Supply and Climate Crises: Should Carbon Reporting Requirements for Companies Be Increased?

Disruptions in the supply of raw materials, record-high energy prices: the past two years, marked by the COVID-19 pandemic and the terrible war in Ukraine, have revealed the fragility of our globalized economic system and its acute dependence on long-distance flows of resources, people, and energy.

At the same time, The climate crisis is in full swing. Extreme weather events continue to increase in frequency: in April 2022 alone, examples include the deadly heat waves in India (temperatures of 46 °C are expected in New Delhi on Thursday, April 28, and 48 °C in Rajasthan)^[1] which also affect agricultural production—floods in South Africa, historic droughts in California and much of South America, megafires in Siberia, and so on. The latest IPCC report (released in April 2022) reminds us that if we want to comply with the Paris Agreement and limit global warming to 1.5°C, Emissions must peak between 2020 and 2025 at the latest and decline until carbon neutrality is achieved in 2050. The problem is that average annual emissions during the 2010–2019 period were higher than those of any previous decade^[2].

That is the paradox of a an economic system caught between a rock (too many resources) and a hard place (not enough resources)eco-friendly.

On the one hand, There are more than enough fossil fuels available to cause large-scale global warming : Don't count on resources running out to do the job. To be certain of limiting global warming to +1.5°C/2°C, we would have to leave 80% of proven reserves in the ground.

On the other hand, We consume too many resources relative to the amounts available. The NGO Global Footprint Network calculates “Earth Overshoot Day”—that is, the day on which we have consumed the “annual budget” that the planet can regenerate in a year.  If our ecological footprint were sustainable, that date would be December 31. In 2021, it was July 29.^[3].

More specifically, regarding oil, which, incidentally, powers 94% of the world's transportation^[4], Peak oil was already reached in 2008 for conventional production, that is, oil from “conventional” reservoir rocks. Consequently, the increase in production needed to meet our needs has been made possible by unconventional resources, notably U.S. shale oil—which has experienced a veritable boom over the past decade—as well as Canada’s oil sands. But the long-term sustainability of this supply is widely called into question: the industry’s production would need to shale oil double or triple between 2019 and 2025, with significant investments needed just to offset the decline in traditional sources, even though the profitability of the shale industry is far from guaranteed regardless of the price per barrel (it is a sector that has historically operated at a loss). Mandatory oil detox—especially in Europe—is just around the corner.

Is there any good news in this bleak landscape? There are tools available to help companies address these two issues. One of them is called the carbon footprint.

Carbon accounting isn't just there to "look good" in annual reports

In a world where a company’s performance, relevance, and sustainability are measured solely in euros or dollars, carbon accounting offers a complementary method for assessing a company’s long-term viability, recognizing that organizations are not isolated entities that operate by “magic.” Indeed, The economy is part of the environment, and as a result, the company depends on physical flows to function properly: energy, raw materials, people, and their movement… Without trucks on the roads to transport products, without agricultural raw materials available to fuel food production, it is hard to imagine that a company could continue to thrive for very long.

The carbon footprint—a snapshot of the greenhouse gas emissions generated by a company’s operations across its entire value chain over the course of a year—is based on accounting direct and indirect physical flows. It therefore makes it possible to assess the company's reliance on GHG emissions—and thus on fossil fuels— (since 80% of our global energy consumption comes from fossil fuels).

Finally, the carbon footprint says something about the risks and opportunities arising from a company's greater or lesser dependence on carbon : If carbon constraints increase in society—particularly to meet carbon neutrality goals—through taxes, regulations, new technologies, or changes in customer or employee behavior, how will this affect the company within its value chain? This is therefore a key piece of information for the business model, which should be monitored and managed at the highest level of the company.

But by the way, do all companies report their greenhouse gas emissions? And what scope do they cover?

The Importance of Accounting Across the Entire Value Chain

Six years ago, Carbone 4 published an overview of the mechanisms for reporting Corporate carbon emissions worldwide^[5]. One of the key findings of the analysis was that France, although not the first country to have implemented a reporting Although it was mandatory, it was the only country to require the companies in question to disclose their direct emissions and indirect, that is, the episodes of the the famous Scope 3.

This peculiarity stems from Article 173-IV of the Energy Transition Act (2015), which amended the disclosure requirements for the companies in question^[6] through the Non-Financial Performance Statement (DPEF, French Commercial Code, transposition of the European directive on non-financial reporting). The 2016 implementing decree specifies that the scope of the required information includes “significant direct and indirect emissions across the company’s entire value chain, that is, including the upstream and downstream aspects of its operations"^[7].

As a reminder, Scope 3 encompasses all emissions upstream and downstream of the company’s direct operations. For example, emissions from the production of raw materials used by the company represent upstream emissions, while emissions associated with the use of the products sold—such as the fuel used in a car manufacturer’s vehicles—represent downstream emissions. For virtually all companies, Scope 3 accounts for the majority of emissions across the value chain : An analysis based on data from the CDP’s “supply chain” program indicates that a given company’s Scope 3 emissions are, on average, 11.5 times higher than its direct reported emissions^[8]. Do not include Scope 3 (for example, in the case of an oil company, not counting emissions from the combustion of oil; or in the case of an aircraft manufacturer, not counting emissions from the combustion of jet fuel), It's like not seeing the elephant in the room.

A February 2021 study^[9] A study of the 2,000 largest companies in the world revealed that More than three-quarters do not disclose any information about their GHG emissions.

Is this French exception still valid in 2022? More generally, What's happening with regard to reporting requirements for carbon and, more broadly, climate-related information for companies? Has there been any progress on that front? transparency of information ultimately in the service of climate action?

A Brief Look at Climate Reporting Requirements for Companies

Mandatory climate reporting by companies is not limited to the disclosure of greenhouse gas emissions generated by their operations. Strategic information that helps understand the climate risks and opportunities associated with a business model has been largely influenced by the publications of the Task Force on Climate-Related Financial Disclosure (TCFD), a working group appointed by the Financial Stability Board (FSB) in December 2015. Based on the observation that the information disclosed by companies does not allow for an assessment of climate risk, The TCFD published its final report in June 2017^[10], whose recommendations introduce three main innovations:

The information requested (as part of this voluntary initiative) is therefore (and this is a good thing!) much broader in scope than the reporting of GHG emissions.

Developments in the European Non-Financial Reporting Directive (NFRD)^[11], which was transposed into French law in 2018 under the name “Non-Financial Performance Statement,” is largely aligned with the TCFD’s recommendations. Indeed, this statement must present the company's business model, followed by a presentation of non-financial risks, a description of the policies and procedures implemented, and the results and performance indicators for each category of information. This approach, therefore, focuses on The Materiality of Climate Issues at the Heart of Corporate Strategy.

Is the European Union becoming the driving force behind climate reporting requirements?

On April 21, 2021, the Commission adopted a proposal for a directive on corporate sustainability reporting (CSRD), which amends and replaces the reporting requirements of the Non-Financial Reporting Directive (NFRD).

This directive is expected to expand the scope of mandatory climate-related disclosures required of companies, as well as the number of companies subject to these requirements. It emphasizes the concept of double materiality by addressing not only climate-related risks to companies but also the impact that companies have on the climate.

The final version is expected to be approved in the spring of 2022. The first reports are expected to be published in 2025 (based on data from 2024) for companies already subject to the NFRD.

Regarding the reporting of GHG emissions, the final compromise^[12] The European Parliament’s March 2022 proposal on the CSRD states that “Sustainability reporting standards specify, taking into account the purpose of a particular standard, the information that companies must disclose regarding environmental factors, including information on [...] climate change mitigation, in particular [...] emissions across all greenhouse gas emission scopes, including Scope 1, 2, and 3 GHG emissions, and other relevant indicators, as appropriate”^[13].

This statement is consistent with EFRAG’s latest proposal on climate reporting, released in April 2022^[14].

We can therefore assume that the European Union might require large listed and unlisted companies to disclose their Scope 3 emissions starting in 2025.

Finally, it should be noted that companies subject to the NFDR and subsequently the CSRD will also have to comply with the requirements of the European taxonomy, meaning they must report the portion of their activities classified as “green” by the European regulator (reporting of eligible activities in 2022, reporting of aligned activities starting in 2023).

In conclusion, the European Union is significantly expanding its legislative framework regarding climate transparency, particularly for large companies, which will be required to report more information regarding greenhouse gas emissions, their strategy for contributing to carbon neutrality, their management of climate risks, and the compatibility of their products and services with the economy of the future (through “green share” indicators linked to the taxonomy).

However, the final provisions of the CSRD (particularly regarding Scope 3 emissions) have yet to be approved and could ultimately exclude publicly traded small and medium-sized enterprises (SMEs)^[15] and it will take three years for it to take effect.

Is America back?

What about across the Atlantic? The U.S. financial markets regulator, the SEC (U.S. Securities and Exchange Commission), proposed new climate reporting rules in March 2022 that, if adopted within the following two months, would become mandatory for hundreds of companies listed on the New York Stock Exchange.

This proposal is also largely based on the TCFD framework. Companies would be required to disclose information—by 2024 through 2026, depending on their size—on:

• their climate-related risks and the actual or likely material impacts on the company, its strategy, operations, and financial condition in the short, medium, and long term;
• climate risk governance and the processes for managing these risks;
• details of their greenhouse gas emissions (Scopes 1 and 2);
• climate-related financial metrics and data;
• information on climate targets and objectives, transition scenarios and plans, if available.

With regard to Scope 3, reporting could be made mandatory if the company has set a reduction target for this scope or if the emissions are deemed material (in absolute terms^[16]). This requirement would be delayed by one year compared to Scopes 1 and 2 (and would therefore take effect no earlier than 2025, based on 2024 data), and would exclude “small businesses”^[17] and may not apply if “such information is unknown to and not reasonably available to the reporting entity, either because obtaining the information would involve unreasonable effort or expense, or because the information is specifically known to another person not affiliated with the reporting entity.” This last point suggests that many companies might be able to justify not reporting Scope 3 emissions…

What about our friends from the UK, New Zealand, and Japan?^[18]

United Kingdom

As part of the SECR^[19], only large publicly traded companies and limited liability partnerships^[20]are required to report a (very) small portion of their Scope 3 emissions, specifically those generated by business travel in rental cars or vehicles owned by employees when they are responsible for purchasing the fuel. The remainder of Scope 3 emissions is not mandatory; it is merely recommended by the regulator.

More recently, in 2022, the government implemented a new mandatory climate reporting requirement for the same companies, including elements inspired by the TCFD framework. Companies must report^[21] :

• (a) a description of the company’s governance arrangements regarding the assessment and management of climate-related risks and opportunities;
• (b) a description of how the company identifies, assesses, and manages climate-related risks and opportunities;
• (c) a description of how the processes for identifying, assessing, and managing climate-related risks are integrated into the company’s overall risk management process;
• (d) a description of the following items
  • (i) the key climate-related risks and opportunities arising from the company’s operations, and
  • (ii) the time periods against which these risks and opportunities are assessed;
• (e) a description of the actual and potential impacts of the main climate-related risks and opportunities on the company’s business model and strategy;
• (f) an analysis of the resilience of the company’s business model and strategy, taking into account various climate-related scenarios;
• (g) a description of the objectives the company uses to manage climate-related risks and seize climate-related opportunities, as well as the results achieved against those objectives; and
• "(h) a description of the key performance indicators used to assess progress toward the objectives established to manage climate-related risks and seize climate-related opportunities, as well as the calculations on which those key performance indicators are based.";

In this final section, it is not specified under which scope(s) companies should report their emissions^[22].

New Zealand^[23]

The New Zealand government is in the process of finalizing a new mandatory climate reporting framework for publicly traded companies^[24], which are heavily based on the TCFD’s requirements (the strategy section is very detailed). With regard to GHG emissions, this reporting would include the Disclosure of Scope 1, 2, and 3 emissions across the entire value chain. The schedule calls for the first publication in 2024, based on 2023 data.

Japan

The Japanese government is encouraging companies to take action on climate change in line with the TCFD’s recommendations, particularly by setting science-based emissions reduction targets (in line with the Science Based Targets initiative). The government has provided technical support to companies that are engaged in these international environmental initiatives and are pursuing ambitious goals.^[25].

ISSB

Finally, the new International Sustainability Standards Board (ISSB) aims to develop sustainability reporting standards focused on corporate value. This approach will allow national and regional jurisdictions to build on this global foundation to define additional standards. This work is expected to be completed by the end of 2022. The current proposals, largely inspired by the TCFD framework, include reporting on Scope 3 emissions.^[26].

Toward a Useful Carbon Accounting System to Support Carbon Neutrality

In summary, despite significant progress on mandatory corporate climate transparency, France is still (based on our current understanding) The only country in the world to definitively require reporting of Scope 3 emissions: Hooray! This special provision is expected to end starting in 2024.

If we take a step back from this somewhat simplistic view, what should companies do to tackle the climate issue head-on?

First, establish a carbon accounting system correctly and effectively. Accurately, within a framework that includes Scope 3, and intelligently, using tools and calculation models that enable the company to dynamically manage its carbon strategy and track progress over time. On both of these fronts, there is still significant progress to be made. And this is primarily a matter of the resources dedicated to the task: while a large company may have a sizeable team of accountants for its financial operations, it often assigns just one or two people to calculate the group-wide carbon footprint. Some corporate representatives point out that calculating Scope 3 emissions is too complex to be included in mandatory carbon reporting. Let’s simply compare the complexity of IFRS accounting standards with the GHG Protocol’s carbon accounting standard: this isn’t a matter of complexity; it’s a matter of the resources committed.

Next, Use this exercise to gain an understanding of the company's dependence on physical flows, particularly in the energy sector. For example, companies could assess their “fossil fuel dependence” by analyzing the sources of the direct and indirect oil, gas, and coal they rely on and evaluating the sustainability of these supply chains.

War, Agriculture, and Climate: The Limits of Our Food System

This article Carbone 4 provides a concrete example of how three agricultural sectors—tomatoes, poultry, and field crops—depend on energy resources.

Finally, while it is essential for companies to develop in-house expertise to ensure they have a robust carbon footprint that is aligned with their strategic priorities, this alone is not enough to chart a course toward a low-carbon future. If we succeed in the energy transition, the economy of 2050 will not be a carbon copy of today’s economy, which will have “simply” decarbonized all of its activities. Many companies will disappear, while others will emerge, with one essential factor in the equation: a much greater degree of moderation in production and consumption. Companies must therefore consider the value of their products and services and whether their business models are well-suited to a range of transition scenarios.. That is the very purpose of the “Strategy” component proposed by the TCFD, many elements of which will become mandatory for an increasing number of companies around the world (depending on various regulations).

To this end, the Net Zero Initiative matrix and scenario analysis are excellent tools available to organizations:

• The Matrix of the Net Zero Initiative to consider the emissions avoided through products and services (Pillar B) and to help increase carbon sinks (Pillar C). This raises the question of how useful its products and services are to other players in the economy!
• thescenario analysis to compare how the business model evolves under contrasting transition scenarios, drawing in particular on changes in physical flows.

So the challenge is a big one: On the one hand, to gain a detailed understanding of the carbon footprint of existing activities in order to be able to decarbonize them (based, therefore, on precise physical data), while steering the “liner” toward new products and services that reduce dependence on non-renewable physical resources. A true balancing act that requires time, human resources, and financial resources.

Conclusions

Carbon and climate reporting requirements for companies are improving worldwide, particularly in the European Union: This is good news, as it sparks a discussion about, on the one hand, companies’ dependence on energy and raw materials, and, on the other hand, the sustainability of their business models in a carbon-neutral economy.

However, several more years will pass before these new measures take effect. So much time wasted on climate issues, in a situation where the matter is of the utmost urgency.

That is why the regulator has an essential role to play: Greater transparency and more information will not guarantee action on the part of private actors. More radical policies must be implemented across all sectors to plan for the phase-out of fossil fuels and a drastic reduction in our energy consumption: It is, above all, the role of the government.

At the same time, companies that take a long-term view and adopt a “risks and opportunities” approach would be well advised to increase the resources allocated to managing their carbon strategy right away and to train their executives on environmental issues.