The first in a series of posts from Managing Director Steve Bows, with ideas on how to incorporate ESG metrics into connected planning models.
Last year I took a year out to do a Masters in Sustainability. I’ve been building planning models for over 25 years (originally in Adaytum – anyone old enough to remember that?), and most of them have been different permutations of Financial Planning & Analysis use cases. As an accountant, this is a comfortable space for me, focussing on profitability and cashflow planning. I’ve also been a keen advocate for environmental conservation, and until recently I hadn’t even considered that I might be able to combine these two worlds.
But a chance meeting with an academic who has conducted pioneering work in sustainability analysis changed all that. He showed me how direct and indirect carbon emissions can be mathematically modelled, and how these approaches can be extended to many other environmental and social metrics. I was sufficiently intrigued to sign up for the MSust to explore these techniques in more detail.
So, what I’d like to do in this set of three articles is to take one ESG use case (carbon footprinting), explain some of the concepts and approaches involved, and how I think they can be incorporated into Anaplan models.
Scope 1 and 2 emissions
But first, some terminology. I will be referring to different ‘scopes’ of carbon emissions as I go, so let me provide some definitions.
Scope 1 emissions refer to the direct emissions that your company, entity, household or individual is responsible for. This is the easiest ‘scope’ to grasp – when we burn natural gas for heating, petrol in our cars, or coking coal to make steel, these produce Scope 1 carbon emissions.
Scope 2 emissions are one step removed and refer exclusively to electricity. Electricity can be generated from renewable sources (eg solar, wind, hydro) or by burning fossil fuels (coal and natural gas). Therefore, a percentage of the grid electricity that you consume (as a business or individual) will have come from burning fossil fuels. Most governments (see https://www.dcceew.gov.au/climate-change/publications/national-greenhouse-accounts-factors-2022 for the latest Australian figures) will provide emissions factors for both Scope 1 (eg kgCO2e/litre of petrol burnt)* or Scope 2 (eg kgCO2e/kWh of electricity consumed). This means, as an Anaplan modeller, all you need to do is estimate the litres and kWh respectively and you can project Scope 1 and 2 emissions.
Most companies have worked this bit out, and some will go as far as to say that reducing their Scope 1 and 2 emissions to ‘Net Zero’ is the entirety of their emissions reduction strategy. Building an Anaplan model that tracks how a company plans to reduce their litres of fuel burnt (eg switching the fleet of diesel trucks to hydrogen fuel cell equivalents) or kWhs of grid electricity (eg by installing their own solar panels) is easy enough. But it turns out that this is just scratching the surface, because it ignores what are called Scope 3 emissions.
Scope 3 emissions
Scope 3 emissions are often called ‘indirect’ emissions, or ‘embodied carbon’. They represent emissions that have been generated anywhere upstream or downstream in your supply chain, but not directly by your company’s operations. They can range from 50-90% of a company’s total emissions, and they are much harder to abate – because they are harder to control.
So, if these emissions are hard to control (and hard to measure as well), why should we include them? Don’t they belong to someone else? Well, mainly to avoid ‘gaming’ of the system. Imagine sitting round the boardroom table and discussing the cheapest way to reduce Scope 1 emissions from your truck fleet. You could transition them all to hydrogen fuel cell vehicles (more economical than battery electric vehicles for heavy vehicles, but still more expensive than the existing fleet), or you could just outsource all your logistics to a third party. Problem solved! Scope 1 emissions have disappeared overnight. They are now part of your Scope 3 emissions and your company has greenwashed its way to ‘Net Zero’.
This is one of the reasons why the ISSB (part of IFRS) is keen to include Scope 3 in its latest exposure draft (https://www.ifrs.org/content/dam/ifrs/project/climate-related-disclosures/issb-exposure-draft-2022-2-climate-related-disclosures.pdf). So, hard as they may be to measure and abate, every listed company will soon have to consider its Scope 3 reduction strategy to go alongside its Scope 1 and Scope 2 plans.
Two approaches to Scope 3
There are two approaches to measuring Scope 3 emissions, and I’ll be describing each of these in more detail in the second and third articles. The first is a ‘bottom-up’ technique called Life Cycle Assessment (LCA). LCA studies are typically performed by specialist engineers, who analyse every** stage of a production process, from ‘cradle to grave’, and measure the emissions of each of those components. Some is Scope 1, some Scope 2, but they also measure Scope 3 insofar as that is possible. They tend to take a long time, be quite costly, and hence can only cover a small part of a company’s production process. However, they produce incredibly valuable data, and we will be talking in article 2 about how this data can be used to augment an Anaplan production planning model.
LCAs measure the emissions footprint per physical unit of production, which is the closest we can get to a causal or driver-based relationship. However, we can never measure the whole supply chain in this way – it would be prohibitively expensive – so we need to complete the picture using Input Output Analysis (IOA). This uses mathematical techniques developed in the 1940s to model the inter-relationships between different industries in an economy, and allows us to attribute a kgCO2e/$ to all of the other purchases that have not been addressed by LCA data. We’ll be looking at this in the third article of the series.
Summary
When designing an Anaplan model, the first step is break your business process down into manageable chunks by asking the right questions. Hopefully you can start to see how this would apply to building a carbon footprint model. “What are your sources of Scope 1 emissions?” would be a great first question, followed by “can we get estimates of litres (petrol), GJ (natural gas) and kWh (electricity) used in your business, so we can build a driver-based model for Scope 1 and 2 emissions?”.
You’re making progress already! In the next two articles in this series I’ll cover the use of Life Cycle Assessment (Part 2) and Input Output Analysis (in Part 3) for Scope 3 emissions planning.
* kgCO2e is ‘kilograms of Carbon Dioxide equivalent’, the standard unit of carbon footprint measurement, reflecting the fact that it is not just Carbon Dioxide that causes global warming
** Some LCA studies will restrict themselves to a portion of this life cycle, eg Cradle-to-Gate (upstream supply chain) or Gate-to-Grave (downstream supply chain) depending on where the problem areas are most likely to be In the previous article in this series, we learned the difference between Scope 1, Scope 2 and Scope 3 carbon emissions, and how we could incorporate energy use data (fossil fuels burnt and electricity consumed) to determine our Scope 1 and Scope 2 emissions. We also learnt that Scope 3 emissions are both larger, and harder to identify, than Scope 1 and Scope 2.
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