2016
FOR INVESTMENT PROFESSIONALS ONLY
Carbon footprinting
How much carbon do I own?
Carbon emissions are part of our lives. The air
we breathe, the cars we drive, the food we
eat and the lights we put on. But exactly how
much is my investment portfolio contributing
to global greenhouse gas emissions?
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FOR INVESTMENT PROFESSIONALS ONLY
2
Carbon footprinting is the process used by investors to
understand the level of exposure an investment portfolio
has to carbon dioxide emissions and fossil fuel reserves,
and therefore its contribution to overall greenhouse
gas emissions. By looking at individual company
holdings and their respective emission levels,
one can understand the level of carbon exposure
and compare the results between portfolios and
benchmark indices.
Why do it?
Our clients are showing increasing interest in
understanding carbon exposure in investment
portfolios. There is a growing awareness – among
investors and institutions such as the Bank of England –
that climate change is one of the key long-term financial
risks that investors face. The risks are three-fold:
1. Physical risks: from the impact of weather changes
globally
2. Litigation risks: from those seeking compensation
for loss or damage from the effects of climate
change
•
social constraints as a result of pollution
Carbon data may not directly link into a company’s
bottom line, but can be used as a proxy to assess a
company’s efficiency and transition path.
How is it done?
There is no agreed or perfect way to ‘footprint’ a
portfolio and understand carbon risks. It requires
a combination of quantitative and qualitative
assessments. This is because an average investment
portfolio contains companies whose business
operations are vastly different from each other.
3. Transition risks: impact of policy and technological
changes that could lead to a reassessment in
valuation of financial assets*
The World Economic Forum’s Global Risk Report
highlighted that climate change, extreme weather
events and subsequent water crises have consistently
been rated among the most serious threats in each of
the past five years.
Fundamentally, energy is a cost and is often one of the
biggest costs businesses face. Being a commodity, it is
exposed to volatile price fluctuations. Companies with
high exposure to fossil fuels and energy costs could
face constraints through:
•
carbon taxes, carbon pricing and emission
regulations
•
increasing costs of extraction and transport from
unconventional fossil fuel sources
•
demand disruption through falling costs of
renewable generation, electric storage and
transport
Carbon emissions figures are the easiest and simplest
quantitative tool. These outline how much carbon is
emitted by each portfolio, using comparable datasets.
There are broadly three types of carbon emission
measures, as shown in figure 1:
•
Scope 1: All direct greenhouse gases (GHG)
emissions from sources owned or controlled by the
company.
•
Scope 2: Indirect GHG emissions from consumption
of purchased electricity, heat, or steam.
•
Scope 3: Other indirect emissions that occur from
sources not owned or controlled by the company.
This includes extraction and production of
purchased materials; transportation of purchased
fuels; and use of sold products and services. It
is not consistently calculated or disclosed by
companies.
*Speech from Mark Carney, Governor of Bank of England, 29 September 2015
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FOR INVESTMENT PROFESSIONALS ONLY
3
Figure 1: Direct and indirect emissions
CO2
CH4
N2O
Scope 2
Indirect
HFCs
PFCs
SF6
Scope 1
Direct
Scope 3
Indirect
purchased
goods and
services
Scope 3
Indirect
transportation
and
distribution
purchased electricity,
steam, heating and
cooling for
own use
leased
assets
capital
goods
investments
company
facilities
processing of
sold products
employee
commuting
fuel and
energy related
activities
transportation
and
distribution
Business
travel
company
vehicles
use of sold
products
waste
Upstream activities
franchises
Reporting company
leased
assets
end-of-life
treatment of sold
products
Downstream activities
Source: GHG Protocol: overview of scope and emissions across the value chain
The FTSE All World Index, which includes around 3,000 stocks in both developed and developing markets, has
been broken down by sector and its contribution to scope 1, 2 and 3 (only upstream) emissions, with the results
shown in figure 2.
Figure 2: Carbon emissions by sector
7,000,000
Scope 3
6,000,000
Scope 2
Scope 1
Tonnes CO2e
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
0
Oil
and Gas
Consumer
Goods
Utilities
Industrials
Basic
materials
Financials
Technology Consumer TelecommunServices
ications
Health
Care
Source: Trucost, 31 December 2015. Note: Weighted absolute exposure relative to FTSE All World Index as at 29 March 2016, hence
the overall contribution of greenhouse gas emission. Trucost Scope 3 data only pertain to the supply chain (i.e. upstream GHG
emissions), so does not include products and services companies provide.
It is not showing the energy intensity of the companies which may be more useful if comparing one company / portfolio to another.
As might be expected, in some sectors, direct emissions are a key component of business drivers, while others
have carbon embedded in areas over which they have limited control. For example, for food retailers – part of the
consumer goods sector – a significant proportion of carbon emissions are in the supply chain in the goods they
sell. Oil and gas has large direct and indirect emissions, as the supply chain of oil and gas is as intensive as direct
operations.
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FOR INVESTMENT PROFESSIONALS ONLY
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means that the emission from utilities is double
counted. Similarly, emission to make computers in
the technology sector could be counted again in semi
conductor sectors.
Caution!
Before looking more closely at the data, it is worth
highlighting that the data and analysis are not
flawless. Carbon emissions data does not address
how companies may be exposed to wider climate
risks such as the impact of weather on its operations.
Furthermore, disclosure by companies is voluntary
in many jurisdictions with little oversight on quality.
Where there are gaps in disclosure, data providers
use certain assumptions, and these can vary from one
provider to another (in this case, we used Trucost as a
data provider).
While Scope 1 and 2 are disclosed relatively widely and
the data quality can be monitored to some extent, scope
3 is extremely patchy in disclosure and there are no
consistent disclosure methodologies. We find that this
is very different from one company/industry to another.
Given the poor reliability of the data and the double
/ triple counting of emissions, we believe that further
portfolio analysis is best carried out only on scope 1
and 2. The same portfolio of FTSE All World Index has
been dissected by region to demonstrate the overall
emission contribution of the index from each sector in
each region, with the result shown in figure 3.
In addition, by showing the three elements (scope 1,
2 and 3) at the same time, the same emission can be
double or even triple counted by different companies.
For instance, scope 2 shows bought electricity, which
Figure 3: Carbon emissions by region
UK
Millions (tons) CO2e
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
North America
Millions (tons) CO2e
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
EUROPE
Millions (tons) CO2e
Japan
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Millions (tons) CO2e
Asia
Millions (tons) CO2e
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Emerging market
Millions (tons) CO2e
Oil and Gas
Financials
Utilities
Consumer Goods
Basic materials
Consumer Services
Industrials
Technology
Telecom
Health Care
North America
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
UK
Europe ex UK
Asia ex Japan
Japan
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Emerging market
Source: Trucost, 31 December 2015. Note: Weighted absolute exposure relative to FTSE All World Index as at 29 March 2016,
hence the overall contribution of greenhouse gas emission through scope 1 and 2.
As can be seen, more than half of the emissions are in North America, and almost half of the total comes from
oil and gas. Utilities and basic materials are also significant. Having a market capitalisation based index, where
developed markets dominate, will naturally result in a high carbon emissions exposure as energy-related stocks
make up a large part of these markets.
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FOR INVESTMENT PROFESSIONALS ONLY
5
These findings are helpful to long-term investors,
particularly those that have less capacity to alter their
asset allocation as regulations and technological
backgrounds change.
Carbon emission vs carbon reserve
From Brown to Green
The emissions figure indicates the current level of
operational impacts companies have. On the other
hand, carbon reserves indicate the fossil fuel assets
owned by companies which will become future
emissions. There are coal, oil and gas assets that are
still in the ground that will be extracted to sell on. The
chart below demonstrates the distribution of reserve
assets owned by companies in each region.
Figure 4: Carbon reserve
160
Utilities
Oil and Gas
Basic Materials
140
Tonnes CO2e
120
In the listed equity space, the disclosure of companies
producing ‘green’ revenues is still very poor. Many
companies may discuss their role in this transition,
but only a handful publish revenue breakdown by
product area that is detailed enough to be useful to
external parties. The table below shows the number
of companies in each sector and region that produce
green revenues as of last year.
100
80
60
40
20
0
The carbon footprint does not only have to focus on
the risk side of the climate trend. There is also an
impactful energy transition taking place, where the
way we generate, store and consume energy are
being transformed by new innovations. Driven by both
technology and the societal needs to build a low carbon
economy, companies are increasingly participating in
this transition with products and services that provide
solutions.
Emerging
Markets
UK
North
Asia
America ex Japan
Europe
ex UK
Japan
Figure 5: Green revenue
Source: Trucost, as at 31 December 2015, absolute emissions
weighted by FTSE all world index
The highest assets are concentrated in North America,
where the market is heavily concentrated on oil and gas.
UK companies own a significant portion of the basic
materials assets.
The reserve information is key to understanding the
exposure of each portfolio to the changes in demand for
fossil fuel assets globally. As it currently stands, if we
were to meet the international carbon emission targets,
which aim to limit the global temperature rise to 2°C,
some of these reserves could not be burned and hence
would become ‘stranded’. Even if policy commitments
waiver, local changes in emission limits of coal plants or
automobiles and/or acceleration of electrification could
significantly impact the value of the reserves these
companies own.
UK
Basic Materials
3
Consumer Goods
Developed
North
Europe ex
America
UK
Developed
Asia
ex Japan
10
4
13
5
6
3
8
3
3
2
Consumer Services
Health Care
Japan
2
1
Industrials
4
17
9
9
4
Oil and Gas
1
4
5
2
2
Technology
4
4
4
Telecommunications
2
Utilities
3
12
1
14
7
5
Source: FTSE LCE (low carbon economy) data as at 31 December 2015
2016
FOR INVESTMENT PROFESSIONALS ONLY
Green revenue is defined by FTSE, who use a robust
methodology to identify the revenue sources from
products, goods, or services that adapt, mitigate
or remediate climate change, resource depletion or
environmental erosion.
As can be seen, fewer than 180 of around 3,000
companies in the index produce this data currently.
Interestingly, many of the sectors previously noted
to be highly exposed to carbon – such as basic
materials, utilities and oil and gas – also have
companies producing green revenues. For example,
a utility company that burns coal to produce
electricity may also be generating energy from
renewables. Therefore, this footprinting exercise
should lead to an effective way to capture both risks
and opportunities. It should also warn against blunt
exclusions by sector which could inversely hinder the
low carbon transition. Disclosure and the revenue
proportions from green sources are expected to
increase over time.
What to do with this information?
This information is barely the start of the
conversation. Individual asset owners may want to
carry out more detailed analyses on the exposure
to this trend by assessing their own specific
investments. The popularity of index-tracking
funds may lead to more discussions on the carbon
composition of indices, while active funds may start
looking at carbon exposure of the funds relative to
the benchmark index.
The analysis used in this document was carried
out for one global listed equity index, but similar
exercises may be carried out for private equity, fixed
income and real assets. We hope that this tool would
enhance the discussion amongst scheme members
and with their consultant and investment managers.
6
Integrated engagement by LGIM
Engaging directly with companies who are playing
an important role in this energy transition is a
responsibility we take seriously at LGIM. It is
important to note that we still need fossil fuels
and we think it is likely this will continue to be a
key component of overall energy provision in the
future. Many companies will continue to play an
important role in shaping our energy system. We
have engaged with the majority of highest emitting
companies who are large constituents of the index.
In the oil and gas sector, we engaged with
ExxonMobil and Chevron in the US, and Royal Dutch
Shell and BP in the UK. Our discussions cover a
wide range of topics but focus on having a strong
governance framework that allows long-term and
systemic risks like climate change to be addressed
appropriately. We also request disclosure around
their plans to transition to a low carbon economy.
In recent years, we have supported shareholders
resolutions that ask for a better articulation of their
business models in the 2°C scenario.
With the largest mining company, BHP Billiton, we
have been engaged on the issue of climate change
for a number of years. In response to the investors’
request, they published the ‘Climate Change Portfolio
Analysis’ to provide insight into the scenario
planning approach including the implication of a
transition to a 2°C world.
2015
A more detailed narrative
on company and policy
engagements on climate
change and energy
transition can be found
in our annual report.
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Note:
Carbon dioxide is the most significant contributor to global greenhouse gas
emissions (consist also of methane, nitrous oxide and fluorinated gases). In order
to align all emissions under the same metric, all greenhouse gas emissions by
companies are measured in CO2e – carbon dioxide equivalent measured in tonnes.
The vast majority of emissions from companies would be in carbon dioxide.
2016
FOR INVESTMENT PROFESSIONALS ONLY
7
Questions for you
Based on this information, we’ve listed some of the questions investors may wish to address in relation
to climate impacts:
Questions
To what extent are our investments
affected given our timeframe?
Which asset classes / sectors /
companies are most at risk?
Have we articulated an investment
belief on this topic?
What is my investment consultant /
adviser saying on this topic?
What are my investment managers
doing to address this transition?
How do we respond to our
stakeholders?
Your answer
Notes
CONTACT US
For further information on anything you have read in this report or to provide feedback, please contact us at
[email protected]. Please visit our website www.lgim.com/corporategovernance where you will also find
more information including frequently asked questions.
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