissions disclosure have gained traction. The Task Force on Climate Related Financial Disclosure (TCFD) recommendations backed by the Bank of England, UNEP FI’s Net Zero Alliance and many more initiatives in the financial field have helped accelerate the transition to low carbon, rewarding companies’ emissions reduction actions and increasing data transparency in the financial industry.
However, research carried out by the Grantham Research Institute on Climate Change at the London School of Economics, commissioned by the Transition Pathway Initiative, states that only 18% of companies in their study group representing 40% of global emissions were found to be reducing their emissions at the rate necessary to meet the 2°C target of the Paris Agreement (TPI, 2020). This calls for increased efforts towards a net zero decarbonisation path, but also shows that more action and new approaches are needed.
In an exclusive interview with iClima, Barbara Buchner of CPI refers to a downward trend in total emissions at a rate of 7.6% per year required to meet the 1.5 degree Celsius goal. This percentage is the message of the UN Environment Programme Emissions Gap Report 2019 which highlights the importance of action, and the perils of inaction, stating:, “today we need to reduce emissions by 7.6% every year… Every day we delay, the steeper and more difficult it becomes. By just 2025 the cut needed would be 15.5 % each year…”
The 7.6% annual emission reduction is a clear target. But we need a specific figure to measure our achievements against, a metric for the roadmap towards halving current emissions by 2030. We see CO2e avoidance as the relevant metric.
CO2e avoidance as a tangible metric
As we show in the table below, 7.6% of the current annual global emissions of ~56 GtCO2e equals a required reduction of 4.26 GtCO2e in year 1 (i.e. 2021). The reduction for 2022 is estimated as 7.6% of the new global emissions number of ~51 GtCO2e, or 3.93 GtCO2e, and so on. That means that we need both recurring avoidance and new avoidance every year to be in line with the end of the decade milestone. If we can meet the target of an annual reduction of 7.6% p.a. in emissions, we will have achieved ~30 GtCO2e of cumulative avoidance until 2030.
Viewing the global emissions problem from an emissions reduction standpoint is only part of the solution. As advocated by the Avoided Emission Framework, a shift to low-carbon will require “new approaches driven by companies delivering innovative and disruptive solutions that will bring significant changes in societal behaviour and overall reduction in emissions”. It will also require new robust ways to measure climate impact which is not possible with the static and backward-looking carbon footprint methodology that the majority are using today (Vontobel, 2018).
This is the gap in the market that iClima Earth aims to fill, by taking a solution-oriented route to navigate investors towards the enablers of the transition to a net zero emissions world. Our “climate champions” are companies that provide real solutions to climate change and have a significant impact measured by GHG emissions avoided as a result of their use.
A fundamental shift can happen if more capital flows into the segments that support the transition to a low carbon economy, accelerating the uptake of existing individual and system solutions, and encouraging the development of new solutions. We believe the assessment of GHG emissions avoidance (CO2e avoidance) will provide a quantitative measurement of the climate impact, or decarbonisation potential, of the “climate champion” companies.
iClima’s approach allows a shift in narrative, helping investors to identify who is “doing more good” rather than who is “doing less bad”. We believe that very relevant investment products can be built by focusing on the companies enabling CO2e avoidance through their products. We identified the climate champions through a rigorous rules and fact-based vetting process. The question then became: how much CO2e avoidance can these solutions deliver?
CO2E avoidance definition – two sides of the same coin
Avoided emissions are emission reductions that occur as a result of a solution product or service (GHG Protocol, 2019) that provides the same or similar function as existing products in the marketplace but with significantly less GHG emissions or enables emission reductions of a third party (Avoided Emissions Framework, 2019). Avoided emissions can appear in any stage of the solution’s life-cycle in Scope 1, 2 and/or 3, depending on the type of product or service offered and how it affects the third parties’ value chain.
Following the definition, avoided emissions can be translated into a formula as the difference between GHG emissions from a business-as-usual (BAU) baseline scenario and GHG emissions from a climate change solution scenario:
Net Avoided Emissions = BAU baseline emissions – solution enabled emissions
Many companies are reducing their Scope 2 emissions, defined as indirect emissions from electricity purchased and used by the company across its operations. How do they reduce these indirect emissions from energy used? By entering into long term Power Purchase Agreements (a PPA) with 100% renewable energy companies generating energy from solar PV, onshore wind or offshore wind projects. While this is applaudable, much more is needed.
The companies that have been able to reduce their carbon footprint (like Google and Microsoft) are the users of key climate change solutions, such as renewable energy, electric vehicles and even plant-based meals served in their cafeterias. What we do at iClima Earth is to focus on the other side of the coin – we focus on the suppliers of the solutions. We focus on them not only because we think that these companies can do well financially, as they sell what the world needs to fight climate change and see increased demand for their products, but also because more capital needs to be channelled to the companies in all these key segments. We think shedding the light on the “climate champions” will help increase the capital flow in the direction of much needed R&D and innovation.
The Methodology and the different results it yields
At iClima Earth we have developed a fact-based, data driven methodology to vet the companies that have potential to contribute towards the goal of decarbonising the planet. Believing that the best way to reduce CO2e in the atmosphere is by not emitting in the first place, we are driven by the products and services that can enable CO2 avoidance. We started by looking at the 100 most substantive, technologically viable, existing solutions that can decarbonise the planet as presented by the incredible work done by Project Drawdown. We triangulated those solutions and the CO2 avoidance estimated by Drawdown until 2050 with the list of products and services classified as “green revenue” using the EU Taxonomy. Moreover, we put in place a detailed set of negative screening rules to avoid including companies that also enable unacceptable levels of harmful solutions as part of the benchmark (for example, the EV companies in our universe cannot also have material sales derived from Internal Combustion Engine vehicles powered by diesel or gasoline). No equity benchmark index with a similar approach exists, so we created our iClima Global Decarbonisation Enablers Index, managed by Solactive.
We have spent over 15 months quantifying the CO2 avoidance that each company in our Index can generate from annual sales. We look at the solutions to assess those that are transient (like a plant-based Beyond Meat burger, or a telepresence call on Zoom) and those that are based on products with long useful lives (like a Siemens Gamesa wind turbine, or a Tesla EV car), with avoidance that can be has an impact over the long term.
Also key for us is the comparison of what the companies in our index can potentially avoid in CO2e emissions in 2021 to the amount of CO2e that needs to be avoided in the year (as shown in the table above, that equates to 4.26 GtCO2e). This comparison allows us to ascertain how impactful the solutions of the companies we have selected are and to focus on the number that we should all have clear in our minds – the CO2e that needs to be avoided per year. Like a long car trip, or a diet that aims for the loss of a material amount of body weight, the target needs to be a specific figure, the plan needs to be quantified and the milestones determined.
Our iClima Global Decarbonisation Enablers Index is currently comprised of 151 companies. The products and services they represent fall within five different categories (Green Energy, Green Transportation, Sustainable Products, Enabling Solutions and Water & Waste Improvements, these are further broken-down into 28 subsegments). These companies are suppliers of relevant climate change solutions. Using the California goldrush analogy, they are the companies supplying the shovels. We see tail winds supporting the positive trends for these “climate champions” coming from global agreements and targets combined with green stimulus and policies and a positive shift in consumer behaviour. Our Total Return Index is up 63.6% YTD in GBP terms as of December 2nd.
An example of the solutions in iClima Decarbonisation ETF
The users of the products and services sold by the constituents of iClima index can reduce their carbon footprint measured by Scope 1, 2 and 3 emissions. To illustrate the point, we elaborate on what an e-commerce company like Amazon (a “user” in our parlance, so not part of iClima’s index) could be achieving in emissions reductions by using the solutions from some of the 151 companies in our benchmark.
Scope 1 is defined as direct emissions from a company’s facilities and vehicles. In our EV solutions subsegments, we have companies like Workhorse or Aptiv that could help an e-commerce player embrace zero carbon emission delivery solutions based on electric trucks, or of course EV makers like Tesla to reduce the emissions of the company’s own fleet of cars. Moreover, German maker of electric forklifts and zero-emission warehouse automation Kion Group, could help reduce the emission load of the many warehouses of a global player. Scope 2 is defined as indirect emissions embedded in the energy sourced by a company. Rightly so, this is where a lot of companies have been able to lower emissions, by sourcing electricity from solar or wind. iClima’s benchmark has several global and more local asset owners of renewable energy projects including Iberdrola, NextEra Energy, and Orsted amongst others.
Lastly, the harder to assess Scope 3. These are emissions from both upstream and downstream activities, encompassing 15 areas including: emissions from goods and services purchased, business travel, waste generated in the company’s operations, emissions that take place in the use of the products sold and end of life treatment of the products sold. It is easy to see that Scope 3 is hard to measure but without doing so a company does not take into account the real extent of its carbon footprint. By calculating CO2e avoidance of the solutions within Scope 3 companies would be able to at least quantify the reduction in their Scope 3 emissions, even in the absence of a total Scope 3 emission figure. In our e-commerce example, recycled and sustainable packaging solutions from DS Smith or Lee & Man paper would allow for a lower emission rate in the waste generated by operations; Zoom and Uber would be relevant telepresence and ride sharing solutions with a lower footprint than business travel and employee commuting.
Brian O’Hanlon from the Rocky Mountain Institute made a crucial point when he said, “You can have the best framework in the world, but unless it’s widely adopted, its utility will be limited”. To that end, we believe that time has come for the world to quantify CO2e avoidance, and we hope to contribute to this task by providing our own framework of potential CO2e avoidance by the companies in our index. We are stepping on the shoulders of the great minds behind Project Drawdown and the Mission Innovation team that developed the Avoided Emissions Framework in order to provide our own carbon avoidance benchmark, and we hope CO2e avoided emissions will become a metric that is widely referred to.