Businesses that are conscious of the extent of climate change and its negative effects on our environment are increasingly turning to carbon accounting and using it to their advantage to make informed, data-driven decisions regarding their carbon-reduction strategies.
In this blog post, we help you understand what carbon accounting is and why it is important for your business, then we explain the new carbon tax at the EU’s borders and how it will affect multiple sectors of activity.
What is Carbon Accounting?
Carbon accounting or Greenhouse gas (GHG) accounting is a process that covers a range of practices directed to calculate or quantify the climate impact of a company in the form of a greenhouse gas (GHG) emission inventory, also known as the “Carbon Footprint”.
It helps estimate how much carbon or greenhouse gas is being released into the atmosphere, and it also measures which part of the company’s operations is responsible for those emissions.
This will eventually help in taking action to reduce the organization’s climate impact and manage its carbon footprint in the first place, but it also helps in acquiring carbon credits that are traded on carbon markets.
Carbon accounting is generally divided into two categories:
→ Physical carbon accounting: Physical carbon accounting refers to the method of measuring direct and indirect GHG emissions of a company’s operations into the atmosphere (Scope 1, 2, and 3).
→ Financial carbon accounting: On the other hand, financial carbon accounting gives the carbon produced and absorbed a financial market value.
Benefits of Carbon Accounting
✔ Economic: Implementing Carbon accounting can help companies identify business operations that use the most energy and therefore reduce consumption and resource use. These savings are achieved through lower energy bills and more efficient business activities.
✔ Social: Tracking, reporting, and calculating your company’s carbon footprint helps you gain a competitive advantage when it comes to attracting new customers, new talents, and also investors. Organizations that control their carbon emissions are highly favored to access green funding and capital.
✔ Environmental: Carbon accounting helps companies become more environmentally conscious by reducing the concentration of carbon dioxide in the atmosphere, which is a significant factor in the ultimate goal of stopping global warming.
How to calculate GHG emissions?
To calculate the quantity of GHG emissions released by a company, two elements are needed: Activity data and Emission factors.
Activity data is the extent or rate of a specific operation that produces greenhouse gas emissions. For example, it could be the amount of kWh of electricity used in a building.
Meanwhile, Emission factors are coefficients that refer to the average rate of greenhouse gas emissions that result from a specific activity.
Note: These factors are calculated through analysis of emissions of gasses over the life-cycle of a product or service. Governmental organizations collaborate with international institutions such as the IEA to share public databases of emission factors.
To calculate the amount of CO2e emitted, the activity data is multiplied by the corresponding emission factor:
CO2e Emissions = Activity data x Emission factor
What are Scope 1, 2, and Scope 3 Emissions?
The carbon accounting standard used by businesses, governments, and other organizations to report on their carbon emissions is the Greenhouse Gas Protocol.
This protocol categorizes emissions in three different “Scopes”, which refer to how much control a company has over the sources of emissions.
Scope 1: Direct Emissions
Scope 1 emissions are those created on-site, coming as a direct result of a company’s set of activities and operations.
For example, these can include emissions from the combustion of fuel in furnaces, fuel usage by company vehicles..etc.
Scope 2: Indirect Energy Emissions – Owned
Scope 2 emissions are generated by the purchase of energy consumed by the company.
They are “Indirect” because the GHG emissions are occurring off-site but in the interests of the company in question. They include emissions from electricity, heating, and cooling.
Scope 3: All other Indirect Emissions – Not Owned
The biggest chunk of emissions for most organizations comes from scope 3 emissions (For example, PepsiCo stated that Scope 3 emissions accounted for 78% of their global GHG emissions in 2021).
This category covers all greenhouse gas emissions that the company is indirectly responsible for, also referred to as “value chain” emissions. These are the most difficult to account for and mitigate.
For example, they can include emissions coming from the shipping of a product, third-party transportation and distribution, and customers using the company’s product.
While reporting on Scope 1 & 2 emissions is mandatory, Scope 3 reporting is optional but highly encouraged.
Carbon Accounting is no longer an “Extra” thing to have. It’s becoming an urgent industry requirement. Here’s why.
The New Carbon Tax at The EU’s Borders
At the core of the “Fit for 55” climate package, and as the EU intends to achieve climate neutrality by 2050, the border carbon adjustment mechanism – also referred to as the “European carbon tax” – should enable the Union to impose its environmental standards on foreign companies exporting to its territory.
In practice, this mechanism would make it possible to apply additional costs according to the carbon emissions of companies located in non-EU countries.
Goods imported into the EU whose production has a carbon footprint above the set limit would then be charged a greater cost.
This way, exporting companies would be encouraged to turn to less carbon-intensive technologies, limiting the EU’s “external” climate footprint and encouraging other countries to strengthen their environmental policies as well.
On a side note, many countries, including The Group Of Seven (G7), are backing moves to force companies to disclose their climate-related risks.
How and when will it work?
First, it is important to understand the basic idea behind carbon markets and emissions trading:
In theory, a company that reduces its emissions below its set limit has something to sell – its unused right to emit – which is measured in tons of co2 equivalent. Countries and companies that are unable to meet their targets can buy these one-ton units to make up for the shortfall.
Alright, now back to the EU’s carbon tax.
The European Union has set up a carbon market, which allocates greenhouse gas emission quotas to companies. If these quotas are exceeded, they are required to pay a fee, the amount of which is defined by the market (Around 80 euros per ton of CO2 in 2021, which will increase mainly due to the rise in energy prices).
The difference between Emissions Trading System (ETS) and Carbon taxes
A carbon tax – as opposed to an ETS – has a defined carbon price but an emission reduction outcome that is not defined in advance.
Meanwhile, an ETS leaves it to the market to set the price of carbon.
EU emissions allowances – ETS spot and futures prices
(Sources: Refinitiv, Bloomberg, and ECB calculations)
However, the current scheme also grants free carbon emission allowances to companies operating in sectors that are under pressure due to the economic situation and competition.
The European Commission has therefore planned the gradual reduction – and then the disappearance – of these free quotas as of 2026.
The new mechanism will be implemented progressively from January 1, 2023, with the following sectors to be covered initially: Iron and steel, aluminum, cement, fertilizer, and electricity.
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