Under the Skin of Scope 2

A bright spot in corporate decarbonisation…

Scope 2 would seem to be a bright spot in corporate decarbonisation. While scope 3 is proving a headache (see our November newsletter), companies have made progress in reducing operational emissions. According to Accenture, the world’s largest 2,000 companies have reduced their operational emissions by 55% since 2016. The share of scope 2 emissions in a firm’s operational footprint varies by sector but for many it will represent a significant component.

Another study by Bain found that UK-headquartered companies achieved an average annual rate of decarbonisation of 6% p.a. in operational emissions from their base year to 2023. This is compatible with the scale of decarbonisation required by science-based targets (4.2% p.a.) and much better than the 2% average reduction in scope 3.

One reason why scope 2 - in particular - seems to be progressing is that the levers are easier to pull. Improving energy efficiency and switching to renewable power lowers scope 2 emissions but can also generate positive returns on investment, making the business case compelling.

‍

Yet, despite this apparent success, persistent questions remain around the extent to which scope 2 reductions are truly representative of corporate decarbonisation efforts. And, indeed, whether claimed decarbonisation achieved through renewables adoption may be overstated.

A question of perspective

Under GHG Protocol rules, companies operating in competitive energy markets must report using both the:

• Location-based method - to reflect the average emissions intensity of electricity grids where the consumption takes place, and
• Market-based method - to reflect emissions from electricity that companies have purposefully chosen to buy.

The two approaches represent different lenses for allocating emissions from electricity consumption to companies.

The location-based method is often considered to be the more accurate and transparent way of allocating emissions in a shared grid. It captures the average emissions associated with the assets that have been used to generate electricity on the grid where consumption actually happens. So a company connected to the UK grid will have consumed electricity that on average last year was generated 30% from wind, 26% from gas, 14% from nuclear, and so on.

But it is not that easy for companies to influence their location-based emissions. They can reduce their energy consumption or take location into consideration when siting new facilities. But aside from on-site renewables, there is no way for a company to dictate the electricity it’s receiving from the grid. This depends on top-down policy and action by energy utilities. In this sense, companies could be seen as beneficiaries of progress in reducing grid carbon intensity.

‍

‍

The market-based approach applies a different lens by focusing on the influence that companies may exert on energy suppliers through their purchasing decisions. Firms can procure clean energy using instruments to reflect their preferences for how the electricity is generated. This is distinct from what they actually consume on their grid but could be considered to have an influence on generation decisions.

Depending on the perspective, scope 2 reductions achieved by companies can look quite different on a location and market basis. While location-based emissions are a function of energy consumption and top-down grid decarbonisation, market-based emissions can be eliminated by procuring renewable energy to match consumption. The result is that in aggregate companies are reporting larger reductions on a market relative to a location-basis.

‍

‍

Making it meaningful

The crux of the issue is whether you believe that market-based instruments are really able to influence the electricity that is being generated. Critics argue that market-based measures of scope 2 have significantly overstated actual decarbonisation by companies, while proponents claim market-based instruments create essential incentives for renewable generation.

In practice, a lot depends on: the (i) additionality, or the extent to which procurement constructs lead to new renewable energy generation, and the (ii) deliverability of renewable energy acquired.

Current GHG Protocol rules don’t make much differentiation in this regard, which has meant that lower quality (i.e. lower cost) interventions have tended to dominate. This is now a key topic in the revision of GHG Protocol standards (see last month’s newsletter for context). In the following sections, we look at some of the proposals under consideration to improve the quality of market-based scope 2 actions.

‍

‍

Ensuring additionality

How renewable energy is procured can have a significant impact on whether new capacity is actually added to the grid. There are a variety of instruments which companies can use for procuring renewable energy aside from on-site installation.

The most common option - buying renewable energy credits (RECs) - suffers from well known issues related to oversupply and low prices. RECs give the right to 1MWh of renewable electricity generation but are often not additional. One study found that use of standalone RECs means that 42% of reductions reported by companies for SBTi targets may not result in real-world mitigation.

By contrast, purchase power agreements (PPAs) - where companies enter into a long-term contract to buy a certain amount of electricity from a renewable asset - can help secure project finance for new installations.

The GHG Protocol is considering introducing additionality requirements. Newness is also a criterion on the table. Funding that goes to established installations is unlikely to be additional whereas it might be for new installations. Even so, some critics argue that the improved cost competitiveness of renewables means that new installations will likely go ahead regardless.

Improving deliverability

Another concern is that companies are procuring renewable energy that cannot be physically delivered to them. This could happen if they buy renewable energy in one market to match electricity consumed in another because it is cheaper or more efficient to do so. The GHG Protocol is considering whether to require procured renewable energy to enter the overall grid where consumption is happening.

A similar problem can occur if firms are only matching procurement of renewable energy to electricity consumption on an annual basis. In reality, renewable energy production is intermittent and can vary throughout the day - as does customer load. If a company has purchased solar energy to match its consumption but the sun isn’t shining or it’s night time, other generation resources will need to be dispatched.

‍

‍

If there is no requirement for hourly matching, it’s likely that fossil fuel resources will be used to meet the demand. Introducing hourly matching would require companies to invest in renewable resources that can be dispatched to meet their demand (e.g. battery storage) or else better manage their load.

The Minimum Line

The progress made in reducing the emissions intensity of electricity grids is undoubtedly one of a relatively small number of decarbonisation success stories. Corporate demand has played a role - especially in the early days - though it’s hard to know exactly how much.

At its best, the market-based Scope 2 measure is a way to show how firms’ deliberate purchasing decisions can help influence the electricity they receive on the grid. At its worst, it can be a loophole for the less scrupulous to exaggerate their decarbonisation achievements.

The bottom line is GHG Protocol rules need updating - they don’t do a good enough job in distinguishing between the two. The GHG Protocol is now trying to fix this. But it won’t be easy.

Focusing solely on the location-based measure may be more accurate for a shared grid but it creates few incentives for action. Applying more stringent criteria to market-based practices (e.g. additionality constraints or hourly matching) would ensure market-based actions have more influence. Some companies, primarily large tech firms, are already moving down this road, but for many this would significantly increase complexity and might not be feasible in some markets.

Our reading of ongoing GHG Protocol discussions is that they may end up introducing some hierarchies to distinguish between higher and lower quality levels of market-based action. They might not rule out lower quality practices but will give something for companies to shoot for.

Ultimately, this conversation matters because electrification is a crucial prerequisite for system-wide decarbonisation. At a company level, having a detailed carbon inventory is key to identify opportunities to electrify, increase energy efficiency, and source clean power.

Interested in building future-proof carbon inventories with Minimum?

Subscribe to our monthly newsletter here or email info@minimum.com.

‍