The biggest corporations and political entities promise that by a certain date, they will add no carbon into the air. How can anyone prove such a thing?
Thereby grows a profession that currently goes by the name of carbon accounting. But it's a more mutable practice than traditional accounting.
Here's another account of carbon accounting in its ascendancy.
With the proliferation of net-zero pledges, these commitments have become a new criterion for businesses that only a few understand but many proffer as an appeal to investors. But how can an investor or a customer know how much greenhouse gas (GHG) emissions a soap maker or bank really dumped into the atmosphere?
Carbon accounting, the system behind accurately counting, tracking, and communicating the emissions of an organization, tackles this question. The practice integrates the natural world with capital markets, underpinning the climate transition.
Accounting may seem meek amidst a backdrop of extreme climate disasters, increasing political controversy surrounding net-zero targets, and a rising number of organizations scrambling to reach those targets. But the definition of standards and targets in carbon accounting is neither a fad nor is it solely a specialist's concern. Rather, it represents a critical building block to a sustainable future and the key to a cascading of decarbonization strategies.
This article explores key considerations, dynamics, and trends in the carbon accounting industry that will shape its future. The below diagram by Sapphire Ventures maps out complementary industries including carbon offsetting and climate analytics. But we’ll focus on the dynamics primarily dedicated to carbon accounting.
Source: Sapphire Ventures – Decarbonizing the Future blogpost in October 2021
Evaluating what a carbon accounting firm offers starts with understanding net-zero. The concept of net-zero pledges emerged following the 2015 Paris Agreement, at which the United Nations' Intergovernmental Panel on Climate Change established the goal to keep global mean temperature rise below 1.5C. In guiding pledge implementation, the IPCC published a Special Report in 2018 that introduced net-zero.
Net-zero represents the process of reducing greenhouse gases by producing less and removing gases already in the atmosphere. This concept can be adopted by any organization. According to the organization Science Based Targets, in 2019, net-zero pledges covered 16% of the global economy. As of early 2023, this figure has reached 92%.
However, someone has to keep track of what’s happening in the atmosphere if society wants to ensure net-zero as a whole. This was highlighted in 2021 by a Washington Post analysis that revealed global emissions were underreported between 8.5 to 13.3 billion tons a year. For scale, this amount equates to the total emissions of the US on the low end or China on the high end.
Analysis revealed global emissions were underreported by 8.5 to 13.3 billion tons a year.
Thus, setting the pledge is merely the first step. Carbon accounting can guide investors to steer capital to effective strategies that reduce emissions if it runs on robust principles like those adhered to by the Generally Accepted Accounting Principles (GAAP), the financial accounting standard in the US.
Currently, the industry lacks a clear set of rules for businesses, individuals, or countries. For starters, regulators have yet to mandate a standardized methodology or approach for measuring, reporting, or verification. Nonetheless, the regulatory market is just one dynamic in the broader context of carbon counting – and all these dynamics are undergoing change.
The market for carbon accounting can be distilled in four key dynamics:
- Compliance standards and regulatory environment: federal, state and other legislative bodies who are developing mandatory disclosures
- Market suppliers offering carbon accounting services
- Market demanders: companies, government bodies and other organizations that are seeking outsourced solutions
- An underlying foundation of how to categorize and count GHG emissions
For a quick deep-dive on the fourth dynamic, the foundation of categorizing and counting GHG emissions (dynamic 4): first, an organization’s activities are categorized using the globally adopted framework of Scope 1, 2, and 3 emissions that was established in 2021 by the Greenhouse Gas (GHG) protocol. Scope 1 refers to emissions from sources that the organization controls directly; Scope 2 from energy consumption; Scope 3 from indirect emissions (e.g., employees traveling for business). Second, an organization's activities are then converted to GHG emissions. The three most common methodologies to calculating GHG emissions are activity-level, spend-based, and continuous emissions monitoring.
In light of these dynamics, who are the players in this market, what are they claiming to be doing, and are they actually doing it?
Prior to 2018, there were few carbon accounting service providers. But with the global momentum behind net-zero pledges, new players and methodologies in carbon accounting emerged in response.
The exponential growth of carbon accounting can be attributed, in part, to the limited barriers for talent to enter the space and to private capital that accelerated new businesses. In contrast to the stringent requirements placed on financial accountants to qualify as chartered professional accountants (CPA), those offering carbon accounting services face fewer regulations.
Furthermore, carbon accounting startups drew a lot of private capital from venture capital (VC) investors. Carbon accounting startups attracted VC funding because these startup models mirrored traditional fintech businesses – low capital expenditure, software as a service (SaaS) – a proven model of success for investors. This was evident in the surge of global VC funding for climate fintech, which reached $1.2 billion in 2022, three times over all previous years, with over a third dedicated to carbon accounting startups.
Until recently, early entrants of VC-backed startups such as WaterShed, Persefoni, and Plan A dominated the industry. However, as demand for carbon accounting services continues to rise, incumbents have also begun developing their own in-house solutions or acquiring smaller players.
From a consumer perspective, what distinguishes one carbon accounting platform from another? This challenge is exacerbated by a lack of standards in reporting and by geographical differentiation.
One class of provider tailors its services towards a specific industry. For example, SINAI supports industrial heavy emitters, CarbonCloud the food industry, and Persefoni major financial institutions (asset managers, private equityfirms, pension funds, etc.). Given the complexity and nuance of business models inherent across different industries, carbon accounting platforms dedicated to an industry demonstrate a greater ability to onboard and meet the needs of specific customers.
Another form of differentiation is to focus on the size of the organization. Small-medium enterprises (SMEs) have less budget for carbon accounting services. As such, startups such as Bend are tailored for SMEs to help calculate emissions data quickly through spend-level data rather than by tracking each activity. A more detailed breakdown of the three methodologies most commonly used to calculate emissions will be explored later on. Furthermore, unlike major corporations that have net-zero pledges of their own and are seeking greater accuracy in their calculations, SMEs typically have weaker incentives for measuring emissions. Instead, they are usually responding to downward business pressures from the large players to whom they sell due to Scope 3 emission requirements.
Finally, some players are differentiating by offering greater precision. Nevada-based startup nZero, recognized by Time magazine as holding one of the “Best Inventions in 2022,” automates data collection and draws data directly from electric meters among other company-specific sources. For major companies like Google that have 24/7 carbon free pledges and can benefit from tracking on a more granular timescale, nZero provides a compelling service relative to other players. But it's unclear how important this level of accuracy is for other consumers, especially without regulatory requirements that mandate this precision.
With no market leader today, it remains uncertain which differentiating factor is defensible or sustainable.
But in the race to reach these net-zero pledges, academic and industry experts have emerged with a more pressing question: are emissions being categorized and counted in the most rigorous, verifiable method that is effectively driving progress towards the 1.5C target?
Revisiting the four dynamics outlined earlier in this article, Alicia Seiger, Managing Director at Stanford University’s Sustainable Finance Initiative, and other notable experts have said that the current framework for measuring emissions (dynamic number 4) is flawed when applied as a tool for financial and strategic decision making.
During a seminar hosted by Stanford’s Sustainable Finance Initiative (SFI) in January 2023, Seiger said the GHG Protocol’s framework for Scope 1, 2, and 3 emissions works effectively for internal decision making, but in measuring the global stock of emissions across all institutions, the process is convoluted and not easily scalable. Specifically, the GHG Protocol’s model is susceptible to double counting and misalignment as an organization’s Scope 2 and 3 emissions belong to another’s Scope 1.
In a similar vein, research conducted at Oxford University has revealed deficiencies in the methodology used to calculate emissions. Recall the three most common methodologies; activity-level, spend-based, and continuous emissions monitoring. The spend-based approach is most commonly adopted by SMEs given its relatively straightforward nature but it can lack precision. Continuous emissions monitoring is the most accurate method but can be expensive to implement and only viable for a few emission sources, such as an industrial facility with a gas analyzer placed at its exhaust.
As such, the activity-level approach presents a balanced compromise between precision, affordability, and operational feasibility, making it the most widely adopted method to calculate emissions. However, this approach is not auditable given the subjectivity behind the underlying assumptions.
For instance, using the activity-level framework which is sometimes also referred to a “bottoms-up approach”, an entity’s total emissions is the product of its (1) activity data, (2) emissions factor (EF), and (3) global warming potential (normalizing across the different greenhouse gasses). Of the three factors, only global warming potential is standardized today.
Further breaking down this methodology, within the first category of activity level data, the GHG Protocol’s framework of the scopes is the most widely accepted approach, but while there is increasing uniformity in Scopes 1 and 2, Scope 3 remains highly subjective. Specifically, Scope 3 expands beyond an organization's walls which leads to challenges in data collection and determining which activities to consider. Moreover, for emission factors, there is no global standard and instead, over 100 databases worldwide provide varying emission factors.