Earlier this year I worked with Matthew Brander and Theodor Cojoianu of the University of Edinburgh Business School on research that, we hope, breaks new ground in helping investors better understand a company’s climate impact.

Our paper – Avoided Emissions of Portfolios – Scoping Study – was published last month. It points a spotlight on the new and little understood topic of ‘avoided emissions’ that could have implications for corporate and security valuations, or even influence decisions on whether something is investable.

Here’s a short primer:

What are avoided emissions?

Avoided emissions are a measure of carbon emissions that have been prevented during the lifetime of a product or service, compared to what would have been produced if those products and services had not been used. These are climate products and services – electric vehicles, insulated windows, energy-efficient buildings – that help us to lower energy consumption and reduce carbon emissions.

Why has tracking them been a problem?

This is something that the industry has only started doing in the last two years or so. Quantifying avoided emissions requires an intimate knowledge of the emissions that are caused by a product, the product’s life cycle, the number of products sold, as well as the level of emissions that would have been produced had that product not been available.

In addition to problems linked to getting this raw information, we must rely on the companies’ own data and there’s no agreed methodology on how to track avoided emissions. That’s why this isn’t something we could ever do with a great deal of confidence.

Why is it important to find a better way to track them?

So far, the industry has been measuring a company’s carbon impact by tracking its Scope 1, 2 and 3 emissions. Scope 1 refers to sources of emissions under a company’s direct control; Scope 2 refers to emissions linked to how a company gets its energy; Scope 3 – the hardest to track – are emissions produced within a company’s entire value chain.

But tracking avoided emissions leads to a more sophisticated understanding of climate impact. For example, making wind turbines requires lots of energy, as well as energy-intensive materials such as steel and concrete. Based on these considerations alone, investors would see them as carbon intensive and unsuitable for climate-focused mandates. But clearly, wind turbines help displace fossil fuels in a country’s energy grid.

This becomes more important when discussing companies, such as lithium miners, that are often maligned as ‘dirty’. But lithium miners provide a critical ingredient in the manufacture of rechargeable batteries found at the heart of every electric vehicle. They’re selling something that helps others avoid emissions.

In what way does this paper break new ground?

We’ve reviewed the existing academic literature and suggested new solutions to problems investors face. For example, we’ve proposed practical answers to the question of which companies in a supply chain can claim credit for the avoided emissions.

At what point do you decide that the maker of the concrete used in the construction of a wind turbine gets to claim a share of the avoided emissions? If you produce the car seats that go into an electric vehicle, should you get recognition for that? Does a vertically integrated company that does everything in-house get to claim credit once, or for every unit that contributed?

Why should investors care?

A focus on Scope 1, 2 and 3 emissions doesn’t go far enough. Tracking avoided emissions gives a clearer picture of the climate impact of a company, both individually and as part of a portfolio.

Investors are better able to:

  • Identify opportunities – A company with significant avoided emissions implies that it has some product or service that is helping the rest of the world decarbonise. At the very least, this firm operates in an area that’s expected to grow in the coming decades. A better understanding of avoided emissions may also change how investors view some industries that play a vital role in delivering ‘green’ technologies yet struggle to attract investment.   
  • Quantify climate impact – By looking beyond Scope 1, 2 and 3, avoided emissions can provide a fuller picture of the climate impact of a company. Current methods of tracking the carbon footprint of companies and portfolios fail to consider, let alone measure, the benefits of avoided emissions. If done correctly, measuring avoided emissions can improve investors’ understanding of how their investments affect the environment.